69–119 

110TH CONGRESS EXEC. REPT. " ! SENATE 2d Session 110–16 

TAX CONVENTION AND PROTOCOL WITH BULGARIA 

SEPTEMBER 11, 2008.—Ordered to be printed 

Mr. DODD, from the Committee on Foreign Relations, 

submitted the following 

R E P O R T 

[To accompany Treaty Doc. 110–18] 

The Committee on Foreign Relations, to which was referred the 

Convention between the Government of the United States of America and the Government of the Republic of Bulgaria for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with 

Respect to Taxes on Income, with accompanying Protocol, signed at 

Washington on February 23, 2007, as well as the Protocol Amending the Convention between the Government of the United States 

of America and the Government of the Republic of Bulgaria for the 

Avoidance of Double Taxation and the Prevention of Fiscal Evasion 

with Respect to Taxes on Income, signed at Sofia on February 26, 

2008 (Treaty Doc. 110–18), having considered the same, reports favorably thereon with one declaration, as indicated in the resolution 

of advice and consent, and recommends that the Senate give its advice and consent to ratification thereof, as set forth in this report 

and the accompanying resolution of advice and consent. 

CONTENTS 

Page 

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

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

III. Major Provisions ............................................................................................ 2 

IV. Entry Into Force; Effective Dates ................................................................. 6 

V. Implementing Legislation ............................................................................. 6 

VI. Committee Action .......................................................................................... 6 

VII. Committee Recommendation and Comments .............................................. 6 

VIII. Resolution of Advice and Consent to Ratification ....................................... 7 

IX. Annex I.—Technical Explanation ................................................................. 9 

X. Annex II.—Responses to Additional Questions Submitted for the Record 107 

I. PURPOSE

The Convention, as amended by the 2008 Protocol, would promote and facilitate trade and investment between the United 

States and Bulgaria. In particular, the Convention is designed 

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principally to reduce tax barriers to cross-border investment, provide for better exchange of tax information, and facilitate cross-border tax administration more generally. 

II. BACKGROUND

The Convention, the first income tax treaty concluded between 

the United States and Bulgaria, was signed on February 23, 2007. 

Before transmitting the Convention to the Senate, however, the executive branch concluded a Protocol to amend the Convention, 

which was signed just over a year later on February 26, 2008. The 

2008 Protocol essentially contains technical corrections to the 2007 

Convention that would, as explained by the Treasury Department, 

‘‘address features of the Bulgarian tax system and treaty network 

that could result in a Bulgarian tax exemption for U.S. source income attributable to offshore branches of the Bulgarian company 

receiving the U.S. source income.’’ The 2008 Protocol would amend 

the Convention to address this potential and unintended ‘‘double 

exemption.’’ With some notable exceptions discussed below, the 

Convention, as amended by the 2008 Protocol, is generally consistent with the 2006 U.S. Model Tax Treaty and with tax treaties 

that the United States has with other countries. 

III. MAJOR PROVISIONS

A detailed, article-by-article analysis of the Convention may be 

found in the Technical Explanation published by the Department 

of the Treasury on July 10, 2008, which is reprinted in Annex I. 

In addition, the staff of the Joint Committee on Taxation prepared 

an analysis of the Convention, Document JCX-59–08 (July 8, 2008), 

which was of great assistance to the committee in reviewing the 

Convention. A summary of the key provisions of the Convention is 

set forth below. 

1. Dividends 

Under the Convention, withholding taxes on cross-border portfolio dividend payments may be imposed at a maximum rate of 10 

percent. See Article 10(2)(b). When the beneficial owner of a crossborder dividend is a company that directly owns at least 10 percent 

of the stock of the company paying the dividend, a withholding tax 

may be imposed at a maximum rate of five percent. See Article 

10(2)(a). No withholding tax, however, is permitted on dividends 

paid by a company resident in one of the countries to a pension 

fund that is a resident in the other country provided the dividend 

is not derived from the carrying on of a trade or business by such 

pension fund. See Article 10(4). 

2. Royalties and Interest 

Under the Convention, withholding taxes on cross-border royalty 

payments would be imposed at a maximum rate of five percent. See 

Article 12(2). Similarly, withholding taxes on cross-border interest 

payments may be imposed at a maximum rate of five percent. See 

Article 11(2). No withholding tax on a cross-border interest payment is generally permitted, however, when the interest is beneficially owned by the government of the other country (or by a central bank or other institution wholly owned by that government); 

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a resident of the other country with respect to debt-claims guaranteed, insured or indirectly financed by the government of the other 

country (or an institution controlled by that government); a pension 

fund resident in the other country, provided the interest is not derived from the carrying on of a trade or business by such pension 

fund; or, with some exceptions, a financial institution (including a 

bank or insurance company) resident in the other country. See Article 11(3). 

Under the 2007 Protocol signed on the same day as the Convention, the United States and Bulgaria are to reconsider source-country taxation of interest and royalties arising in Bulgaria and beneficially owned by a resident of the United States, at a time that is 

‘‘consistent with the conclusion of the transition period’’ under a 

European Union Council Directive (‘‘EU Directive’’) applicable to 

interest and royalties deemed to arise in Bulgaria and beneficially 

owned by a resident of the European Union, which is due to occur 

on December 31, 2014. See Paragraph 7 of the 2007 Protocol. 

In response to Committee questions regarding this commitment 

to consult, the Treasury Department indicated that: 

At the conclusion of the transition period under the [EU Directive], Bulgaria is expected to adopt rates of withholding on cross-border interest and 

royalties for residents of European Union member states that are lower 

than the rate provided for in the proposed treaty. The provision of the 2007 

Protocol is intended to memorialize the understanding between Bulgaria 

and the United States that the United States will have the opportunity at 

the conclusion of the transition period to negotiate a further protocol to the 

proposed treaty with Bulgaria that could reduce the maximum rate of withholding that may be imposed on cross-border interest and royalties arising 

in Bulgaria. 

3. Permanent Establishment 

In general, U.S. bilateral tax treaties attempt to ensure that a 

person or entity is not subject to undue and overly burdensome taxation in instances in which the taxpayer has minimal contacts with 

the taxing jurisdiction. This is accomplished in the Convention 

through provisions under which each country generally agrees not 

to tax business income derived from sources within that country by 

residents of the other country unless the business activities in the 

taxing country are substantial enough to constitute a permanent 

establishment. See Article 7(1). A permanent establishment is generally defined as ‘‘a fixed place of business through which the business of an enterprise is wholly or partly carried on.’’ See Article 

5(1). Examples include a place of management, offices, branches, 

and factories. See Article 5(2). 

The Convention, however, includes a special rule that would effectively expand the definition of a permanent establishment in a 

way that would affect enterprises that provide services. Specifically, an enterprise of one country would be deemed to have a permanent establishment in the other country if either a) services are 

performed by an individual who is present in the other country for 

at least 183 days during any 12-month period and more than 50 

percent of the enterprise’s gross active business revenues during 

that time is income derived from those services, or (b) the services 

are provided in the other country for at least 183 days during any 

12-month period with respect to the same or a connected project for 

customers who are residents of that country or who have a permaVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00003 Fmt 6659 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
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nent establishment there for which the services are provided. See 

Article 5(8). Thus, an enterprise that met either of these criteria 

would be deemed to have a permanent establishment in the treaty 

partner country, even if it did not have a fixed place of business 

in that country, and attributable business profits would be subject 

to tax by that country. 

This special rule presents a number of administrative and compliance challenges. For example, a number of the terms used in 

this rule, such as what constitutes ‘‘presence’’ or a ‘‘connected 

project,’’ are ambiguous and require further clarification. In addition, when combined with Article 14 of the Convention, further 

complexities arise. Article 14(1) of the Convention, with certain exceptions, sets forth a general rule that if an employee who is a resident of one treaty country (the ‘‘residence country’’) is working in 

the other treaty country (the ‘‘employment country’’), his or her salaries, wages, and other remuneration derived from the exercise of 

employment in that country may be taxed by that country (the employment country). Notwithstanding this general rule, Article 14(2) 

of the treaty provides that the remuneration derived by the employee from the exercise of employment in the employment country 

shall be taxed only by the residence country (and not the employment country) if: 1) the employee is present in the employment 

country for 183 days or less in any 12-month period commencing 

or ending in the taxable year concerned; 2) the remuneration is 

paid by, or on behalf of, an employer who is not a resident of the 

employment country; and 3) the remuneration is not ‘‘borne’’ by a 

permanent establishment that the employer has in the employment 

country. It is the final requirement, which states that the remuneration must not be ‘‘borne’’ by a permanent establishment that 

the employer has in the employment country, that interacts with 

the special rule in Article 5(8) in a potentially significant and negative way. 

In other words, the salaries, wages, and other remuneration derived by an employee performing services through a permanent establishment arising under Article 5(8) of the Treaty would be subject under Article 14 to being taxed by the employment country, 

even if the other requirements of the test in Article 14(2) had been 

met. Thus, the interaction of these two provisions increases the 

complexities associated with the special rule. For example, such a 

scenario would mean that an employer and the relevant employees 

would need to fulfill several tax-related obligations, including obtaining tax identification numbers and providing for the withholding of income taxes and other taxes as appropriate that would 

cover the period beginning on the first day such services were performed by such employee during the affected year, despite the fact 

that they may not know whether the enterprise will be deemed to 

have a permanent establishment under the Treaty until perhaps 6 

months into the relevant 12-month period, and will therefore be 

subject to various taxes, including employment taxes, by the services country reaching back to the beginning of the relevant 12- 

month period. 

Another aspect of the rule that would appear to be difficult to 

manage is that the 12-month period is not tied to a fiscal or calendar year. Also, it is necessary to determine whether customers 

in the source country are residents or have a permanent establishVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00004 Fmt 6659 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
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ment in that country. Moreover, an enterprise with a deemed permanent establishment in another country that is not an actual 

fixed base is unlikely to have the infrastructure in that other country to do the things necessary to comply with the rules of this provision. For example, such an enterprise is unlikely to keep in the 

employment country a full set of financial records or records tracking employees’ activities there. 

The committee asked the Treasury Department a number of 

questions regarding this provision in an attempt to gain greater insight and clarity into its operation. These questions and answers 

can be found in Annex II. 

4. Limitation on Benefits 

Consistent with current U.S. treaty policy, the Convention includes a ‘‘Limitation on Benefits’’ provision, which is designed to 

avoid treaty-shopping by limiting the indirect use of a treaty’s benefits by persons who were not intended to take advantage of those 

benefits. Among other things, this provision provides that a company resident in a treaty country whose shares are regularly traded on a recognized stock exchange may qualify for treaty benefits 

if the company satisfies one of two tests: either the company must 

be primarily traded on a recognized stock exchange in its country 

of residence or the company’s primary place of management and 

control must be in its country of residence. See Article 21(2). This 

requirement is intended to ensure that there is an adequate connection to the company’s claimed country of residence. 

5. Exchange of Information 

The Convention provides for an exchange of information between 

the United States and Bulgaria, which will facilitate the enforcement of U.S. domestic tax rules. Specifically, the Convention would 

allow the United States to obtain information (including bank information) for its own tax purposes. See Article 25. 

6. Fiscally Transparent Entities 

The 2006 U.S. Model Tax Treaty allows recipients of ‘‘income, 

gains, or profits’’ through an entity that is fiscally transparent 

under the tax laws of the recipient’s residence to enjoy the same 

treaty benefits on that income as they would have if the ‘‘income, 

gains, or profits’’ had been received by them directly. Fiscallytransparent entities (a subset of which are called ‘‘disregarded entities’’) are entities that act as a conduit, apportioning all income received to those holding an interest in the entity. There is no requirement that the income be currently distributed to the interest 

holder, only that it be apportioned to them for tax purposes. Common examples are partnerships and limited liability companies 

(LLCs) that do not choose to be taxed as corporations under the 

U.S. ‘‘check the box’’ provisions. The Convention provision is consistent with the 2006 U.S. Model Tax Treaty provision. See Article 

1(6). 

7. Pension and Pension Funds 

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

that country and only at such time and to the extent that a pension 

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distribution is made. See Article 17. Moreover, the Convention 

would eliminate withholding tax on cross-border dividend payments to pension funds. See Article 10(4). 

IV. ENTRY INTO FORCE; EFFECTIVE DATES

The United States and Bulgaria shall notify each other through 

diplomatic channels when their respective requirements for the 

entry into force of this Convention have been satisfied. This Convention shall enter into force on the date of receipt of the later of 

these notifications. 

The provisions of the Convention shall have effect in both countries with respect to taxes withheld at source, on income paid or 

credited on or after the first day of January in the calendar year 

next following the year in which this Convention enters into force; 

and with respect to other taxes on income, for any taxable period 

beginning on or after the first day of January in the calendar year 

next following the year in which this Convention enters into force. 

V. IMPLEMENTING LEGISLATION

As is the case generally with income tax treaties, the Convention 

is self-executing and does not require implementing legislation for 

the United States. 

VI. COMMITTEE ACTION

The committee held a public hearing on the Convention on July 

10, 2008. Testimony was received from Mr. Michael Mundaca, Deputy Assistant Secretary (International), Office of Tax Policy, U.S. 

Department of the Treasury and Emily S. McMahon, Deputy Chief 

of Staff to the Joint Committee on Taxation. A transcript of this 

hearing can be found in Annex II to Executive Report 110–15. 

On July 29, 2008, the committee considered the Convention and 

ordered it favorably reported by voice vote, with a quorum present 

and without objection. 

VII. COMMITTEE RECOMMENDATION AND COMMENTS

The Committee on Foreign Relations believes that the Convention, as amended by the 2008 Protocol, will stimulate increased 

trade and investment, substantially deny treaty-shoppers the benefits of this tax treaty, and promote closer cooperation between the 

United States and Bulgaria. The committee therefore urges the 

Senate to act promptly to give advice and consent to ratification of 

the Convention and the 2008 Protocol, as set forth in this report 

and the accompanying resolution of advice and consent. 

A. SPECIAL PERMANENT ESTABLISHMENT RULE FOR SERVICES

As discussed in Section III, the Convention includes a special 

rule that would effectively expand the standard definition of a permanent establishment in a way that affects enterprises that provide services. This provision also appears in the Canada Tax Protocol currently under consideration and presents a number of serious administrative and compliance challenges to service enterprises 

that may be subject to the rule. The Treasury Department has 

made clear in testimony before the committee that the inclusion of 

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1The United States has included similar provisions in the tax treaties with, for example, Indonesia (Treaty Doc. 100–22; Article 5(2)), India (Treaty Doc. 101–5; Article 5(2)), and Thailand 

(Treaty Doc. 105–2; Article 5(3)). 

this provision in the Convention and the Canada Tax Protocol 

‘‘does not reflect a change in U.S. tax treaty policy, and inclusion 

of such a provision in the U.S. Model is not being considered.’’ The 

committee welcomes this statement and urges the Treasury Department to avoid including such a provision in future tax treaties. 

Although the United States has included similar provisions in 

some of its tax treaties with developing nations1 and a rationale exists for providing for expanded source taxation in treaties with developing countries that frequently rely on service providers from 

wealthier nations that do not necessarily have a fixed place of business in their country, the inherent difficulties in implementing this 

rule are substantial. 

Finally, the committee urges the Treasury Department to engage 

in discussions not just with Canada, but also with Bulgaria, regarding the interpretation and application of the new rule concerning the taxation of services in an effort to improve its implementation. Upon completion of such discussions, the committee 

urges the Treasury Department to produce guidance on its application and ways in which enterprises might approach their compliance. 

B. RESOLUTION

The proposed resolution of advice and consent for the Convention 

includes a declaration. 

Declaration 

The committee has included a proposed declaration, which states 

that the Convention is self-executing, as is the case generally with 

income tax treaties. The committee has in the past included such 

a statement in the committee’s report but, in light of the recent Supreme Court decision, Medellı ́n v. Texas, 128 S. Ct. 1346 (2008), 

the committee has determined that a clear statement in the Resolution is warranted. A further discussion of the committee’s views 

on this matter can be found in Section VIII of Executive Report 

110–12. 

VIII. RESOLUTION OF ADVICE AND CONSENT TO RATIFICATION

TEXT OF RESOLUTION OF ADVICE AND CONSENT TO RATIFICATION OF

THE TAX CONVENTION AND PROTOCOL WITH BULGARIA

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

SECTION 1. SENATE ADVICE AND CONSENT SUBJECT TO A DECLARATION 

The Senate advises and consents to the ratification of the Convention between the Government of the United States of America 

and the Government of the Republic of Bulgaria for the Avoidance 

of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, with accompanying Protocol, signed at 

Washington on February 23, 2007, as well as the Protocol Amending the Convention between the Government of the United States 

of America and the Government of the Republic of Bulgaria for the 

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Avoidance of Double Taxation and the Prevention of Fiscal Evasion 

with Respect to Taxes on Income, signed at Sofia on February 26, 

2008 (Treaty Doc. 110–18), subject to the declaration of section 2. 

SECTION 2. DECLARATION 

The advice and consent of the Senate under section 1 is subject 

to the following declaration: 

This Convention is self-executing. 

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IX. ANNEX I.—TECHNICAL EXPLANATION

TECHNICAL EXPLANATION OF THE CONVENTION BETWEEN THE UNITED

STATES OF AMERICA AND THE REPUBLIC OF BULGARIA FOR THE

AVOIDANCE OF DOUBLE TAXATION AND THE PREVENTION OF FISCAL

EVASION WITH RESPECT TO TAXES ON INCOME, SIGNED AT WASHINGTON ON FEBRUARY 23, 2007

This is a technical explanation of the Convention between the 

United States and Bulgaria for the Avoidance of Double Taxation 

and the Prevention of Fiscal Evasion with Respect to Taxes on Income, signed on February 23, 2007, and the Protocol between the 

United States and Bulgaria signed on the same date (the ‘‘Protocol’’), as amended by the Protocol between the United States and 

Bulgaria signed on February 26, 2008 (collectively, the ‘‘Convention’’). The Protocol is discussed below in connection with the relevant articles of the Convention. 

Negotiations took into account the U.S. Treasury Department’s 

current tax treaty policy, and the Treasury Department’s Model Income Tax Convention, updated as of November 15, 2006. Negotiations also took into account the Model Tax Convention on Income 

and on Capital, published by the Organisation for Economic Cooperation and Development (the ‘‘OECD Model’’), and recent tax 

treaties concluded by both countries. 

The Technical Explanation is an official guide to the Convention. 

It reflects the policies behind particular Convention provisions, as 

well as understandings reached during the negotiations with respect to the application and interpretation of the Convention. References in the Technical Explanation to ‘‘he’’ or ‘‘his’’ should be 

read to mean ‘‘he or she’’ or ‘‘his and her.’’ 

ARTICLE 1 (GENERAL SCOPE)

Paragraph 1 

Paragraph 1 of Article 1 provides that the Convention applies 

only to residents of the United States or Bulgaria except where the 

terms of the Convention provide otherwise. Under Article 4 (Resident) a person is generally treated as a resident of a Contracting 

State if that person is, under the laws of that State, liable to tax 

therein by reason of his domicile, citizenship, residence, or other 

similar criteria. However, if a person is considered a resident of 

both Contracting States, Article 4 provides rules for determining a 

State of residence (or no State of residence). This determination 

governs for all purposes of the Convention. 

Certain provisions are applicable to persons who may not be residents of either Contracting State. For example, paragraph 1 of Article 23 (Non-Discrimination) applies to nationals of the Contracting States. Under Article 25 (Exchange of Information and 

Adminis-trative Assistance), information may be exchanged with 

respect to residents of third states. 

Paragraph 2 

Paragraph 2 states the generally accepted relationship both between the Convention and domestic law and between the Convention and other agreements between the Contracting States. That is, 

10 

no provision in the Convention may restrict any exclusion, exemption, deduction, credit or other benefit accorded by the tax laws of 

the Contracting States, or by any other agreement between the 

Contracting States. The relationship between the non-discrimination provisions of the Convention and other agreements is addressed not in paragraph 2 but in paragraph 3. 

Under paragraph 2, for example, if a deduction would be allowed 

under the U.S. Internal Revenue Code (the ‘‘Code’’) in computing 

the U.S. taxable income of a resident of Bulgaria, the deduction 

also is allowed to that person in computing taxable income under 

the Convention. Paragraph 2 also means that the Convention may 

not increase the tax burden on a resident of a Contracting State 

beyond the burden determined under domestic law. Thus, a right 

to tax given by the Convention cannot be exercised unless that 

right also exists under internal law. 

It follows that, under the principle of paragraph 2, a taxpayer’s 

U.S. tax liability need not be determined under the Convention if 

the Code would produce a more favorable result. A taxpayer may 

not, however, choose among the provisions of the Code and the 

Convention in an inconsistent manner in order to minimize tax. A 

taxpayer may use the treaty to reduce its taxable income, but may 

not use both treaty and Code rules where doing so would thwart 

the intent of either set of rules. For example, assume that a resident of Bulgaria has three separate businesses in the United 

States. One is a profitable permanent establishment and the other 

two are trades or businesses that would earn taxable income under 

the Code but that do not meet the permanent establishment 

threshold tests of the Convention. One is profitable and the other 

incurs a loss. Under the Convention, the income of the permanent 

establishment is taxable in the United States, and both the profit 

and loss of the other two businesses are ignored. Under the Code, 

all three would be subject to tax, but the loss would offset the profits of the two profitable ventures. The taxpayer may not invoke the 

Convention to exclude the profits of the profitable trade or business 

and invoke the Code to claim the loss of the loss trade or business 

against the profit of the permanent establishment. See Rev. Rul. 

84–17, 1984–1 C.B. 308. If, however, the taxpayer invokes the Code 

for the taxation of all three ventures, he would not be precluded 

from invoking the Convention with respect, for example, to any dividend income he may receive from the United States that is not effectively connected with any of his business activities in the United 

States. 

Similarly, nothing in the Convention can be used to deny any 

benefit granted by any other agreement between the United States 

and Bulgaria. For example, if certain benefits are provided for military personnel or military contractors under a Status of Forces 

Agreement between the United States and Bulgaria, those benefits 

or protections will be available to residents of the Contracting 

States regardless of any provisions to the contrary (or silence) in 

the Convention. 

Paragraph 3 

Paragraph 3 specifically relates to non-discrimination obligations 

of the Contracting States under the General Agreement on Trade 

11 

in Services (the ‘‘GATS’’). The provisions of paragraph 3 are an exception to the rule provided in paragraph 2 of this Article under 

which the Convention shall not restrict in any manner any benefit 

now or hereafter accorded by any other agreement between the 

Contracting States.Subparagraph 3(a) provides that, unless the 

competent authorities determine that a taxation measure is not 

within the scope of the Convention, the national treatment obligations of the GATS shall not apply with respect to that measure. 

Further, any question arising as to the interpretation of the Convention, including in particular whether a measure is within the 

scope of the Convention shall be considered only by the competent 

authorities of the Contracting States, and the procedures under the 

Convention exclusively shall apply to the dispute. Thus, paragraph 

3 of Article XXII (Consultation) of the GATS may not be used to 

bring a dispute before the World Trade Organization unless the 

competent authorities of both Contracting States have determined 

that the relevant taxation measure is not within the scope of Article 23 (Non-Discrimination) of the Convention. 

The term ‘‘taxation measure’’ for these purposes is defined broadly in subparagraph 3(b). It would include, for example, a law, regulation, rule, procedure, decision, administrative action or guidance, 

or any other form of measure relating to taxation. 

Paragraph 4 

Paragraph 4 contains the traditional saving clause found in all 

U.S. treaties. The Contracting States reserve their rights, except as 

provided in paragraph 5, to tax their residents and citizens as provided in their internal laws, notwithstanding any provisions of the 

Convention to the contrary. For example, if a resident of Bulgaria 

performs professional services in the United States and the income 

from the services is not attributable to a permanent establishment 

in the United States, Article 7 (Business Profits) would by its terms 

prevent the United States from taxing the income. If, however, the 

resident of Bulgaria is also a citizen of the United States, the saving clause permits the United States to include the remuneration 

in the worldwide income of the citizen and subject it to tax under 

the normal Code rules (i.e., without regard to Code section 8 94(a)). 

However, subparagraph 5(a) of Article 1 preserves the benefits of 

special foreign tax credit rules applicable to the U.S. taxation of 

certain U.S. income of its citizens resident in Bulgaria. See paragraph 4 of Article 22 (Relief from Double Taxation). 

For purposes of the saving clause, ‘‘residence’’ is determined 

under Article 4 (Resident). Thus, an individual who is a resident 

of the United States under the Code (but not a U.S. citizen) but 

who is determined to be a resident of Bulgaria under the tie-breaker rules of Article 4 would be subject to U.S. tax only to the extent 

permitted by the Convention. The United States would not be permitted to apply its statutory rules to that person to the extent the 

rules are inconsistent with the treaty. 

However, the person would be treated as a U.S. resident for U.S. 

tax purposes other than determining the individual’s U.S. tax liability. For example, in determining under Code section 957 whether a foreign corporation is a controlled foreign corporation, shares 

in that corporation held by the individual would be considered to 

12 

be held by a U.S. resident. As a result, other U.S. citizens or residents might be deemed to be United States shareholders of a controlled foreign corporation subject to current inclusion of Subpart 

F income recognized by the corporation. See Treas. Reg. section 

301.7701 (b)-7(a)(3). 

Under paragraph 4, the United States also reserves its right to 

tax former citizens and former long-term residents for a period of 

ten years following the loss of such status with respect to income 

from sources within the United States (including income deemed 

under the domestic law of the United States to arise from such 

sources). Thus, paragraph 4 allows the United States to tax former 

U.S. citizens and former U.S. long-term residents in accordance 

with section 877 of the Code. Section 877 generally applies to a 

former citizen or long-term resident of the United States who relinquishes citizenship or terminates long-term residency before June 

17, 2008 if either of the following criteria exceed established 

thresholds: (a) the average annual net income tax of such individual for the period of 5 taxable years ending before the date of 

the loss of status, or (b) the net worth of such individual as of the 

date of the loss of status. Paragraph 1 of the Protocol provides that 

the term ‘‘long-term resident’’ means any individual who is a lawful 

permanent resident of the United States in eight or more taxable 

years during the preceding 15 taxable years. In determining whether the eight-year threshold is met, one does not count any year in 

which the individual is treated as a resident of Bulgaria under the 

Convention (or as a resident of any country other than the United 

States under the provisions of any other U.S. tax treaty), and the 

individual does not waive the benefits of such treaty applicable to 

residents of the other country. This understanding is consistent 

with how this provision is generally interpreted in U.S. tax treaties.. 

Paragraph 5 

Paragraph 5 sets forth certain exceptions to the saving clause. 

The referenced provisions are intended to provide benefits to citizens and residents even if such benefits do not exist under internal 

law. Paragraph 5 thus preserves these benefits for citizens and 

residents of the Contracting States.Subparagraph (a) lists certain 

provisions of the Convention that are applicable to all citizens and 

residents of a Contracting State, despite the general saving clause 

rule of paragraph 4: 

(1) Paragraph 2 of Article 9 (Associated Enterprises) grants 

the right to a correlative adjustment with respect to income tax 

due on profits reallocated under Article 9. 

(2) Paragraphs 2 and 5 of Article 17 (Pensions, Social Security Payments, Annuities, Alimony, and Child Support) provide 

exemptions from source or residence State taxation for certain 

pension distributions and social security payments. 

(3) Article 22 (Relief from Double Taxation) confirms to citizens and residents of one Contracting State the benefit of a 

credit for income taxes paid to the other or an exemption for 

income earned in the other State. 

13 

(4) Article 23 (Non-Discrimination) protects residents and 

nationals of one Contracting State against the adoption of certain discriminatory practices in the other Contracting State. 

(5) Article 24 (Mutual Agreement Procedure) confers certain 

benefits on citizens and residents of the Contracting States in 

order to reach and implement solutions to disputes between 

the two Contracting States. For example, the competent authorities are permitted to use a definition of a term that differs 

from an internal law definition. The statute of limitations may 

be waived for refunds, so that the benefits of an agreement 

may be implemented. 

Subparagraph 5(b) provides a different set of exceptions to the 

saving clause. The benefits referred to are all intended to be granted to temporary residents of a Contracting State (for example, in 

the case of the United States, holders of non-immigrant visas), but 

not to citizens or to persons who have acquired permanent residence in that State. If beneficiaries of these provisions travel from 

one of the Contracting States to the other, and remain in the other 

long enough to become residents under its internal law, but do not 

acquire permanent residence status (i.e., in the U.S. context, they 

do not become ‘‘green card’’ holders) and are not citizens of that 

State, the host State will continue to grant these benefits even if 

they conflict with the statutory rules. The benefits preserved by 

this paragraph are: (1) the host country exemptions for government 

service salaries and pensions under Article 18 (Government Service), certain income of visiting students, trainees, teachers, and researchers under Article 19 (Students, Trainees, Teachers and Researchers), and the income of diplomatic agents and consular officers under Article 26 (Members of Diplomatic Missions and Consular Posts). 

Paragraph 6 

Paragraph 6 addresses special issues presented by fiscally transparent entities such as partnerships and certain estates and trusts. 

Because different countries frequently take different views as to 

when an entity is fiscally transparent, the risk of both double taxation and double non-taxation are relatively high. The intention of 

paragraph 6 is to eliminate a number of technical problems that arguably would have prevented investors using such entities from 

claiming treaty benefits, even though such investors would be subject to tax on the income derived through such entities. The provision also prevents the use of such entities to claim treaty benefits 

in circumstances where the person investing through such an entity is not subject to tax on the income in its State of residence. The 

provision, and the corresponding requirements of the substantive 

rules of Articles 6 through 20, should be read with those two goals 

in mind. 

In general, paragraph 6 relates to entities that are not subject 

to tax at the entity level, as distinct from entities that are subject 

to tax, but with respect to which tax may be relieved under an integrated system. This paragraph applies to any resident of a Contracting State who is entitled to income derived through an entity 

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14 

tracting State. Entities falling under this description in the United 

States include partnerships, common investment trusts under section 584 and grantor trusts. This paragraph also applies to U.S. 

limited liability companies (‘‘LLCs’’) that are treated as partnerships or as disregarded entities for U.S. tax purposes. 

Under paragraph 6, an item of income derived by such a fiscally 

transparent entity will be considered to be derived by a resident of 

a Contracting State if a resident is treated under the taxation laws 

of that State as deriving the item of income. For example, if a company that is a resident of Bulgaria pays interest to an entity that 

is treated as fiscally transparent for U.S. tax purposes, the interest 

will be considered derived by a resident of the United States only 

to the extent that the taxation laws of the United States treats one 

or more U.S. residents (whose status as U.S. residents is determined, for this purpose, under U.S. tax law) as deriving the interest for U.S. tax purposes. In the case of a partnership, the persons 

who are, under U.S. tax laws, treated as partners of the entity 

would normally be the persons whom the U.S. tax laws would treat 

as deriving the interest income through the partnership. Also, it 

follows that persons whom the United States treats as partners but 

who are not U.S. residents for U.S. tax purposes may not claim a 

benefit for the interest paid to the entity under the Convention, because they are not residents of the United States for purposes of 

claiming this treaty benefit. (If, however, the country in which they 

are treated as resident for tax purposes, as determined under the 

laws of that country, has an income tax convention with Bulgaria, 

they may be entitled to claim a benefit under that convention.) In 

contrast, if, for example, an entity is organized under U.S. laws 

and is classified as a corporation for U.S. tax purposes, interest 

paid by a company that is a resident of Bulgaria to the U.S. entity 

will be considered derived by a resident of the United States since 

the U.S. corporation is treated under U.S. taxation laws as a resident of the United States and as deriving the income. 

The same result obtains even if the entity were viewed differently under the tax laws of Bulgaria (e.g., as not fiscally transparent in the first example above where the entity is treated as a 

partnership for U.S. tax purposes). Similarly, the characterization 

of the entity in a third country is also irrelevant, even if the entity 

is organized in that third country. The results follow regardless of 

whether the entity is disregarded as a separate entity under the 

laws of one jurisdiction but not the other, such as a single owner 

entity that is viewed as a branch for U.S. tax purposes and as a 

corporation for tax purposes under the laws of Bulgaria. These results also obtain regardless of where the entity is organized (i.e., 

in the United States, in Bulgaria or, as noted above, in a third 

country). 

For example, income from U.S. sources received by an entity organized under the laws of the United States, which is treated for 

tax purposes under the laws of Bulgaria as a corporation and is 

owned by a shareholder who is a resident of Bulgaria for its 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. Rather, for purposes of the treaty, the income is treated as derived by the U.S. entity. 

15 

These principles also apply to trusts to the extent that they are 

fiscally transparent in either Contracting State. For example, if X, 

a resident of Bulgaria, creates a revocable trust in the United 

States and names persons resident in a third country as the beneficiaries of the trust, the trust’s income would be regarded as being 

derived by a resident of Bulgaria only to the extent that the laws 

of Bulgaria treat X as deriving the income for its tax purposes, perhaps through application of rules similar to the U.S. ‘‘grantor trust’’ 

rules. 

Paragraph 6 is not an exception to the saving clause of paragraph 4. Accordingly, paragraph 6 does not prevent a Contracting 

State from taxing an entity that is treated as a resident of that 

State under its tax law. For example, if a U.S. LLC with members 

who are residents of Bulgaria elects to be taxed as a corporation 

for U.S. tax purposes, the United States will tax that LLC on its 

worldwide income on a net basis, without regard to whether Bulgaria views the LLC as fiscally transparent. 

ARTICLE 2 (TAXES COVERED)

This Article specifies the U.S. taxes and the taxes of Bulgaria to 

which the Convention applies. With two exceptions, the taxes specified in Article 2 are the covered taxes for all purposes of the Convention. A broader coverage applies, however, for purposes of Articles 23 (Non-Discrimination) and 25 (Exchange of Information and 

Administrative Assistance). Article 23 (Non-Discrimination) applies 

with respect to all taxes, including those imposed by state and local 

governments. Article 25 (Exchange of Information and Administrative Assistance) applies with respect to all taxes imposed at the national level. 

Paragraph 1 

Paragraph 1 identifies the category of taxes to which the Convention applies. Paragraph 1 is based on the U.S. and OECD Models 

and defines the scope of application of the Convention. The Convention applies to taxes on income, including gains, imposed on behalf 

of a Contracting State, irrespective of the manner in which they 

are levied. Except with respect to Article 23 (Non-Discrimination), 

state and local taxes are not covered by the Convention. 

Paragraph 2 

Paragraph 2 also is based on the U.S. and OECD Models and 

provides a definition of taxes on income and on capital gains. The 

Convention covers taxes on total income or any part of income and 

includes tax on gains derived from the alienation of property. The 

Convention does not apply, however, to social security charges, or 

any other charges where there is a direct connection between the 

levy and individual benefits. Nor does it apply to property taxes, 

except with respect to Article 23 (Non-Discrimination). 

Paragraph 3 

Paragraph 3 lists the taxes in force at the time of signature of 

the Convention to which the Convention applies. 

The existing covered taxes of Bulgaria are identified in subparagraph 3(a), as the personal income tax and the corporate income 

16 

tax. Paragraph 2 of the Protocol clarifies that these taxes include 

the patent tax, which is a tax imposed on certain small business 

operations in lieu of a net basis income tax.Subparagraph 3(b) provides that the existing U.S. taxes subject to the rules of the Convention are the Federal income taxes imposed by the Code, together with the excise taxes imposed with respect to the investment income of foreign private foundations (Code section 4940). Social security and unemployment taxes (Code sections 1401, 3101, 

3111 and 3301) are excluded from coverage. 

Paragraph 4 

Under paragraph 4, the Convention will apply to any taxes that 

are identical, or substantially similar, to those enumerated in paragraph 3, and which are imposed in addition to, or in place of, the 

existing taxes after February 23, 2007, the date of signature of the 

Convention. The paragraph also provides that the competent authorities of the Contracting States will notify each other of any 

changes that have been made in their laws, whether tax laws or 

non-tax laws, that significantly affect their obligations under the 

Convention. Non-tax laws that may affect a Contracting State’s obligations under the Convention may include, for example, laws affecting bank secrecy. 

ARTICLE 3 (GENERAL DEFINITIONS)

Article 3 provides general definitions and rules of interpretation 

applicable throughout the Convention. Certain other terms are defined in other articles of the Convention. For example, the term 

‘‘resident of a Contracting State’’ is defined in Article 4 (Resident). 

The term ‘‘permanent establishment’’ is defined in Article 5 (Permanent Establishment). These definitions are used consistently 

throughout the Convention. Other terms, such as ‘‘dividends,’’ ‘‘interest’’ and ‘‘royalties’’ are defined in specific articles for purposes 

only of those articles. 

Paragraph 1 

Paragraph 1 defines a number of basic terms used in the Convention. The introduction to paragraph 1 makes clear that these 

definitions apply for all purposes of the Convention, unless the context requires otherwise. This latter condition allows flexibility in 

the interpretation of the Convention in order to avoid results not 

intended by the Convention’s negotiators. 

The geographical scope of the Convention with respect to Bulgaria is set out in subparagraph 1(a). The term ‘‘Bulgaria’’ encompasses the Republic of Bulgaria, including the territory and the territorial sea over which it exercises its State sovereignty, as well as 

the continental shelf and the exclusive economic zone over which 

it exercises sovereign rights and jurisdiction in conformity with 

international law. 

The geographical scope of the Convention with respect to the 

United States is set out in subparagraph 1(b). It encompasses the 

United States of America, including the states, the District of Columbia and the territorial sea of the United States. The term does 

not include Puerto Rico, the Virgin Islands, Guam or any other 

U.S. possession or territory. For certain purposes, the term ‘‘United 

17 

States’’ includes the sea bed and subsoil of undersea areas adjacent 

to the territorial sea of the United States. This extension applies 

to the extent that the United States exercises sovereignty in accordance with international law for the purpose of natural resource 

exploration and exploitation of such areas. This extension of the 

definition applies, however, only if the person, property or activity 

to which the Convention is being applied is connected with such 

natural resource exploration or exploitation. Thus, it would not include any activityinvolving the sea floor of an area over which the 

United States exercised sovereignty for natural resource purposes 

if that activity was unrelated to the exploration and exploitation of 

natural resources. This result is consistent with the result that 

would be obtained under Code section 638, which treats the continental shelf as part of the United States for purposes of natural resource exploration and exploitation. 

Subparagraph 1(c) provides that the terms ‘‘a Contracting State’’ 

and ‘‘the other Contracting State’’ shall mean Bulgaria or the 

United States, as the context requires. 

Subparagraph 1(d) defines the term ‘‘person’’ to include an individual, a company and any other body of persons. Paragraph 3 of 

the Protocol clarifies that the term ‘‘any other body of persons’’ includes partnerships, trusts, and estates. The definition is significant for a variety of reasons. For example, under Article 4, only a 

‘‘person’’ can be a ‘‘resident’’ and therefore eligible for most benefits 

under the Convention. Also, all ‘‘persons’’ are eligible to claim relief 

under Article 24 (Mutual Agreement Procedure). 

The term ‘‘company’’ is defined in subparagraph 1(e) as a body 

corporate or an entity treated as a body corporate for tax purposes 

in the state where it is organized. The definition refers to the law 

of the state in which an entity is organized in order to ensure that 

an entity that is treated as fiscally transparent in its country of 

residence will not get inappropriate benefits, such as the reduced 

withholding rate provided by subparagraph 2(b) of Article 10 (Dividends). It also ensures that the Limitation on Benefits provisions 

of Article 21 will be applied at the appropriate level. 

The terms ‘‘enterprise of a Contracting State’’ and ‘‘enterprise of 

the other Contracting State’’ are defined in subparagraph 1(f) as an 

enterprise carried on by a resident of a Contracting State and an 

enterprise carried on by a resident of the other Contracting State. 

An enterprise of a Contracting State need not be carried on in that 

State. It may be carried on in the other Contracting State or a 

third state (e.g., a U.S. corporation doing all of its business in Bulgaria would still be a U.S. enterprise). 

These terms also encompass an enterprise conducted through an 

entity (such as a partnership) that is treated as fiscally transparent 

in the Contracting State where the entity’s owner is resident. In 

accordance with Article 4 (Resident), entities that are fiscally 

transparent in the Contracting State in which their owners are 

resident are not considered to be residents of that Contracting 

State (although income derived by such entities may be taxed as 

the income of a resident, if taxed in the hands of resident partners 

or other owners). An enterprise conducted by such an entity will 

be treated as carried on by a resident of a Contracting State to the 

extent its partners or other owners are residents. This approach is 

18 

consistent with the Code, which under section 875 attributes a 

trade or business conducted by a partnership to its partners and 

a trade or business conducted by an estate or trust to its beneficiaries. 

Subparagraph (g) defines the term ‘‘enterprise’’ as any activity or 

set of activities that constitutes the carrying on of a business. The 

term ‘‘business’’ is not defined, but subparagraph (h) provides that 

it includes the performance of professional services and other activities of an independent character. Both subparagraphs are identical to definitions recently added to the OECD Model in connection 

with the deletion of Article 14 (Independent Personal Services) 

from the OECD Model. The inclusion of the two definitions is intended to clarify that income from the performance of professional 

services or other activities of an independent character is dealt 

with under Article 7 (Business Profits) and not Article 20 (Other 

Income). Subparagraph (i) further clarifies, at the request of Bulgaria, that ‘‘business profits’’ also include income from the performance of professional services and other activities of an independent 

character. 

Subparagraph 1 (j) defines the term ‘‘international traffic.’’ The 

term means any transport by a ship or aircraft except when such 

transport is solely between places within a Contracting State. The 

exclusion from international traffic of transport solely between 

places within a Contracting State means, for example, that carriage of goods or passengers solely between New York and Chicago 

would not be treated as international traffic, whether carried by a 

U.S. or a foreign carrier. The substantive taxing rules of the Convention relating to the taxation of income from transport, principally Article 8 (International Traffic), therefore, would not apply 

to income from such carriage. Thus, if the carrier engaged in internal U.S. traffic were a resident of Bulgaria (assuming that were 

possible under U.S. law), the United States would not be required 

to exempt the income from that transport under Article 8. The income would, however, be treated as business profits under Article 

7 (Business Profits), and therefore would be taxable in the United 

States only if attributable to a U.S. permanent establishment of 

the foreign carrier, and then only on a net basis. The gross basis 

U.S. tax imposed by section 887 would never apply under the circumstances described. If, however, goods or passengers are carried 

by a carrier resident in Bulgaria from a non-U.S. port to, for example, New York, and some of the goods or passengers continue on 

to Chicago, the entire transport would be international traffic. This 

would be true if the international carrier transferred the goods at 

the U.S. port of entry from a ship to a land vehicle, from a ship 

to a lighter, or even if the overland portion of the trip in the United 

States was handled by an independent carrier under contract with 

the original internation≥al carrier, so long as both parts of the trip 

were reflected in original bills of lading. For this reason, the Convention, following the U.S. Model refers, in the definition of ‘‘international traffic,’’ to ‘‘such transport’’ being solely between places in 

the other Contracting State, while the OECD Model refers to the 

ship or aircraft being operated solely between such places. The formulation in the Convention is intended to make clear that, as in 

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craft for the internal portion of the international voyage than is 

used for the overseas portion of the trip, the definition applies to 

that internal portion as well as the external portion. 

Finally, a ‘‘cruise to nowhere,’’ i.e., a cruise beginning and ending 

in a port in the same Contracting State with no stops in a foreign 

port, would not constitute international traffic. 

Subparagraph 1(k) designates the ‘‘competent authorities’’ for 

Bulgaria and the United States. The Bulgarian competent authority is the Minister of Finance or an authorized representative. The 

U.S. competent authority is the Secretary of the Treasury or his 

delegate. The Secretary of the Treasury has delegated the competent authority function to the Commissioner of Internal Revenue, 

who in turn has delegated the authority to the Deputy Commissioner (International) LMSB. With respect to interpretative issues, 

the Deputy Commissioner (International) LMSB acts with the concurrence of the Associate Chief Counsel (International) of the Internal Revenue Service. 

The term ‘‘national,’’ as it relates to the United States and to 

Bulgaria, is defined in subparagraph 1(l). This term is relevant for 

purposes of Articles 18 (Government Service) and 23 (Non-Discrimination). A national of one of the Contracting States is (1) an 

individual who is a citizen of that State, and (2) any legal person, 

partnership or association deriving its status, as such, from the law 

in force in the State where it is established. 

Subparagraph 1(m) defines the term ‘‘pension fund’’ to include 

any person established in a Contracting State that is generally exempt from income taxation in that State and that is operated principally to administer or provide pension or retirement benefits or 

to earn income for the benefit of one or more such arrangements. 

In the case of the United States, the term ‘‘pension fund’’ includes 

the following: a trust providing pension or retirement benefits 

under a Code section 401(a) qualified pension plan, profit sharing 

or stock bonus plan, a trust providing pension or retirement benefits under a Code section 403(b) plan, a trust that is an individual 

retirement account under Code section 408, a Roth individual retirement account under Code section 408A, or a simple retirement 

account under Code section 408(p), a trust providing pension or retirement benefits under a simplified employee pension plan under 

Code section 408(k), a trust described in section 457(g) providing 

pension or retirement benefits under a Code section 457(b) plan, 

and the Thrift Savings Fund (section 7701(j)). Section 401(k) plans 

and group trusts described in Rev. Rul. 81–100, 1981–1 C.B. 326, 

and meeting the conditions of Rev. Rul. 2004–67, 2204–2 C.B. 28, 

qualify as pension funds because they are covered by Code section 

401(a). 

Paragraph 2 

Terms that are not defined in the Convention are dealt with in 

paragraph 2. 

Paragraph 2 provides that in the application of the Convention, 

any term used but not defined in the Convention will have the 

meaning that it has under the law of the Contracting State whose 

tax is being applied, unless the context requires otherwise, or the 

competent authorities have agreed on a different meaning pursuant 

20 

to Article 24 (Mutual Agreement Procedure). If the term is defined 

under both the tax and non-tax laws of a Contracting State, the 

definition in the tax law will take precedence over the definition in 

the non-tax laws. Finally, there also may be cases where the tax 

laws of a State contain multiple definitions of the same term. In 

such a case, the definition used for purposes of the particular provision at issue, if any, should be used. 

If the meaning of a term cannot be readily determined under the 

law of a Contracting State, or if there is a conflict in meaning 

under the laws of the two States that creates difficulties in the application of the Convention, the competent authorities, as indicated 

in paragraph 3(f) of Article 24 (Mutual Agreement Procedure), may 

establish a common meaning in order to prevent double taxation or 

to further any other purpose of the Convention. This common 

meaning need not conform to the meaning of the term under the 

laws of either Contracting State. 

The reference in paragraph 2 to the internal law of a Contracting 

State means the law in effect at the time the Convention is being 

applied, not the law as in effect at the time the Convention was 

signed. The use of ‘‘ambulatory’’ definitions, however, may lead to 

results that are at variance with the intentions of the negotiators 

and of the Contracting States when the Convention was negotiated 

and ratified. The reference in both paragraphs 1 and 2 to the ‘‘context otherwise requir[ing]’’ a definition different from the Convention definition, in paragraph 1, or from the internal law definition 

of the Contracting State whose tax is being imposed, under paragraph 2, refers to a circumstance where the result intended by the 

Contracting States is different from the result that would obtain 

under either the paragraph 1 definition or the statutory definition. 

Thus, flexibility in defining terms is necessary and permitted. 

ARTICLE 4 (RESIDENT)

This Article sets forth rules for determining whether a person is 

a resident of a Contracting State for purposes of the Convention. 

As a general matter only residents of the Contracting States may 

claim the benefits of the Convention. The treaty definition of residence is to be used only for purposes of the Convention. The fact 

that a person is determined to be a resident of a Contracting State 

under Article 4 does not necessarily entitle that person to the benefits of the Convention. In addition to being a resident, a person also 

must qualify for benefits under Article 21 (Limitation on Benefits) 

in order to receive benefits conferred on residents of a Contracting 

State. 

The determination of residence for treaty purposes looks first to 

a person’s liability to tax as a resident under the respective taxation laws of the Contracting States. As a general matter, a person 

who, under those laws, is a resident of one Contracting State and 

not of the other need look no further. For purposes of the Convention, that person is a resident of the State in which he is resident 

under internal law. If, however, a person is resident in both Contracting States under their respective taxation laws, the Article 

proceeds, where possible, to use tie-breaker rules to assign a single 

State of residence to such a person for purposes of the Convention. 

21 

Paragraph 1 

The term ‘‘resident of a Contracting State’’ is defined in paragraph 1. In general, this definition incorporates the definitions of 

residence in U.S. law and that of Bulgaria by referring to a resident as a person who, under the laws of a Contracting State, is 

subject to tax there by reason of his domicile, residence, citizenship, place of management, place of incorporation or any other 

similar criterion. Thus, residents of the United States include 

aliens who are considered U.S. residents under Code section 

7701(b). Paragraph 1 also specifically includes the two Contracting 

States, and political subdivisions and local authorities of the two 

States, as residents for purposes of the Convention. 

Certain entities that are nominally subject to tax but that in 

practice are rarely required to pay tax also would generally be 

treated as residents and therefore accorded treaty benefits. For example, a U.S. Regulated Investment Company (RIC) and a U.S. 

Real Estate Investment Trust (REIT) are residents of the United 

States for purposes of the treaty. Although the income earned by 

these entities normally is not subject to U.S. tax in the hands of 

the entity, they are taxable to the extent that they do not currently 

distribute their profits, and therefore may be regarded as ‘‘liable to 

tax.’’ They also must satisfy a number of requirements under the 

Code in order to be entitled to special tax treatment. 

Under paragraph 1 of the Convention and paragraph 4 of the 

Protocol, a person who is liable to tax in a Contracting State only 

in respect of income from sources within that State or of profits attributable to a permanent establishment in that State will not be 

treated as a resident of that Contracting State for purposes of the 

Convention. Thus, a consular official of Bulgaria who is posted in 

the United States, who may be subject to U.S. tax on U.S. source 

investment income, but is not taxable in the United States on nonU.S. source income (see Code section 7701 (b)(5)(B)), would not be 

considered a resident of the United States for purposes of the Convention. Similarly, an enterprise of Bulgaria with a permanent establishment in the United States is not, by virtue of that permanent establishment, a resident of the United States. The enterprise 

generally is subject to U.S. tax only with respect to its income that 

is attributable to the U.S. permanent establishment, not with respect to its worldwide income, as it would be if it were a U.S. resident. 

Paragraph 4 of the Protocol also clarifies that if a company is a 

resident of one of the Contracting States under the domestic law 

of that State, but is treated as a resident of a third state under a 

treaty between that State and the third state, then it will not be 

treated as a resident of the Contracting State for purposes of the 

Convention. For example, if a company that is organized in Bulgaria is managed and controlled in the United Kingdom, both countries would treat the company as being a resident under its domestic laws. However, if a treaty between Bulgaria and the United 

Kingdom assigned residence in such a case to the country in which 

the company’s place of effective management is located, and the 

place of effective management is the United Kingdom, the company 

would not qualify for benefits under the U.S.-Bulgaria treaty because it is not subject to tax in Bulgaria as a resident of Bulgaria. 

22 

This rule is consistent with the holding of Rev. Rul. 2004–76, 

2004–2 C.B. 111. 

Paragraph 2 

Paragraph 2 provides that certain tax-exempt entities such as 

pension funds and charitable organizations will be regarded as 

residents of a Contracting State regardless of whether they are 

generally liable to income tax in the State where they are established. The paragraph applies to legal persons organized under the 

laws of a Contracting State and established and maintained in that 

State to provide pensions or other similar benefits pursuant to a 

plan, or exclusively for religious, charitable, scientific, artistic, cultural, or educational purposes. Thus, a section 501(c) organization 

organized in the United States (such as a U.S. charity) that is generally exempt from tax under U.S. law is a resident of the United 

States for all purposes of the Convention. 

Paragraph 3 

If, under the laws of the two Contracting States, and, thus, 

under paragraph 1, an individual is deemed to be a resident of both 

Contracting States, a series of tie-breaker rules are provided in 

paragraph 3 to determine a single State of residence for that individual. These tests are to be applied in the order in which they are 

stated. The first test is based on where the individual has a permanent home. If that test is inconclusive because the individual has 

a permanent home available to him in both States, he will be considered to be a resident of the Contracting State where his personal 

and economic relations are closest (i.e., the location of his ‘‘center 

of vital interests’’). If that test is also inconclusive, or if he does not 

have a permanent home available to him in either State, he will 

be treated as a resident of the Contracting State where he maintains a habitual abode. If he has a habitual abode in both States 

or in neither of them, he will be treated as a resident of the Contracting State of which he is a national. If he is a national of both 

States or of neither, the matter will be considered by the competent 

authorities, who will assign a single State of residence. 

Paragraph 4 

Dual residents other than individuals (such as companies, trusts, 

or estates) are addressed by paragraph 4. If such a person is, under 

the rules of paragraph 1 or 2, resident in both Contracting States, 

the competent authorities shall seek to determine a single State of 

residence for that person for purposes of the Convention. If the 

competent authorities do not reach an agreement on a single State 

of residence, that dual resident may not claim any benefit accorded 

to residents of a Contracting State by the Convention. The dual 

resident may, however, claim any benefits that are not limited to 

residents, such as those provided by paragraph 1 of Article 23 

(Non-Discrimination). Thus, for example, a State cannot discriminate against a dual resident company. 

Dual residents also may be treated as a resident of a Contracting 

State for purposes other than that of obtaining benefits under the 

Convention. For example, if a dual resident company pays a dividend to a resident of Bulgaria, the U.S. paying agent would withVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00022 Fmt 6602 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
23 

hold on that dividend at the appropriate treaty rate because reduced withholding is a benefit enjoyed by the resident of Bulgaria, 

not by the dual resident company. The dual resident company that 

paid the dividend would, for this purpose, be treated as a resident 

of the United States under the Convention. In addition, information relating to dual residents can be exchanged under the Convention because, by its terms, Article 26 (Exchange of Information and 

Administrative Assistance) is not limited to residents of the Contracting States. 

ARTICLE 5 (PERMANENT ESTABLISHMENT)

This Article defines the term ‘‘permanent establishment,’’ a term 

that is significant for several articles of the Convention. The existence of a permanent establishment in a Contracting State is necessary under Article 7 (Business Profits) for the taxation by that 

State of the business profits of a resident of the other Contracting 

State. Articles 10, 11 and 12 (dealing with dividends, interest, and 

royalties, respectively) provide for reduced rates of tax at source on 

payments of these items of income to a resident of the other State 

only when the income is not attributable to a permanent establishment that the recipient has in the source State. The concept is also 

relevant in determining which Contracting State may tax certain 

gains under Article 13 (Capital Gains) and certain ‘‘other income’’ 

under Article 20 (Other Income). 

Paragraph 1 

The basic definition of the term ‘‘permanent establishment’’ is 

contained in paragraph 1. As used in the Convention, the term 

means a fixed place of business through which the business of an 

enterprise is wholly or partly carried on. As indicated in the OECD 

Commentary to Article 5 (see paragraphs 4 through 8), a general 

principle to be observed in determining whether a permanent establishment exists is that the place of business must be ‘‘fixed’’ in 

the sense that a particular building or physical location is used by 

the enterprise for the conduct of its business, and that it must be 

foreseeable that the enterprise’s use of this building or other physical location will be more than temporary. 

Paragraph 2 

Paragraph 2 lists a number of types of fixed places of business 

that constitute a permanent establishment. This list is illustrative 

and non-exclusive. According to paragraph 2, the term permanent 

establishment includes a place of management, a branch, an office, 

a factory, a workshop, and a mine, oil or gas well, quarry or other 

place of extraction of natural resources. 

Paragraph 3 

This paragraph provides rules to determine whether a building 

site or a construction, assembly or installation project, or an installation or drilling rig or ship used for the exploration of natural resources constitutes a permanent establishment for the contractor, 

driller, etc. Such a site or activity does not create a permanent establishment unless the site, project, etc. lasts, or the exploration 

activity continues, for more than six months. It is only necessary 

24 

to refer to ‘‘exploration’’ and not ‘‘exploitation’’ in this context because exploitation activities are defined to constitute a permanent 

establishment under subparagraph (f) of paragraph 2. Thus, a drilling rig does not constitute a permanent establishment if a well is 

drilled in only three months, but if production begins in the following month the well becomes a permanent establishment as of 

that date. 

The six-month test applies separately to each site or project. The 

six-month period begins when work (including preparatory work 

carried on by the enterprise) physically begins in a Contracting 

State. A series of contracts or projects by a contractor that are 

interdependent both commercially and geographically are to be 

treated as a single project for purposes of applying the six-month 

threshold test. For example, the construction of a housing development would be considered as a single project even if each house 

were constructed for a different purchaser. 

In applying this paragraph, time spent by a sub-contractor on a 

building site is counted as time spent by the general contractor at 

the site for purposes of determining whether the general contractor 

has a permanent establishment. However, for the sub-contractor 

itself to be treated as having a permanent establishment, the subcontractor’s activities at the site must last for more than six 

months. If a sub-contractor is on a site intermittently, then, for 

purposes of applying the six-month rule, time is measured from the 

first day the sub-contractor is on the site until the last day (i.e., 

intervening days that the sub-contractor is not on the site are 

counted). 

These interpretations of the Article are based on the Commentary to paragraph 3 of Article 5 of the OECD Model, which contains language that is substantially the same as that in the Convention. These interpretations are consistent with the generally accepted international interpretation of the relevant language in 

paragraph 3 of Article 5 of the Convention. 

If the six-month threshold is exceeded, the site or project constitutes a permanent establishment from the first day of activity. 

Paragraph 4 

This paragraph contains exceptions to the general rule of paragraph 1, listing a number of activities that may be carried on 

through a fixed place of business but which nevertheless do not create a permanent establishment. The use of facilities solely to store, 

display or deliver merchandise belonging to an enterprise does not 

constitute a permanent establishment of that enterprise. The maintenance of a stock of goods belonging to an enterprise solely for the 

purpose of storage, display or delivery, or solely for the purpose of 

processing by another enterprise does not give rise to a permanent 

establishment of the first-mentioned enterprise. The maintenance 

of a fixed place of business solely for the purpose of purchasing 

goods or merchandise, or for collecting information, for the enterprise, or for other activities that have a preparatory or auxiliary 

character for the enterprise, such as advertising, or the supply of 

information, do not constitute a permanent establishment of the 

enterprise. Moreover, subparagraph 4(f) provides that a combination of the activities described in the other subparagraphs of paraVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00024 Fmt 6602 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
25 

graph 4 will not give rise to a permanent establishment if the combination results in an overall activity that is of a preparatory or 

auxiliary character. 

Paragraph 5 

Paragraphs 5 and 6 specify when activities carried on by an 

agent or other person acting on behalf of an enterprise create a 

permanent establishment of that enterprise. For example, under 

subparagraph 5(a), a person is deemed to create a permanent establishment of the enterprise if that person has and habitually exercises an authority to conclude contracts in the name of that enterprise. If, however, his activities are limited to those activities 

specified in paragraph 4 which would not constitute a permanent 

establishment if carried on by the enterprise through a fixed place 

of business, the person does not create a permanent establishment 

of the enterprise. 

The Convention adopts the OECD Model language ‘‘in the name 

of that enterprise’’ rather than the US Model language ‘‘binding on 

the enterprise.’’ This difference in language is not intended to be 

a substantive difference. As indicated in paragraph 32 to the 

OECD Commentaries on Article 5, paragraph 5 of the Article is intended to encompass persons who have ‘‘sufficient authority to bind 

the enterprise’s participation in the business activity in the State 

concerned.’’ 

The contracts referred to in paragraph 5 are those relating to the 

essential business operations of the enterprise, rather than ancillary activities. For example, if the person has no authority to conclude contracts in the name of the enterprise with its customers 

for, say, the sale of the goods produced by the enterprise, but it can 

enter into service contracts in the name of the enterprise for the 

enterprise’s business equipment, this contracting authority would 

not fall within the scope of the paragraph, even if exercised regularly. 

Under subparagraph 5(b), a person is also deemed to create a 

permanent establishment of the enterprise if that person has no 

authority to conclude contracts, but habitually maintains in that 

State a stock of goods or merchandise belonging to the enterprise 

from which the person regularly fills orders or makes deliveries on 

behalf of the enterprise, and additional activities conducted in that 

State on behalf of the enterprise have contributed to the conclusion 

of the sale of such goods or merchandise. 

Paragraph 6 

Under paragraph 6, an enterprise is not deemed to have a permanent establishment in a Contracting State merely because it 

carries on business in that State through an independent agent, including a broker or general commission agent, if the agent is acting 

in the ordinary course of his business as an independent agent. 

Thus, there are two conditions that must be satisfied: the agent 

must be both legally and economically independent of the enterprise, and the agent must be acting in the ordinary course of its 

business in carrying out activities on behalf of the enterprise. 

Whether the agent and the enterprise are independent is a factual determination. Among the questions to be considered is the exVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00025 Fmt 6602 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
26 

tent to which the agent operates on the basis of instructions from 

the enterprise. An agent that is subject to detailed instructions regarding the conduct of its operations or comprehensive control by 

the enterprise is not legally independent. 

In determining whether the agent is economically independent, 

a relevant factor is the extent to which the agent bears business 

risk. Business risk refers primarily to risk of loss. An independent 

agent typically bears risk of loss from its own activities. In the absence of other factors that would establish dependence, an agent 

that shares business risk with the enterprise, or has its own business risk, is economically independent because its business activities are not integrated with those of the principal. Conversely, an 

agent that bears little or no risk from the activities it performs is 

not economically independent and therefore is not described in 

paragraph 6. 

Another relevant factor in determining whether an agent is economically independent is whether the agent acts exclusively or 

nearly exclusively for the principal. Such a relationship may indicate that the principal has economic control over the agent. A number of principals acting in concert also may have economic control 

over an agent. The limited scope of the agent’s activities and the 

agent’s dependence on a single source of income may indicate that 

the agent lacks economic independence. It should be borne in mind, 

however, that exclusivity is not in itself a conclusive test; an agent 

may be economically independent notwithstanding an exclusive relationship with the principal if it has the capacity to diversify and 

acquire other clients without substantial modifications to its current business and without substantial harm to its business profits. 

Thus, exclusivity should be viewed merely as a pointer to further 

investigation of the relationship between the principal and the 

agent. Each case must be addressed on the basis of its own facts 

and circumstances. 

Paragraph 7 

This paragraph clarifies that a company that is a resident of a 

Contracting State is not deemed to have a permanent establishment in the other Contracting State merely because it con-trols, or 

is controlled by, a company that is a resident of that other Contracting State, or that carries on business in that other Contracting 

State. The determination whether a permanent establishment exists is made solely on the basis of the factors described in paragraphs 1 through 6 of the Article. Whether a company is a permanent establishment of a related company, therefore, is based solely 

on those factors and not on the ownership or control relationship 

between the companies. 

Paragraph 8 

Paragraph 8 provides a special rule (subject to the provisions of 

paragraph 4) for an enterprise of a Contracting State that provides 

services in the other Contracting State, but that does not have a 

permanent establishment by virtue of the preceding paragraphs of 

the Article. If (and only if) such an enterprise meets either of two 

tests as provided in subparagraphs 8(a) and 8(b), the enterprise 

27 

will be deemed to provide those services through a permanent establishment in the other State. 

The first test as provided in subparagraph 8(a) has two parts. 

First, the services must be performed in the other State by an individual who is present in that other State for a period or periods 

aggregating 183 days or more in any twelve-month period. Second, 

during that period or periods, more than 50 percent of the gross active business revenues of the enterprise (including revenue from active business activities unrelated to the provision of services) must 

consist of income derived from the services performed in that State 

by that individual. If the enterprise meets both of these tests, the 

enterprise will be deemed to provide the services through a permanent establishment. This test in subparagraph 8(a) is employed to 

determine whether an enterprise is deemed to have a permanent 

establishment by virtue of the presence of a single individual (i.e. 

a natural person). 

For the purposes of subparagraph 8(a), the term ‘‘gross active 

business revenues’’ shall mean the gross revenues attributable to 

active business activities that the enterprise has charged or should 

charge for its active business activities, regardless of when the actual billing will occur or of domestic law rules concerning when 

such revenues should be taken into account for tax purposes. Such 

active business activities are not restricted to the activities related 

to the provision of services. However, the term does not include income from passive investment activities. 

The second test as provided in subparagraph 8(b) provides that 

an enterprise will have a permanent establishment if the services 

are provided in the other State for an aggregate of 183 days or 

more in any twelve-month period with respect to the same or connected projects for customers who either are residents of the other 

State or maintain a permanent establishment in the other State 

with respect to which the services are provided. The various conditions that have to be satisfied in order for subparagraph 8(b) to 

have application are described in detail below. 

In addition to meeting the 183-day threshold, the services must 

be provided for customers who either are residents of the other 

State or maintain a permanent establishment in that State. The intent of this requirement is to reinforce the concept that unless 

there is a customer in the other State, such enterprise will not be 

deemed as participating sufficiently in the economic life of that 

other State to warrant being deemed to have a permanent establishment. 

Paragraph 8 applies only to the provision of services, and only 

to services provided by an enterprise to third parties. Thus, the 

provision does not have the effect of deeming an enterprise to have 

a permanent establishment merely because services are provided to 

that enterprise. 

Further, paragraph 8 only applies to services that are performed 

or provided by an enterprise of a Contracting State within the 

other Contracting State. It is therefore not sufficient that the relevant services be merely furnished to a resident of the other Contracting State. Where, for example, an enterprise provides customer support or other services by telephone or computer to customers located in the other State, those would not be covered by 

28 

paragraph 8 because they are not performed or provided by that 

enterprise within the other State. Another example would be that 

of an architect who is hired to design blueprints for the construction of a building in the other State. As part of completing the 

project, the architect must make site visits to that other State, and 

his days of presence there would be counted for purposes of determining whether the 183-day threshold is satisfied. However, the 

days that the architect spends working on the blueprint in his 

home office shall not count for purposes of the 183-day threshold, 

because the architect is not performing or providing those services 

within the other State. 

For purposes of determining whether the time threshold has 

been met, subparagraph 8(b) permits the aggregation of services 

that are provided with respect to connected projects. For purposes 

of this test, projects shall be considered to be connected if they constitute a coherent whole, commercially and geographically. The determination of whether projects are connected should be determined from the point of view of the enterprise (not that of the customer), and will depend on the facts and circumstances of each 

case. In determining the existence of commercial coherence, factors 

that would be relevant include: 1) whether the projects would, in 

the absence of tax planning considerations, have been concluded 

pursuant to a single contract; 2) whether the nature of the work 

involved under different projects is the same; and 3) whether the 

same individuals are providing the services under the different 

projects. Whether the work provided is covered by one or multiple 

contracts may be relevant, but is not determinative, in finding that 

projects are commercially coherent. 

The aggregation rule addresses, for example, potentially abusive 

situations in which work has been artificially divided into separate 

components in order to avoid meeting the 183-day threshold. Assume for example, that a technology consultant has been hired to 

install a new computer system for a company in the other country. 

The work will take ten months to complete. However, the consultant purports to divide the work into two five-month projects with 

the intention of circumventing the rule in paragraph 8. In such 

case, even if the two projects were considered separate, they will 

be considered to be commercially coherent. Accordingly, subject to 

the additional requirement of geographic coherence, the two 

projects could be considered to be connected, and could therefore be 

aggregated for purposes of subparagraph 8(b). In contrast, assume 

that the technology consultant is contracted to install a particular 

computer system for a company, and is also hired by that same 

company, pursuant to a separate contract, to train its employees on 

the use of another computer software that is unrelated to the first 

system. In this second case, even though the contracts are both 

concluded between the same two parties, there is no commercial coherence to the two projects, and the time spent fulfilling the two 

contracts may not be aggregated for purposes of subparagraph 8(b). 

Another example of projects that do not have commercial coherence 

would be the case of a law firm which, as one project provides tax 

advice to a customer from one portion of its staff, and as another 

project provides trade advice from another portion of its staff, both 

to the same customer. 

29 

Additionally, projects, in order to be considered connected, must 

also constitute a geographic whole. An example of projects that lack 

geographic coherence would be a case in which a consultant is 

hired to execute separate auditing projects at different branches of 

a bank located in different cities pursuant to a single contract. In 

such an example, while the consultant’s projects are commercially 

coherent, they are not geographically coherent and accordingly the 

services provided in the various branches shall not be aggregated 

for purposes of applying subparagraph 8(b). The services provided 

in each branch should be considered separately for purposes of subparagraph 8(b). 

The method of counting days for purposes of subparagraph 8(a) 

differs slightly from the method for subparagraph 8(b). Subparagraph 8(a) refers to days in which an individual is present in the 

other country. Accordingly, physical presence during a day is sufficient. In contrast, subparagraph 8(b) refers to days during which 

services are provided by the enterprise in the other country. Accordingly, non-working days such as weekends or holidays would 

not count for purposes of subparagraph 8(b), as long as no services 

are actually being provided while in the other country on those 

days. For the purposes of both subparagraphs, even if the enterprise sends many individuals simultaneously to the other country 

to provide services, their collective presence during one calendar 

day will count for only one day of the enterprise’s presence in the 

other country. For instance, if an enterprise sends 20 employees to 

the other country to provide services to a client in the other country for 10 days, the enterprise will be considered present in the 

other country only for 10 days, not 200 days (20 employees x 10 

days). 

By deeming the enterprise to provide services through a permanent establishment in the other Contracting State, paragraph 8 allows the application of Article 7 (Business Profits), and accordingly, 

the taxation of the services shall be on a net-basis. Such taxation 

is also limited to the profits attributable to the activities carried on 

in performing the relevant services. It will be important to ensure 

that only the profits properly attributable to the functions performed and risks assumed by provision of the services will be attributed to the deemed permanent establishment. 

Paragraph 8 applies subject to the provisions of paragraph 4. In 

no case will paragraph 8 apply to deem services to be provided 

through a permanent establishment if the services are limited to 

those mentioned in paragraph 4 which, if performed through a 

fixed place of business, would not make the fixed place of business 

a permanent establishment under the provisions of that paragraph. 

Further, days spent on preparatory or auxiliary activities shall not 

be taken into account for purposes of applying subparagraph 8(b). 

ARTICLE 6 (INCOME FROM IMMOVABLE PROPERTY (REAL PROPERTY))

This Article deals with the taxation of income from immovable 

property (real property) situated in a Contracting State (the ‘‘situs 

State’’). The Article does not grant an exclusive taxing right to the 

situs State; the situs State is merely given the primary right to 

tax. However, until such time as Bulgaria provides, with respect to 

income taxable under this Article, for an election to be subject to 

30 

tax on a net basis as though such income were business profits attributable to a permanent establishment, the Bulgarian rate of tax 

may not exceed 10 percent of the gross amount of income derived 

by a U.S. resident from real property situated in Bulgaria. 

Paragraph 1 

The first paragraph of Article 6 states the general rule that income of a resident of a Contracting State derived from real property situated in the other Contracting State may be taxed in the 

Contracting State in which the property is situated. The paragraph 

specifies that income from real property includes income from agriculture and forestry. 

Paragraph 2 

The term ‘‘real property’’ is defined in paragraph 2 by reference 

to the internal law definition in the situs State. In the case of the 

United States, the term has the meaning given to it by Treas. Reg. 

section 1.897–1(b). In addition to the statutory definitions in the 

two Contracting States, the paragraph specifies certain additional 

classes of property that, regardless of internal law definitions, are 

within the scope of the term for purposes of the Convention. This 

expanded definition conforms to that in the OECD Model. The definition of ‘‘real property’’ for purposes of Article 6 is more limited 

than the expansive definition of ‘‘real property’’ in paragraph 1 of 

Article 13 (Capital Gains). The Article 13 term includes not only 

real property as defined in Article 6 but certain other interests in 

real property. 

Paragraph 3 

Paragraph 3 makes clear that all forms of income derived from 

the exploitation of real property are taxable in the Contracting 

State in which the property is situated. This includes income from 

any use of real property, including, but not limited to, income from 

direct use by the owner (in which case income may be imputed to 

the owner for tax purposes) and rental income from the letting of 

real property. 

Other income closely associated with real property is covered by 

other Articles of the Convention, however, and not Article 6. For 

example, income from the disposition of an interest in real property 

is not considered ‘‘derived’’ from real property; taxation of that income is addressed in Article 13 (Capital Gains). Interest paid on a 

mortgage on real property would be covered by Article 11 (Interest). Distributions by a U.S. Real Estate Investment Trust or certain regulated investment companies would fall under Article 13 

(Capital Gains) in the case of distributions of U.S. real property 

gain or Article 10 (Dividends) in the case of distributions treated 

as dividends. Finally, distributions from a United States Real Property Holding Corporation are not considered to be income from the 

exploitation of real property; such payments would fall under Article 10 or 13. 

Paragraph 4 

This paragraph specifies that the basic rule of paragraph 1 (as 

elaborated in paragraph 3) applies to income from real property of 

31 

an enterprise. This clarifies that the situs country may tax the real 

property income (including rental income) of a resident of the other 

Contracting State in the absence of attribution to a permanent establishment in the situs State. This provision represents an exception to the general rule under Article 7 (Business Profits) that income must be attributable to a permanent establishment in order 

to be taxable in the situs state. However, if a resident of a Contracting State carries on a business in the other Contracting State 

through a permanent establishment situated therein and the real 

property is effectively connected with such permanent establishment, the provisions of Article 7 apply to the real property income. 

This rule is important in view of the lack of an election to be subject to tax on a net basis with respect to income taxable under this 

Article under Bulgarian law and the Convention. Accordingly, if a 

U.S. resident has a permanent establishment in Bulgaria through 

which the real property income is earned, that income will be taxed 

on a net basis using the rates and rules of taxation generally applicable to residents of Bulgaria, as such rules may be modified by the 

Convention. 

Paragraph 5 

This paragraph contains a special rule limiting the rate of Bulgarian taxation to 10 percent of the gross amount of income derived 

by a U.S. resident from real property situated in Bulgaria. This 

special rule applies for as long as U.S. residents are not entitled 

under Bulgarian law to make an election to compute the tax on income from real property situated in Bulgaria on a net basis as if 

such income were business profits attributable to a permanent establishment in Bulgaria. 

ARTICLE 7 (BUSINESS PROFITS)

This Article provides rules for the taxation by a Contracting 

State of the business profits of an enterprise of the other Contracting State. 

Paragraph 1 

Paragraph 1 states the general rule that business profits of an 

enterprise of one Contracting State may not be taxed by the other 

Contracting State unless the enterprise carries on business in that 

other Contracting State through a permanent establishment (as defined in Article 5 (Permanent Establishment)) situated there. When 

that condition is met, the State in which the permanent establishment is situated may tax the enterprise on the income that is attributable to the permanent establishment. 

Although the Convention does not include a definition of ‘‘business profits,’’ the term is intended to cover income derived from 

any trade or business. In accordance with this broad definition, the 

term ‘‘business profits’’ includes income attributable to notional 

principal contracts and other financial instruments to the extent 

that the income is attributable to a trade or business of dealing in 

such instruments or is otherwise related to a trade or business (as 

in the case of a notional principal contract entered into for the purpose of hedging currency risk arising from an active trade or business). Any other income derived from such instruments is, unless 

32 

specifically covered in another article, dealt with under Article 20 

(Other Income). 

The term ‘‘business profits’’ also includes income derived by an 

enterprise from the rental of tangible personal property (unless 

such tangible personal property consists of aircraft, ships or containers, income from which is addressed by Article 8 (International 

Traffic)). The inclusion of income derived by an enterprise from the 

rental of tangible personal property in business profits means that 

such income earned by a resident of a Contracting State can be 

taxed by the other Contracting State only if the income is attributable to a permanent establishment maintained by the resident in 

that other State, and, if the income is taxable, it can be taxed only 

on a net basis. Income from the rental of tangible personal property 

that is not derived in connection with a trade or business is dealt 

with in Article 20 (Other Income). 

In addition, as a result of the definitions of ‘‘enterprise’’ and 

‘‘business’’ in Article 3 (General Definitions), the term includes income derived from the furnishing of personal services. Thus, a consulting firm resident in one State whose employees or partners perform services in the other State through a permanent establishment may be taxed in that other State on a net basis under Article 

7, and not under Article 14 (Income from Employment), which applies only to income of employees. With respect to the enterprise’s 

employees themselves, however, their salary remains subject to Article 14. 

Because this Article applies to income earned by an enterprise 

from the furnishing of personal services, the Article also applies to 

income derived by a partner resident in a Contracting State that 

is attributable to personal services performed in the other Contracting State through a partnership with a permanent establishment in that other State. Income that may be taxed under this Article includes all income attributable to the permanent establishment in respect of the performance of the personal services carried 

on by the partnership (whether by the partner himself, other partners in the partnership, or by employees assisting the partners) 

and any income from activities ancillary to the performance of 

those services (e.g., charges for facsimile services). 

The application of Article 7 to a service partnership may be illustrated by the following example: a partnership has five partners 

(who agree to split profits equally), four of whom are resident and 

perform personal services only in Bulgaria at Office A, and one of 

whom performs personal services at Office B, a permanent establishment in the United States. In this case, the four partners of the 

partnership resident in Bulgaria may be taxed in the United States 

in respect of their share of the income attributable to the permanent establishment, Office B. The services giving rise to income 

which may be attributed to the permanent establishment would include not only the services performed by the one resident partner, 

but also, for example, if one of the four other partners came to the 

United States and worked on an Office B matter there, the income 

in respect of those services. Income from the services performed by 

the visiting partner would be subject to tax in the United States 

regardless of whether the visiting partner actually visited or used 

Office B while performing services in the United States. 

33 

Paragraph 2 

Paragraph 2 provides rules for the attribution of business profits 

to a permanent establishment. The Contracting States will attribute to a permanent establishment the profits that it would have 

earned had it been a distinct and separate enterprise engaged in 

the same or similar activities under the same or similar conditions 

and dealing wholly independently with the enterprise of which it 

is a permanent establishment. 

The ‘‘attributable to’’ concept of paragraph 2 provides an alternative to the analogous but somewhat different ‘‘effectively connected’’ concept in Code section 864(c). Depending upon the circumstances, the amount of income ‘‘attributable to’’ a permanent 

establishment under Article 7 may be greater or less than the 

amount of income that would be treated as ‘‘effectively connected’’ 

to a U.S. trade or business under Code section 864. In particular, 

in the case of financial institutions, the use of internal dealings to 

allocate income within an enterprise may produce results under Article 7 that are significantly different than the results under the effectively connected income rules. For example, income from interbranch notional principal contracts may be taken into account 

under Article 7, notwithstanding that such transactions may be ignored for purposes of U.S. domestic law. 

The profits attributable to a permanent establishment may be 

from sources within or without a Contracting State. However, as 

stated in paragraph 5 of the Protocol, the business profits attributable to a permanent establishment include only those profits derived from the assets used, risks assumed, and activities performed 

by, the permanent establishment. 

Paragraph 5 of the Protocol confirms that the arm’s length method of paragraphs 2 and 3 consists of applying the OECD Transfer 

Pricing Guidelines, but taking into account the different economic 

and legal circumstances of a single legal entity (as opposed to separate but associated enterprises). Thus, any of the methods used in 

the Transfer Pricing Guidelines, including profits methods, may be 

used as appropriate and in accordance with the Transfer Pricing 

Guidelines. However, the use of the Transfer Pricing Guidelines applies only for purposes of attributing profits within the legal entity. 

It does not create legal obligations or other tax consequences that 

would result from transactions having independent legal significance. 

For example, an entity that operates through branches rather 

than separate subsidiaries generally will have lower capital requirements because all of the assets of the entity are available to 

support all of the entity’s liabilities (with some exceptions attributable to local regulatory restrictions). This is the reason that most 

commercial banks and some insurance companies operate through 

branches rather than subsidiaries. The benefit that comes from 

such lower capital costs must be allocated among the branches in 

an appropriate manner. This issue does not arise in the case of an 

enterprise that operates through separate entities, since each entity will have to be separately capitalized or will have to compensate 

another entity for providing capital (usually through a guarantee). 

Under U.S. domestic regulations, internal ‘‘transactions’’ generally are not recognized because they do not have legal signifiVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00033 Fmt 6602 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
34 

cance. In contrast, the rule provided by the Convention is that such 

internal dealings may be used to attribute income to a permanent 

establishment in cases where the dealings accurately reflect the allocation of risk within the enterprise. One example is that of global 

trading in securities. In many cases, banks use internal swap 

transactions to transfer risk from one branch to a central location 

where traders have the expertise to manage that particular type of 

risk. Under the Convention, such a bank may also use such swap 

transactions as a means of attributing income between the 

branches, if use of that method is the ‘‘best method’’ within the 

meaning of Treas. Reg. section 1.482–1(c). The books of a branch 

will not be respected, however, when the results are inconsistent 

with a functional analysis. So, for example, income from a transaction that is booked in a particular branch (or home office) will 

not be treated as attributable to that location if the sales and risk 

management functions that generate the income are performed in 

another location. 

Because the use of profits methods is permissible under paragraph 2, it is not necessary for the Convention to include a provision corresponding to paragraph 4 of Article 7 of the OECD Model. 

Paragraph 3 

Paragraph 3 provides that in determining the business profits of 

a permanent establishment, deductions shall be allowed for the expenses incurred for the purposes of the permanent establishment, 

ensuring that business profits will be taxed on a net basis. This 

rule is not limited to expenses incurred exclusively for the purposes 

of the permanent establishment, but includes expenses incurred for 

the purposes of the enterprise as a whole, or that part of the enterprise that includes the permanent establishment. Deductions are to 

be allowed regardless of which accounting unit of the enterprise 

books the expenses, so long as they are incurred for the purposes 

of the permanent establishment. For example, a portion of the interest expense recorded on the books of the home office in one State 

may be deducted by a permanent establishment in the other if 

properly allocable thereto. The amount of expense that must be allowed as a deduction is determined by applying the arm’s length 

principle. As noted above with respect to paragraph 2 of Article 1 

(General Scope), if a deduction would be allowed under the Code 

in computing the U.S. taxable income, the deduction also is allowed 

in computing taxable income under the Convention. However, except where the Convention provides for more favorable treatment, 

a taxpayer cannot take deductions for expenses in computing taxable income under the Convention to a greater extent than would 

be allowed under the Code where doing so would be inconsistent 

with the intent of the Code. For example, assume that a Bulgarian 

taxpayer with a permanent establishment in the United States borrows $100 to purchase U.S. tax exempt bonds, and that the $100 

of tax-exempt bonds and the $100 of related debt would be treated 

as assets and liabilities of the permanent establishment. For purposes of computing the profits attributable to the permanent establishment under the Convention, both the tax exempt interest from 

the bonds and the interest expense from the related debt would be 

excluded. 

35 

As noted above, paragraph 5 of the Protocol provides that the 

OECD Transfer Pricing Guidelines apply, by analogy, in determining the profits attributable to a permanent establishment. Accordingly, a permanent establishment may deduct payments made 

to its head office or another branch in compensation for services 

performed for the benefit of the branch. The method to be used in 

calculating that amount will depend on the terms of the arrangements between the branches and head office. For example, the enterprise could have a policy, expressed in writing, under which 

each business unit could use the services of lawyers employed by 

the head office. At the end of each year, the costs of employing the 

lawyers would be charged to each business unit according to the 

amount of services used by that business unit during the year. 

Since this appears to be a kind of cost-sharing arrangement and 

the allocation of costs is based on the benefits received by each 

business unit, such a cost allocation would be an acceptable means 

of determining a permanent establishment’s deduction for legal expenses. Alternatively, the head office could agree to employ lawyers 

at its own risk, and to charge an arm’s length price for legal services performed for a particular business unit. If the lawyers were 

under-utilized, and the ‘‘fees’’ received from the business units were 

less than the cost of employing the lawyers, then the head office 

would bear the excess cost. If the ‘‘fees’’ exceeded the cost of employing the lawyers, then the head office would keep the excess to 

compensate it for assuming the risk of employing the lawyers. If 

the enterprise acted in accordance with this agreement, this method would be an acceptable alternative method for calculating a permanent establishment’s deduction for legal expenses. 

Paragraph 5 of the Protocol also makes clear that a permanent 

establishment cannot be funded entirely with debt, but must have 

sufficient capital to carry on its activities as if it were a distinct 

and separate enterprise. To the extent that the permanent establishment does not have such capital, a Contracting State may, for 

profit attribution purposes, attribute such capital to the permanent 

establishment in accordance with the arm’s length principle and 

deny an interest deduction to the extent necessary to reflect that 

capital attribution. The method prescribed by U.S. domestic law for 

making this attribution is found in Treas. Reg. section 1.882–5. 

Both section 1.882–5 and the method prescribed in the Convention 

start from the premise that all of the capital of the enterprise supports all of the assets and risks of the enterprise, and therefore the 

entire capital of the enterprise must be allocated to its various 

businesses and offices. 

However, section 1.882–5 does not take into account the fact that 

some assets create more risk for the enterprise than do other assets. An independent enterprise would need less capital to support 

a perfectly-hedged U.S. Treasury security than it would need to 

support an equity security or other asset with significant market 

and/or credit risk. Accordingly, in some cases section 1.882–5 would 

require a taxpayer to allocate more capital to the United States, 

and therefore would reduce the taxpayer’s interest deduction more, 

than is appropriate. To address these cases, paragraph 5 of the 

Protocol allows a taxpayer to apply a more flexible approach that 

takes into account the relative risk of its assets in the various juVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00035 Fmt 6602 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
36 

risdictions in which it does business. In particular, in the case of 

financial institutions other than insurance companies, the amount 

of capital attributable to a permanent establishment is determined 

by allocating the institution’s total equity between its various offices on the basis of the proportion of the financial institution’s 

risk-weighted assets attributable to each of them. This recognizes 

the fact that financial institutions are in many cases required to 

risk-weight their assets for regulatory purposes and, in other cases, 

will do so for business reasons even if not required to do so by regulators. However, risk-weighting is more complicated than the 

method prescribed by section 1.882–5. Accordingly, to ease this administrative burden, taxpayers may choose to apply the principles 

of Treas. Reg. section 1.882–5(c) to determine the amount of capital 

allocable to its U.S. permanent establishment, in lieu of determining its allocable capital under the risk-weighted capital allocation method provided by the Convention, even if it has otherwise 

chosen the principles of Article 7 rather than the effectively connected income rules of U.S. domestic law. 

Paragraph 4 

Paragraph 4 provides that no business profits can be attributed 

to a permanent establishment merely because it purchases goods or 

merchandise for the enterprise of which it is a part. This paragraph is essentially identical to paragraph 5 of Article 7 of the 

OECD Model. This rule applies only to an office that performs 

functions for the enterprise in addition to purchasing. The income 

attribution issue does not arise if the sole activity of the office is 

the purchase of goods or merchandise because such activity does 

not give rise to a permanent establishment under Article 5 (Permanent Establishment). A common situation in which paragraph 4 is 

relevant is one in which a permanent establishment purchases raw 

materials for the enterprise’s manufacturing operation conducted 

outside the United States and sells the manu≥factured product. 

While business profits may be attributable to the permanent establishment with respect to its sales activities, no profits are attributable to it with respect to its purchasing activities. 

Paragraph 5 

Paragraph 5 provides that profits shall be determined by the 

same method each year, unless there is good reason to change the 

method used. This rule assures consistent tax treatment over time 

for permanent establishments. It limits the ability of both the Contracting State and the enterprise to change accounting methods to 

be applied to the permanent establishment. It does not, however, 

restrict a Contracting State from imposing additional requirements, such as the rules under Code section 481, to prevent 

amounts from being duplicated or omitted following a change in accounting method. Such adjustments may be necessary, for example, 

if the taxpayer switches from using the domestic rules under section 864 in one year to using the rules of Article 7 in the next. Also, 

if the taxpayer switches from Convention-based rules to U.S. domestic rules, it may need to meet certain deadlines for making 

elections that are not necessary when applying the rules of the 

Convention. 

37 

Paragraph 6 

Paragraph 6 coordinates the provisions of Article 7 and other 

provisions of the Convention. Under this paragraph, when business 

profits include items of income that are dealt with separately under 

other articles of the Convention, the provisions of those articles 

will, except when they specifically provide to the contrary, take 

precedence over the provisions of Article 7. For example, the taxation of dividends will be determined by the rules of Article 10 

(Dividends), and not by Article 7, except where, as provided in 

paragraph 6 of Article 10, the dividend is attributable to a permanent establishment. In the latter case the provisions of Article 7 

apply. Thus, an enterprise of one State deriving dividends from the 

other State may not rely on Article 7 to exempt those dividends 

from tax at source if they are not attributable to a permanent establishment of the enterprise in the other State. By the same 

token, if the dividends are attributable to a permanent establishment in the other State, the dividends may be taxed on a net income basis at the source State full corporate tax rate, rather than 

on a gross basis under Article 10 (Dividends). 

As provided in Article 8 (International Traffic), income derived 

from shipping and air transport activities in international traffic 

described in that Article is taxable only in the country of residence 

of the enterprise regardless of whether it is attributable to a permanent establishment situated in the source State. 

The Convention incorporates the rule of Code section 864(c)(6). 

Like the Code section on which it is based, paragraph 5 of the Protocol provides that any income or gain attributable to a permanent 

establishment during its existence is taxable in the Contracting 

State where the permanent establishment is situated, even if the 

payment of that income or gain is deferred until after the permanent establishment ceases to exist. This rule applies with respect 

to Article 7 (Business Profits), paragraph 4 of Article 6 (Income 

from Immovable Property (Real Property)), paragraph 6 of Article 

10 (Dividends), paragraph 5 of Article 11 (Interest), paragraph 4 of 

Article 12 (Royalties), paragraph 3 of Article 13 (Capital Gains) 

and paragraph 2 of Article 20 (Other Income). 

The effect of this rule can be illustrated by the following example. Assume a company that is a resident of Bulgaria and that 

maintains a permanent establishment in the United States winds 

up the permanent establishment’s business and sells the permanent establishment’s inventory and assets to a U.S. buyer at the 

end of year 1 in exchange for an interest-bearing installment obligation payable in full at the end of year 3. Despite the fact that 

Article 13’s threshold requirement for U.S. taxation is not met in 

year 3 because the company has no permanent establishment in 

the United States, the United States may tax the deferred income 

payment recognized by the company in year 3. 

Relationship to other Articles 

This Article is subject to the saving clause of paragraph 4 of Article 1 (General Scope). Thus, if a citizen of the United States who 

is a resident of Bulgaria under the treaty derives business profits 

from the United States that are not attributable to a permanent establishment in the United States, the United States may, subject 

38 

to the special foreign tax credit rules of paragraph 4 of Article 22 

(Relief from Double Taxation), tax those profits, notwithstanding 

paragraph 1 of this Article, which would exempt the income from 

U.S. tax. 

The benefits of this Article are also subject to Article 21 (Limitation on Benefits). Thus, an enterprise of Bulgaria and that derives 

income effectively connected with a U.S. trade or business may not 

claim the benefits of Article 7 unless the resident carrying on the 

enterprise qualifies for such benefits under Article 21. 

ARTICLE 8 (INTERNATIONAL TRAFFIC)

This Article governs the taxation of profits from the operation of 

ships and aircraft in international traffic. The term ‘‘international 

traffic’’ is defined in subparagraph 1(j) of Article 3 (General Definitions). 

Paragraph 1 

Paragraph 1 provides that profits derived by an enterprise of a 

Contracting State from the operation in international traffic of 

ships or aircraft are taxable only in that Contracting State. Because paragraph 6 of Article 7 (Business Profits) defers to Article 

8 with respect to shipping income, such income derived by a resident of one of the Contracting States may not be taxed in the other 

State even if the enterprise has a permanent establishment in that 

other State. Thus, if a U.S. airline has a ticket office in Bulgaria, 

Bulgaria may not tax the airline’s profits attributable to that office 

under Article 7. Since entities engaged in international transportation activities normally will have many permanent establishments in a number of countries, the rule avoids difficulties that 

would be encountered in attributing income to multiple permanent 

establish≥ments if the income were covered by Article 7 (Business 

Profits). 

Paragraph 2 

The income from the operation of ships or aircraft in international traffic that is exempt from tax under paragraph 1 is defined in paragraph 2. 

In addition to income derived directly from the operation of ships 

and aircraft in international traffic, this definition also includes 

certain items of rental income. First, income of an enterprise of a 

Contracting State from the rental of ships or aircraft on a full basis 

(i.e., with crew) is income of the lessor from the operation of ships 

and aircraft in international traffic and, therefore, is exempt from 

tax in the other Contracting State under paragraph 1. Also, paragraph 2 encompasses income from the lease of ships or aircraft on 

a bareboat basis (i.e., without crew) when the income is incidental 

to other income of the lessor from the operation of ships or aircraft 

in international traffic. If the income is not incidental to other income of the lessor from the operation of ships or aircraft in international traffic, income from bareboat rentals would constitute 

business profits. 

Paragraph 6 of the Protocol clarifies, consistent with the U.S. 

Model and the Commentary to Article 8 of the OECD Model, that 

profits derived by an enterprise from the inland transport of tanVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00038 Fmt 6602 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
39 

gible property or passengers within either Contracting State is 

treated as profits from the operation of ships or aircraft in international traffic if such transport is undertaken as part of international traffic. Thus, if a U.S. shipping company contracts to carry 

property from Bulgaria to a U.S. city and, as part of that contract, 

it transports the property by truck from its point of origin to an 

airport in Bulgaria (or it contracts with a trucking company to 

carry the property to the airport) the income earned by the U.S. 

shipping company from the overland leg of the journey would be 

taxable only in the United States. Similarly, Article 8 also would 

apply to all of the income derived from a contract for the international transport of goods, even if the goods were transported to 

the port by a lighter, not by the vessel that carried the goods in 

international waters. 

Finally, certain non-transport activities that are an integral part 

of the services performed by a transport company, or are ancillary 

to the enterprise’s operation of ships or aircraft in international 

traffic, are understood to be covered in paragraph 1, though they 

are not specified in paragraph 2. These include, for example, the 

provision of goods and services by engineers, ground and equipment maintenance and staff, cargo handlers, catering staff and customer services personnel. Where the enterprise provides such goods 

to, or performs services for, other enterprises and such activities 

are directly connected with or ancillary to the enterprise’s operation of ships or aircraft in international traffic, the profits from 

the provision of such goods and services to other enterprises will 

fall under this paragraph. 

For example, enterprises engaged in the operation of ships or aircraft in international traffic may enter into pooling arrangements 

for the purposes of reducing the costs of maintaining facilities 

needed for the operation of their ships or aircraft in other countries. For instance, where an airline enterprise agrees (for example, 

under an International Airlines Technical Pool agreement) to provide spare parts or maintenance services to other airlines landing 

at a particular location (which allows it to benefit from these services at other locations), activities carried on pursuant to that agreement will be ancillary to the operation of aircraft in international 

traffic by the enterprise. 

Also, advertising that the enterprise may do for other enterprises 

in magazines offered aboard ships or aircraft that it operates in 

international traffic or at its business locations, such as ticket offices, is ancillary to its operation of these ships or aircraft. Profits 

generated by such advertising fall within this paragraph. Income 

earned by concessionaires, however, is not covered by Article 8. 

These interpretations of paragraph 1 also are consistent with the 

Commentary to Article 8 of the OECD Model. 

Paragraph 3 

Under this paragraph, profits of an enterprise of a Contracting 

State from the use, maintenance or rental of containers (including 

equipment for their transport) used for the transport of goods or 

merchandise are exempt from tax in the other Contracting State, 

unless those containers are used for transport solely in the other 

Contracting State. This result obtains under paragraph 3 regardVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00039 Fmt 6602 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
40 

less of whether the recipient of the income is engaged in the operation of ships or aircraft in international traffic, and regardless of 

whether the enterprise has a permanent establishment in the other 

Contracting State. Only income from the use, maintenance or rental of containers that is incidental to other income from international traffic is covered by Article 8 of the OECD Model. 

Paragraph 4 

This paragraph clarifies that the provisions of paragraphs 1 and 

3 also apply to profits derived by an enterprise of a Contracting 

State from participation in a pool, joint business or international 

operating agency. This refers to various arrangements for international cooperation by carriers in shipping and air transport. For 

example, airlines from two countries may agree to share the transport of passengers between the two countries. They each will fly 

the same number of flights per week and share the revenues from 

that route equally, regardless of the number of passengers that 

each airline actually transports. Paragraph 4 makes clear that with 

respect to each carrier the income dealt with in the Article is that 

carrier’s share of the total transport, not the income derived from 

the passengers actually carried by the airline. This paragraph corresponds to paragraph 4 of Article 8 of the OECD Model. 

Relationship to other Articles 

The taxation of gains from the alienation of ships, aircraft or containers is not dealt with in this Article but in paragraphs 4 and 

5 of Article 13 (Capital Gains). 

As with other benefits of the Convention, the benefit of exclusive 

residence country taxation under Article 8 is available to an enterprise only if it is entitled to benefits under Article 21 (Limitation 

on Benefits). 

This Article also is subject to the saving clause of paragraph 4 

of Article 1 (General Scope) of the Model. Thus, if a citizen of the 

United States who is a resident of Bulgaria derives profits from the 

operation of ships or aircraft in international traffic, notwithstanding the exclusive residence country taxation in paragraph 1 

of Article 8, the United States may, subject to the special foreign 

tax credit rules of paragraph 4 of Article 22 (Relief from Double 

Taxation), tax those profits as part of the worldwide income of the 

citizen. (This is an unlikely situation, however, because non-tax 

considerations (e.g., insurance) generally result in shipping activities being carried on in corporate form.) 

ARTICLE 9 (ASSOCIATED ENTERPRISES)

This Article incorporates in the Convention the arm’s-length 

principle reflected in the U.S. domestic transfer pricing provisions, 

particularly Code section 482. It provides that when related enterprises engage in a transaction on terms that are not arm’s-length, 

the Contracting States may make appropriate adjustments to the 

taxable income and tax liability of such related enterprises to reflect what the income and tax of these enterprises with respect to 

the transaction would have been had there been an arm’s-length 

relationship between them. 

41 

Paragraph 1 

This paragraph is essentially the same as its counterpart in the 

U.S. and OECD Models. It addresses the situation where an enterprise of a Contracting State is related to an enterprise of the other 

Contracting State, and there are arrangements or conditions imposed between the enterprises in their commercial or financial relations that are different from those that would have existed in the 

absence of the relationship. Under these circumstances, the Contracting States may adjust the income (or loss) of the enterprise to 

reflect what it would have been in the absence of such a relationship. 

The paragraph identifies the relationships between enterprises 

that serve as a prerequisite to application of the Article. As the 

Commentary to the OECD Model makes clear, the necessary element in these relationships is effective control, which is also the 

standard for purposes of section 482. Thus, the Article applies if an 

enterprise of one State participates directly or indirectly in the 

management, control, or capital of the enterprise of the other State. 

Also, the Article applies if any third person or persons participate 

directly or indirectly in the management, control, or capital of enterprises of different States. For this purpose, all types of control 

are included, i.e., whether or not legally enforceable and however 

exercised or exercisable. 

The fact that a transaction is entered into between such related 

enterprises does not, in and of itself, mean that a Contracting State 

may adjust the income (or loss) of one or both of the enterprises 

under the provisions of this Article. If the conditions of the transaction are consistent with those that would be made between independent persons, the income arising from that trans-action should 

not be subject to adjustment under this Article. 

Similarly, the fact that associated enterprises may have concluded arrangements, such as cost sharing arrangements or general services agreements, is not in itself an indication that the two 

enterprises have entered into a non-arm’s-length transaction that 

should give rise to an adjustment under paragraph 1. Both related 

and unrelated parties enter into such arrangements (e.g., joint venturers may share some development costs). As with any other kind 

of transaction, when related parties enter into an arrangement, the 

specific arrangement must be examined to see whether or not it 

meets the arm’s-length standard. In the event that it does not, an 

appropriate adjustment may be made, which may include modifying the terms of the agreement or re-characterizing the transaction to reflect its substance. 

It is understood that the ‘‘commensurate with income’’ standard 

for determining appropriate transfer prices for intangibles, added 

to Code section 482 by the Tax Reform Act of 1986, was designed 

to operate consistently with the arm’s-length standard. The implementation of this standard in the section 482 regulations is in accordance with the general principles of paragraph 1 of Article 9 of 

the Convention, as interpreted by the OECD Transfer Pricing 

Guidelines. 

This Article also permits tax authorities to deal with thin capitalization issues. They may, in the context of Article 9, scrutinize 

more than the rate of interest charged on a loan between related 

42 

persons. They also may examine the capital structure of an enterprise, whether a payment in respect of that loan should be treated 

as interest, and, if it is treated as interest, under what circumstances interest deductions should be allowed to the payor. 

Paragraph 3 of the Commentary to Article 9 of the OECD Model, 

together with the U.S. observation set forth in paragraph 15, sets 

forth a similar understanding of the scope of Article 9 in the context of thin capitalization. 

Paragraph 2 

When a Contracting State has made an adjustment that is consistent with the provisions of paragraph 1, and the other Contracting State agrees that the adjustment was appropriate to reflect arm’s-length conditions, that other Contracting State is obligated to make a correlative adjustment (sometimes referred to as 

a ‘‘corresponding adjustment’’) to the tax liability of the related person in that other Contracting State. Although the OECD Model 

does not specify that the other Contracting State must agree with 

the initial adjustment before it is obligated to make the correlative 

adjustment, the Commentary makes clear that the paragraph is to 

be read that way. 

As explained in the Commentary to Article 9 of the OECD Model, 

Article 9 leaves the treatment of ‘‘secondary adjustments’’ to the 

laws of the Contracting States. When an adjustment under Article 

9 has been made, one of the parties will have in its possession 

funds that it would not have had at arm’s length. The question 

arises as to how to treat these funds. In the United States the general practice is to treat such funds as a dividend or contribution to 

capital, depending on the relationship between the parties. Under 

certain circumstances, the parties may be permitted to restore the 

funds to the party that would have the funds had the transactions 

been entered into on arm’s length terms, and to establish an account payable pending restoration of the funds. See Rev. Proc. 99– 

32, 1999–2 C.B. 296. 

The Contracting State making a secondary adjustment will take 

the other provisions of the Convention, where relevant, into account. For example, if the effect of a secondary adjustment is to 

treat a U.S. corporation as having made a distribution of profits to 

its parent corporation in Bulgaria, the provisions of Article 10 

(Dividends) will apply, and the United States may impose a 5 percent withholding tax on the dividend. Also, if under Article 22 (Relief from Double Taxation) Bulgaria generally gives a credit for 

taxes paid with respect to such dividends, it would also be required 

to do so in this case. 

The competent authorities are authorized by paragraph 3 of Article 24 (Mutual Agreement Procedure) to consult, if necessary, to resolve any differences in the application of these provisions. For example, there may be a disagreement over whether an adjustment 

made by a Contracting State under paragraph 1 was appropriate. 

If a correlative adjustment is made under paragraph 2, it is to 

be implemented, pursuant to paragraph 2 of Article 24 (Mutual 

Agreement Procedure), notwithstanding any time limits or other 

procedural limitations in the law of the Contracting State making 

the adjustment. If a taxpayer has entered into a closing agreement 

43 

(or other written settlement) with the United States prior to bringing a case to the competent authorities, the U.S. competent authority will endeavor only to obtain a correlative adjustment from Bulgaria. See, Rev. Proc. 2006–54, 2006–2 C.B. 1035, Section 7.05. 

Relationship to other Articles 

The saving clause of paragraph 4 of Article 1 (General Scope) 

does not apply to paragraph 2 of Article 9 by virtue of an exception 

to the saving clause in subparagraph 5(a) of Article 1. Thus, even 

if the statute of limitations has run, a refund of tax can be made 

in order to implement a correlative adjustment. Statutory or procedural limitations, however, cannot be overridden to impose additional tax, because paragraph 2 of Article 1 provides that the Convention cannot restrict any statutory benefit. 

ARTICLE 10 (DIVIDENDS)

Article 10 provides rules for the taxation of dividends paid by a 

company that is a resident of one Contracting State to a beneficial 

owner that is a resident of the other Contracting State. The Article 

provides for full residence country taxation of such dividends and 

a limited source-State right to tax. Article 10 also provides rules 

for the imposition of a tax on branch profits by the State of source. 

Finally, the Article prohibits a State from imposing taxes on a company resident in the other Contracting State, other than a branch 

profits tax, on undistributed earnings. 

Paragraph 1 

The right of a shareholder’s country of residence to tax dividends 

arising in the source country is preserved by paragraph 1, which 

permits a Contracting State to tax its residents on dividends paid 

to them by a company that is a resident of the other Contracting 

State. For dividends from any other source paid to a resident, Article 20 (Other Income) grants the State of residence exclusive taxing 

jurisdiction (other than for dividends attributable to a permanent 

establishment in the other State). 

Paragraph 2 

The State of source also may tax dividends beneficially owned by 

a resident of the other State, subject to the limitations of paragraphs 2 and 4. Paragraph 2 generally limits the rate of withholding tax in the State of source on dividends paid by a company 

resident in that State to 10 percent of the gross amount of the dividend. If, however, the beneficial owner of the dividend is a company resident in the other State and owns directly shares representing at least 10 percent of the voting power of the company 

paying the dividend, then the rate of withholding tax in the State 

of source is limited to 5 percent of the gross amount of the dividend. Shares are considered voting shares if they provide the 

power to elect, appoint or replace any person vested with the powers ordinarily exercised by the board of directors of a U.S. corporation. 

The benefits of paragraph 2 may be granted at the time of payment by means of reduced rate of withholding tax at source. It also 

is consistent with the paragraph for tax to be withheld at the time 

44 

of payment at full statutory rates, and the treaty benefit to be 

granted by means of a subsequent refund so long as such procedures are applied in a reasonable manner. 

The determination of whether the ownership threshold for subparagraph 2(a) is met for purposes of the 5 percent maximum rate 

of withholding tax is made on the date on which entitlement to the 

dividend is determined. Thus, in the case of a dividend from a U.S. 

company, the determination of whether the ownership threshold is 

met generally would be made on the dividend record date. 

Paragraph 2 does not affect the taxation of the profits out of 

which the dividends are paid. The taxation by a Contracting State 

of the income of its resident companies is governed by the internal 

law of the Contracting State, subject to the provisions of paragraph 

4 of Article 23 (Non-Discrimination). 

The term ‘‘beneficial owner’’ is not defined in the Convention, 

and is, therefore, defined as under the internal law of the country 

imposing tax (i.e., the source country). The beneficial owner of the 

dividend for purposes of Article 10 is the person to which the dividend income is attributable for tax purposes under the laws of the 

source State. Thus, if a dividend paid by a corporation that is a 

resident of one of the States (as determined under Article 4 (Resident)) is received by a nominee or agent that is a resident of the 

other State on behalf of a person that is not a resident of that other 

State, the dividend is not entitled to the benefits of this Article. 

However, a dividend received by a nominee on behalf of a resident 

of that other State would be entitled to benefits. These limitations 

are confirmed by paragraph 12 of the Commentary to Article 10 of 

the OECD Model. 

Special rules, however, apply to shares that are held through fiscally transparent entities. In that case, the rules of paragraph 6 of 

Article 1 (General Scope) will apply to determine whether the dividends should be treated as having been derived by a resident of a 

Contracting State. Residence State principles shall be used to determine who derives the dividend, to assure that the dividends for 

which the source State grants benefits of the Convention will be 

taken into account for tax purposes by a resident of the residence 

State. Source state principles of beneficial ownership shall then 

apply to determine whether the person who derives the dividends, 

or another resident of the other Contracting State, is the beneficial 

owner of the dividend. The source State may conclude that the person who derives the dividend in the residence State is a mere 

nominee, agent, conduit, etc., for a third country resident and deny 

benefits of the Convention. If the person who derives the dividend 

under paragraph 6 of Article 1 would not be treated under the 

source State’s principles for determining beneficial ownership as a 

nominee, agent, custodian, conduit, etc., that person will be treated 

as the beneficial owner of the income, profits or gains for purposes 

of the Convention. 

Assume, for instance, that a company resident in Bulgaria pays 

a dividend to LLC, an entity which is treated as fiscally transparent for U.S. tax purposes but is treated as a company for Bulgarian tax purposes. USCo, a company incorporated in the United 

States, is the sole interest holder in LLC. Paragraph 6 of Article 

1 provides that USCo derives the dividend. Bulgaria’s principles of 

45 

beneficial ownership shall then be applied to USCo. If under the 

laws of Bulgaria USCo is found not to be the beneficial owner of 

the dividend, USCo will not be entitled to the benefits of Article 10 

with respect to such dividend. The payment may be entitled to benefits, however, if USCo is found to be a nominee, agent, custodian 

or conduit for a person who is a resident of the United States. 

Beyond identifying the person to whom the principles of beneficial ownership shall be applied, the principles of paragraph 6 of 

Article 1 will also apply when determining whether other requirements, such as the ownership threshold of subparagraph 2(a) have 

been satisfied. 

For example, assume that BulCo, a company that is a resident 

of Bulgaria, owns all of the outstanding shares in ThirdDE, an entity that is disregarded for U.S. tax purposes that is resident in a 

third country. ThirdDE owns 100% of the stock of USCo. Bulgaria 

views ThirdDE as fiscally transparent under its domestic law, and 

taxes BulCo currently on the income derived by ThirdDE. In this 

case, BulCo is treated as deriving the dividends paid by USCo 

under paragraph 6 of Article 1. Moreover, BulCo is treated as owning the shares of USCo directly. The Convention does not address 

what constitutes direct ownership for purposes of Article 10. As a 

result, whether ownership is direct is determined under the internal law of the country imposing tax (i.e., the source country) unless 

the context otherwise requires. Accordingly, a company that holds 

stock through such an entity will generally be considered to directly own such stock for purposes of Article 10. 

This result may change, however, if ThirdDE is regarded as nonfiscally transparent under the laws of Bulgaria. Assuming that 

ThirdDE is treated as non-fiscally transparent by Bulgaria, the income will not be treated as derived by a resident of Bulgaria for 

purposes of the Convention. However, ThirdDE may still be entitled to the benefits of the U.S. tax treaty, if any, with its country 

of residence. 

The same principles would apply in determining whether companies holding shares through fiscally transparent entities such as 

partnerships, trusts, and estates would qualify for benefits. As a result, companies holding shares through such entities may be able 

to claim the benefits of subparagraph (a) under certain circumstances. The lower rate applies when the company’s proportionate share of the shares held by the intermediate entity meets 

the 10 percent threshold, and the company meets the requirements 

of Article 1(6) (i.e., the company’s country of residence treats the 

intermediate entity as fiscally transparent) with respect to the dividend. Whether this ownership threshold is satisfied may be difficult to determine and often will require an analysis of the partnership or trust agreement. 

Paragraph 3 

Paragraph 3 imposes limitations on the rate reductions provided 

by paragraphs 2 and 4 in the case of dividends paid by a RIC or 

a REIT. 

The first sentence of subparagraph 3(a) provides that dividends 

paid by a RIC or a REIT are not eligible for the 5 percent rate of 

withholding tax of subparagraph 2(a). 

46 

The second sentence of subparagraph 3(a) provides that the 10 

percent maximum rate of withholding tax of subparagraph 2(b) applies to dividends paid by RICs and that the elimination of sourcecountry withholding tax of paragraph 4 applies to dividends paid 

by RICs and beneficially owned by a pension fund.The third sentence of subparagraph 3(a) provides that the 10 percent rate of 

withholding tax also applies to dividends paid by a REIT, and that 

the elimination of source-country withholding tax of paragraph 4 

applies to dividends paid by REITs and beneficially owned by a 

pension fund, provided that one of the three following conditions is 

met. First, the beneficial owner of the dividend is an individual or 

a pension fund, in either case holding an interest of not more than 

10 percent in the REIT. Second, the dividend is paid with respect 

to a class of stock that is publicly traded and the beneficial owner 

of the dividend is a person holding an interest of not more than 5 

percent of any class of the REIT’s shares. Third, the beneficial 

owner of the dividend holds an interest in the REIT of not more 

than 10 percent and the REIT is ‘‘diversified.’’ 

A REIT is diversified if the gross value of no single interest in 

real property held by the REIT exceeds 10 percent of the gross 

value of the REIT’s total interest in real property. Foreclosure 

property is not considered an interest in real property, and a REIT 

holding a partnership interest is treated as owning its proportionate share of any interest in real property held by the partnership. 

Subparagraph (b) provides that the rules of subparagraph (a) 

shall also apply to dividends paid by companies resident in Bulgaria that are similar to a RIC or a REIT. Whether companies that 

are residents of Bulgaria are similar to RICs or REITs will be determined by mutual agreement of the competent authorities.The 

restrictions set out above are intended to prevent the use of these 

entities to gain inappropriate tax benefits. For example, a company 

resident in Bulgaria that wishes to hold a diversified portfolio of 

U.S. corporate shares could hold the portfolio directly and would 

bear a U.S. withholding tax of 10 percent on all of the dividends 

that it receives. Alternatively, it could hold the same diversified 

portfolio by purchasing 10 percent or more of the interests in a 

RIC. If the RIC is a pure conduit, there may be no U.S. tax cost 

to interposing the RIC in the chain of ownership. Absent the special rule in paragraph 3, such use of the RIC could transform portfolio dividends, taxable in the United States under the Convention 

at a 10 percent maximum rate of withholding tax, into direct investment dividends taxable at a 5 percent maximum rate of withholding tax. 

Similarly, a resident of Bulgaria directly holding U.S. real property would pay U.S. tax upon the sale of the property either at a 

30 percent rate of withholding tax on the gross income or at graduated rates on the net income. As in the preceding example, by 

placing the real property in a REIT, the investor could, absent a 

special rule, transform income from the sale of real estate into dividend income from the REIT, taxable at the rates provided in Article 10, significantly reducing the U.S. tax that otherwise would be 

imposed. Paragraph 3 prevents this result and thereby avoids a 

disparity between the taxation of direct real estate investments 

47 

and real estate investments made through REIT conduits. In the 

cases in which paragraph 3 allows a dividend from a REIT to be 

eligible for the 10 percent rate of withholding tax, the holding in 

the REIT is not considered the equivalent of a direct holding in the 

underlying real property. 

Paragraph 4 

Paragraph 4 provides that, notwithstanding paragraph 2, the 

State of source will not tax dividends beneficially owned by a pension fund resident in the other Contracting State, unless such dividends are derived from the carrying on of a business by the pension fund or from an associated enterprise that is not itself a pension fund resident in the other Contracting State. For these purposes, the term ‘‘pension fund’’ is defined in subparagraph 1(m) of 

Article 3 (General Definitions). 

The exemption is provided because pension funds normally do 

not pay tax (either through a general exemption or because reserves for future pension liabilities effectively offset all of the 

fund’s income), and therefore cannot benefit from a foreign tax 

credit. Moreover, distributions from a pension fund generally do 

not maintain the character of the underlying income, so the beneficiaries of the pension are not in a position to claim a foreign tax 

credit when they finally receive the pension, in many cases years 

after the withholding tax has been paid. Accordingly, in the absence of this rule, the dividends would almost certainly be subject 

to unrelieved double taxation. 

Paragraph 5 

Paragraph 5 defines the term dividends broadly and flexibly. The 

definition is intended to cover all arrangements that yield a return 

on an equity investment in a corporation as determined under the 

tax law of the state of source, as well as arrangements that might 

be developed in the future. 

The term includes income from shares, or other corporate rights 

that are not treated as debt under the law of the source State, that 

participate in the profits of the company. The term also includes 

income that is subjected to the same tax treatment as income from 

shares by the law of the State of source. Thus, a constructive dividend that results from a non-arm’s length transaction between a 

corporation and a related party is a dividend. In the case of the 

United States the term dividend includes amounts treated as a dividend under U.S. law upon the sale or redemption of shares or 

upon a transfer of shares in a reorganization. See, e.g., Rev. Rul. 

92–85, 1992–2 C.B. 69 (sale of foreign subsidiary’s stock to U.S. sister company is a deemed dividend to extent of the subsidiary’s and 

sister company’s earnings and profits). Further, a distribution from 

a U.S. publicly traded limited partnership, which is taxed as a corporation under U.S. law, is a dividend for purposes of Article 10. 

However, a distribution by a limited liability company is not taxable by the United States under Article 10, provided the limited liability company is not characterized as an association taxable as a 

corporation under U.S. law. 

Finally, a payment denominated as interest that is made by a 

thinly capitalized corporation may be treated as a dividend to the 

48 

extent that the debt is recharacterized as equity under the laws of 

the source State. 

Paragraph 6 

Paragraph 6 provides a rule for taxing dividends paid with respect to holdings that form part of the business property of a permanent establishment. In such case, the rules of Article 7 (Business Profits) shall apply. Accordingly, the dividends will be taxed 

on a net basis using the rates and rules of taxation generally applicable to residents of the State in which the permanent establishment is located, as such rules may be modified by the Convention. 

An example of dividends paid with respect to the business property 

of a permanent establishment would be dividends derived by a 

dealer in stock or securities from stock or securities that the dealer 

held for sale to customers. 

Paragraph 7 

The right of a Contracting State to tax dividends paid by a company that is a resident of the other Contracting State is restricted 

by paragraph 7 to cases in which the dividends are paid to a resident of that Contracting State or are attributable to a permanent 

establishment in that Contracting State. Thus, a Contracting State 

may not impose a ‘‘secondary’’ withholding tax on dividends paid by 

a nonresident company out of earnings and profits from that Contracting State. 

The paragraph also restricts the right of a Contracting State to 

impose corporate level taxes on undistributed profits, other than a 

branch profits tax. The paragraph does not restrict a State’s right 

to tax its resident shareholders on undistributed earnings of a corporation resident in the other State. Thus, the authority of the 

United States to impose taxes on subpart F income and on earnings deemed invested in U.S. property, and its tax on income of a 

passive foreign investment company that is a qualified electing 

fund is in no way restricted by this provision. 

Paragraph 8 

Paragraph 8 permits a Contracting State to impose a branch 

profits tax on a company resident in the other Contracting State. 

The tax is in addition to other taxes permitted by the Convention. 

The term ‘‘company’’ is defined in subparagraph 1(e) of Article 3 

(General Definitions). 

A Contracting State may impose a branch profits tax on a company if the company has income attributable to a permanent establishment in that Contracting State, derives income from real property in that Contracting State that is taxed on a net basis under 

Article 6 (Income from Immovable Property (Real Property)), or realizes gains taxable in that State under paragraph 1 of Article 13 

(Capital Gains). In the case of the United States, the imposition of 

such tax is limited, however, to the portion of the aforementioned 

items of income that represents the amount of such income that is 

the ‘‘dividend equivalent amount.’’ This is consistent with the relevant rules under the U.S. branch profits tax, and the term dividend equivalent amount is defined under U.S. law. Section 884 defines the dividend equivalent amount as an amount for a particular 

49 

year that is equivalent to the income described above that is included in the corporation’s effectively connected earnings and profits for that year, after payment of the corporate tax under Article 

6, Article 7, or Article 13, reduced for any increase in the branch’s 

U.S. net equity during the year or increased for any reduction in 

its U.S. net equity during the year. U.S. net equity is U.S. assets 

less U.S. liabilities. See Treas. Reg. section 1.884–1. 

The dividend equivalent amount for any year approximates the 

dividend that a U.S. branch office would have paid during the year 

if the branch had been operated as a separate U.S. subsidiary company. If Bulgaria also imposes a branch profits tax, the base of its 

tax must be limited to an amount that is analogous to the dividend 

equivalent amount. 

As discussed in the Technical Explanation to paragraph 2 of Article 1, consistency principles require that a taxpayer may not use 

both treaty and Code rules where doing so would thwart the intent 

of either set of rules. In the context of the branch profits tax, the 

consistency requirement means that an enterprise that uses the 

principles of Article 7 to determine its net taxable income also 

must use those principles in determining the dividend equivalent 

amount. Similarly, an enterprise that uses U.S. domestic law to determine its net taxable income must also use U.S. domestic law in 

complying with the branch profits tax. As in the case of Article 7, 

if an enterprise switches between domestic law and treaty principles from year to year, it will need to make appropriate adjustments or recapture amounts that otherwise might go untaxed. 

Subparagraph b) provides that the branch profits tax shall not 

be imposed at a rate exceeding the direct investment dividend 

withholding rate of five percent. 

Relationship to other Articles 

Notwithstanding the foregoing limitations on source country taxation of dividends, the saving clause of paragraph 4 of Article 1 

permits the United States to tax dividends received by its residents 

and citizens, subject to the special foreign tax credit rules of paragraph 4 of Article 22 (Relief from Double Taxation), as if the Convention had not come into effect. 

The benefits of this Article are also subject to the provisions of 

Article 21 (Limitation on Benefits). Thus, if a resident of the other 

Contracting State is the beneficial owner of dividends paid by a 

U.S. corporation, the shareholder must qualify for treaty benefits 

under at least one of the tests of Article 21 in order to receive the 

benefits of this Article. 

ARTICLE 11 (INTEREST)

Article 11 specifies the taxing jurisdictions over interest arising 

in one Contracting State and paid to a resident of the other Contracting State. 

Paragraph 1 

Paragraph 1 generally grants to the State of residence the nonexclusive right to tax interest arising in the other Contracting 

State and paid to its residents. 

50 

Paragraph 2 

Paragraph 2 provides that the State of source also may tax the 

interest, but if the interest is beneficially owned by a resident of 

the other Contracting State, the rate of tax will be limited to 5 percent of the gross amount of the interest. 

The term ‘‘beneficial owner’’ is not defined in the Convention, 

and is, therefore, defined under the internal law of the State of 

source. The beneficial owner of the interest for purposes of Article 

11 is the person to which the income is attributable under the laws 

of the source State. Thus, if interest arising in a Contracting State 

is received by a nominee or agent that is a resident of the other 

State on behalf of a person that is not a resident of that other 

State, the interest is not entitled to the benefits of Article 11. However, interest received by a nominee on behalf of a resident of that 

other State would be entitled to benefits. These limitations are confirmed by paragraph 9 of the OECD Commentary to Article 11. 

Paragraph 3 

Paragraph (3) provides for exclusive residence-based taxation in 

certain cases. 

Under subparagraph (a), interest beneficially owned by a Contracting State, a political subdivision, or a local authority thereof 

(i.e., in the United States, a State or local government), the central 

bank of that Contracting State or any institution wholly owned by 

that Contracting State is subject to exclusive residence-based taxation. 

Under subparagraph (b), interest beneficially owned by a resident of a Contracting State with respect to debt-claims guaranteed, 

insured or indirectly financed by the Contracting State, a political 

subdivision or a local authority thereof, the central bank of that 

Contracting State or any institution wholly owned by that Contracting State is subject to exclusive residence-based taxation. 

Under subparagraph (c), interest beneficially owned by any financial institution, including, for example, a bank or an insurance 

company, is subject to exclusive residence-based taxation, unless 

the interest is paid as a part of a back-to-back loan or an arrangement that is economically similar to and has the effect of a backto-back loan. Paragraph 8 of the Protocol clarifies that the term 

‘‘back-to-back loan’’ as used in subparagraph c) means a loan structured to obtain the benefits of subparagraph c) in which the loan 

is made to a financial institution that in turn lends the funds directly to the intended borrower. By referencing arrangements that 

are economically similar to, and that have the effect of, a back-toback loan, paragraph (3)(c) reaches transactions that would not 

meet the legal requirements of a loan, but would nevertheless serve 

that purpose economically. For example, the term would encompass 

securities issued at a discount, or certain swap arrangements intended to operate as the economic equivalent of a back to-back 

loan. In addition, nothing in Article 11 is intended to limit the ability of the Contracting States to enforce their domestic anti-avoidance provisions. 

Subparagraph (d) provides for exclusive residence-based taxation 

of interest beneficially owned by a pension fund resident in the 

other Contracting State, provided that the interest is not derived 

51 

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

pension fund. 

Paragraph 4 

The term ‘‘interest’’ as used in Article 11 is defined in paragraph 

4 to include, inter alia, income from debt claims of every kind, 

whether or not secured by a mortgage. Penalty charges for late 

payment are excluded from the definition of interest. Interest that 

is paid or accrued subject to a contingency is within the ambit of 

Article 11. This includes income from a debt obligation carrying the 

right to participate in profits. The term does not, however, include 

amounts that are treated as dividends under Article 10 (Dividends). 

The term interest also includes amounts subject to the same tax 

treatment as income from money lent under the law of the State 

in which the income arises. Thus, for purposes of the Convention, 

amounts that the United States will treat as interest include (i) the 

difference between the issue price and the stated redemption price 

at maturity of a debt instrument (i.e., original issue discount 

(‘‘OID’’)), which may be wholly or partially realized on the disposition of a debt instrument (section 1273), (ii) amounts that are imputed interest on a deferred sales contract (section 483), (iii) 

amounts treated as interest or OID under the stripped bond rules 

(section 1286), (iv) amounts treated as original issue discount 

under the below-market interest rate rules (section 7872), (v) a 

partner’s distributive share of a partnership’s interest income (section 702), (vi) the interest portion of periodic payments made under 

a ‘‘finance lease’’ or similar contractual arrangement that in substance is a borrowing by the nominal lessee to finance the acquisition of property, (vii) amounts included in the income of a holder 

of a residual interest in a REMIC (section 860E), because these 

amounts generally are subject to the same taxation treatment as 

interest under U.S. tax law, and (viii) interest with respect to notional principal contracts that are re-characterized as loans because 

of a ‘‘substantial non-periodic payment.’’ 

Paragraph 5 

Paragraph 5 provides an exception to the rules of paragraphs 1, 

2 and 3 in cases where the beneficial owner of the interest carries 

on business through a permanent establishment in the State of 

source and the interest is attributable to that permanent establishment. In such cases the provisions of Article 7 (Business Profits) 

will apply and the State of source will retain the right to impose 

tax on such interest income. 

In the case of a permanent establishment that once existed in 

the State but that no longer exists, the provisions of paragraph 5 

also apply to interest that would be attributable to such a permanent establishment if it did exist in the year of payment or accrual. 

See the Technical Explanation to Article 7. 

Paragraph 6 

Paragraph 6 provides a source rule for determining the source of 

interest that is identical in substance to the interest source rule of 

the OECD Model. Interest is considered to arise in a Contracting 

52 

State if paid by a resident of that State. As an exception, interest 

on a debt incurred in connection with a permanent establishment 

in one of the States and borne by the permanent establishment is 

considered to arise in that State. For this purpose, interest is considered to be borne by a permanent establishment if it is allocable 

to taxable income of that permanent establishment. 

Paragraph 7 

Paragraph 7 provides that in cases involving special relationships between the payor and the beneficial owner of interest income, Article 11 applies only to that portion of the total interest 

payments that would have been made absent such special relationships (i.e., an arm’s-length interest payment). Any excess amount 

of interest paid remains taxable according to the laws of the United 

States and Bulgaria, respectively, with due regard to the other provisions of the Convention. Thus, if the excess amount would be 

treated under the source country’s law as a distribution of profits 

by a corporation, such amount could be taxed as a dividend rather 

than as interest, but the tax would be subject, if appropriate, to the 

rate limitations of paragraph 2 of Article 10. 

The term ‘‘special relationship’’ is not defined in the Convention. 

In applying this paragraph the United States considers the term to 

include the relationships described in Article 9, which in turn corresponds to the definition of ‘‘control’’ for purposes of section 482 

of the Code. 

This paragraph does not address cases where, owing to a special 

relationship between the payor and the beneficial owner or between 

both of them and some other person, the amount of the interest is 

less than an arm’s-length amount. In those cases a transaction may 

be characterized to reflect its substance and interest may be imputed consistent with the definition of interest in paragraph 4. The 

United States would apply section 482 or 7872 of the Code to determine the amount of imputed interest in those cases. 

Paragraph 8 

Paragraph 8 provides anti-abuse exceptions to the rules of paragraphs 2 and 3 for two classes of interest payments. 

The first class of interest, dealt with in subparagraphs (a) and 

(b) is so-called ‘‘contingent interest.’’ With respect to interest arising in the United States, subparagraph (a) refers to contingent interest of a type that does not qualify as portfolio interest under 

U.S. domestic law. The cross-reference to the U.S. definition of contingent interest, which is found in section 871 (h)(4) of the Code, 

is intended to ensure that the exceptions of section 871 (h)(4)(c) 

will be applicable. With respect to Bulgaria, such interest is defined in subparagraph (b) as any interest arising in Bulgaria that 

is determined by reference to the receipts, sales, income, profits or 

other cash flow of the debtor or a related person, to any change in 

the value of any property of the debtor or a related person or to 

any dividend, partnership distribution or similar payment made by 

the debtor or a related person. Any interest dealt with in subparagraphs (a) and (b) may be taxed in the source State at a rate not 

exceeding 10 percent of the gross amount of the interest. 

53 

The second class of interest is dealt with in subparagraph 8(c). 

This exception is consistent with the policy of Code sections 

860E(e) and 860G(b) that excess inclusions with respect to a real 

estate mortgage investment conduit (REMIC) should bear full U.S. 

tax in all cases. Without a full tax at source foreign purchasers of 

residual interests would have a competitive advantage over U.S. 

purchasers at the time these interests are initially offered. Also, 

absent this rule, the U.S. fisc would suffer a revenue loss with respect to mortgages held in a REMIC because of opportunities for 

tax avoidance created by differences in the timing of taxable and 

economic income produced by these interests. 

Paragraph 9 

Paragraph 9 permits a Contracting State to impose its branch 

level interest tax on a corporation resident in the other Contracting 

State. The base of this tax is the excess, if any, of the interest deductible in the first-mentioned Contracting State in computing the 

profits of the corporation that are subject to tax in the first-mentioned Contracting State and either attributable to a permanent establishment in the first-mentioned Contracting State or subject to 

tax in the first-mentioned Contracting State under Article 6 or Article 13 of the Convention over the interest paid by the permanent 

establishment or trade or business in the first-mentioned Contracting State. Such excess interest may be taxed as if it were interest arising in the first-mentioned Contracting State and beneficially owned by the corporation resident in the other Contracting 

State. Thus, such excess interest may be taxed by the Contracting 

State of source at a rate not to exceed the 5 percent rate provided 

for in paragraph 2, and shall be exempt from tax by the Contracting State of source if the recipient is described in paragraph 

3. 

Relationship to other Articles 

Notwithstanding the foregoing limitations on source country taxation of interest, the saving clause of paragraph 4 of Article 1 (General Scope) permits the United States to tax its residents and citizens, subject to the special foreign tax credit rules of paragraph 4 

of Article 22 (Relief from Double Taxation), as if the Convention 

had not come into force. 

As with other benefits of the Convention, the benefits of this Article are available to a resident of the other State only if that resident is entitled to those benefits under the provisions of Article 21 

(Limitation on Benefits). 

Agreement to Reconsider Withholding Rates 

The Convention permits positive rates of taxation on interest and 

royalties. Paragraph 7 of the Protocol evidences the agreement of 

the Contracting States to reconsider the provisions of Article 11 

and Article 12 with respect to interest and royalties arising in Bulgaria where the beneficial owner of the income is a U.S. resident. 

Such reconsideration is permitted to occur at an appropriate time, 

consistent with the December 31, 2014 conclusion of the transition 

period applicable to interest and royalties deemed to arise in Bulgaria that are beneficially owned by a resident of the European 

54 

Union pursuant to Council Directive 2003/49/EC of 3 June 2003, on 

a common system of taxation applicable to interest and royalty 

payments made between associated companies of different Member 

States. 

ARTICLE 12 (ROYALTIES)

Article 12 provides rules for the taxation of royalties arising in 

one Contracting State and paid to a resident of the other Contracting State. 

Paragraph 1 

Paragraph 1 grants the State of residence the non-exclusive right 

to tax a royalty arising in the other Contracting State and paid to 

its residents. 

Paragraph 2 

Paragraph 2 allows the State of source to tax royalties arising in 

that State. If, however, the beneficial owner of the royalty is a resident of the other Contracting State, the tax may not exceed 5 percent of the gross amount of the royalties. 

The term ‘‘beneficial owner’’ is not defined in the Convention, 

and is, therefore, defined under the internal law of the State of 

source. The beneficial owner of the royalty for purposes of Article 

12 is the person to which the income is attributable under the laws 

of the source State. Thus, if a royalty arising in a Contracting 

State is received by a nominee or agent that is a resident of the 

other State on behalf of a person that is not a resident of that other 

State, the royalty is not entitled to the benefits of Article 12. However, a royalty received by a nominee on behalf of a resident of that 

other State would be entitled to benefits. These limitations are confirmed by paragraph 4 of the OECD Commentary to Article 12. 

Paragraph 3 

The term ‘‘royalties’’ as used in this Article means: 

Paragraph 3 defines the term ‘‘royalties,’’ as used in Article 12, 

to include any consideration for the use of, or the right to use, any 

copyright of literary, artistic, scientific or other work (including 

cinematographic films and films, tapes or other means of image or 

sound reproduction for radio or television broadcasting), any patent, trademark, design or model, plan, secret formula or process, or 

for information concerning industrial, commercial, or scientific experience. The term ‘‘royalties’’ also includes gain derived from the 

alienation of any right or property that would give rise to royalties, 

to the extent the gain is contingent on the productivity, use, or further alienation thereof. Gains that are not so contingent are dealt 

with under Article 13 (Capital Gains). The term ‘‘royalties,’’ however, does not include income from leasing personal property. 

The term royalties is defined in the Convention and therefore is 

generally independent of domestic law. Certain terms used in the 

definition are not defined in the Convention, but these may be defined under domestic tax law. For example, the term ‘‘secret process or formulas’’ is found in the Code, and its meaning has been 

elaborated in the context of sections 351 and 367. See Rev. Rul. 55- 

55 

17, 1955–1 C.B. 388; Rev. Rul. 64–56, 1964–1 C.B. 133; Rev. Proc. 

69- 19, 1969–2 C.B. 301. 

Consideration for the use or right to use cinematographic films, 

or works on film, tape, or other means of reproduction in radio or 

television broadcasting is specifically included in the definition of 

royalties. It is intended that, with respect to any subsequent technological advances in the field of radio or television broadcasting, 

consideration received for the use of such technology will also be 

included in the definition of royalties. 

If an artist who is resident in one Contracting State records a 

performance in the other Contracting State, retains a copyrighted 

interest in a recording, and receives payments for the right to use 

the recording based on the sale or public playing of the recording, 

then the right of such other Contracting State to tax those payments is governed by Article 12. See Boulez v. Commissioner, 83 

T.C. 584 (1984), aff’d, 810 F.2d 209 (D.C. Cir. 1986). By contrast, 

if the artist earns in the other Contracting State income covered 

by Article 16 (Entertainers and Sportsmen), for example, endorsement income from the artist’s attendance at a film screening, and 

if such income also is attributable to one of the rights described in 

Article 12 (e.g., the use of the artist’s photograph in promoting the 

screening), Article 16 and not Article 12 is applicable to such income. 

Computer software generally is protected by copyright laws 

around the world. Under the Convention, consideration received for 

the use, or the right to use, computer software is treated either as 

royalties or as business profits, depending on the facts and circumstances of the transaction giving rise to the payment. 

The primary factor in determining whether consideration received for the use, or the right to use, computer software is treated 

as royalties or as business profits is the nature of the rights transferred. See Treas. Reg. section 1.861–18. The fact that the transaction is characterized as a license for copyright law purposes is 

not dispositive. For example, a typical retail sale of ‘‘shrink wrap’’ 

software generally will not be considered to give rise to royalty income, even though for copyright law purposes it may be characterized as a license. 

The means by which the computer software is transferred are not 

relevant for purposes of the analysis. Consequently, if software is 

electronically transferred but the rights obtained by the transferee 

are substantially equivalent to rights in a program copy, the payment will be considered business profits.The term ‘‘industrial, commercial, or scientific experience’’ (sometimes referred to as ‘‘knowhow’’) has the meaning ascribed to it in paragraph 11 et seq. of the 

Commentary to Article 12 of the OECD Model. Consistent with 

that meaning, the term may include information that is ancillary 

to a right otherwise giving rise to royalties, such as a patent or secret process. 

Know-how also may include, in limited cases, technical information that is conveyed through technical or consultancy services. It 

does not include general educational training of the user’s employees, nor does it include information developed especially for the 

user, such as a technical plan or design developed according to the 

user’s specifications. Thus, as provided in paragraph 11.4 of the 

56 

Commentary to Article 12 of the OECD Model, the term ‘‘royalties’’ 

does not include payments received as consideration for after-sales 

service, for services rendered by a seller to a purchaser under a 

warranty, or for pure technical assistance. 

The term ‘‘royalties’’ also does not include payments for professional services (such as architectural, engineering, legal, managerial, medical, software development services). For example, income 

from the design of a refinery by an engineer (even if the engineer 

employed know-how in the process of rendering the design) or the 

production of a legal brief by a lawyer is not income from the transfer of know-how taxable under Article 12, but is income from services taxable under either Article 7 (Business Profits) or Article 14 

(Income from Employment). Professional services may be embodied 

in property that gives rise to royalties, however. Thus, if a professional contracts to develop patentable property and retains rights 

in the resulting property under the development contract, subsequent license payments made for those rights would be royalties. 

Paragraph 4 

This paragraph provides an exception to the manner of allocating 

taxing rights specified in paragraphs 1 and 2 in cases where the 

beneficial owner of the royalties carries on business through a permanent establishment in the State of source and the royalties are 

attributable to that permanent establishment. In such cases the 

provisions of Article 7 (Business Profits) will apply. 

The provisions of paragraph 5 of the Protocol, regarding Article 

7 (Business Profits), apply to this paragraph. For example, royalty 

income that is attributable to a permanent establishment and that 

accrues during the existence of the permanent establishment, but 

is re-ceived after the permanent establishment no longer exists, remains taxable under the provisions of Article 7 (Business Profits), 

and not under this Article. 

Paragraph 5 

Paragraph 5 contains a source rule for determining the source of 

royalties. Under paragraph 5, royalties are treated as arising in a 

Contracting State if paid by a resident of that State. As an exception, royalties that are attributable to a permanent establishment 

in a Contracting State and borne by the permanent establishment 

are considered to arise in that State. Where, however, the payor of 

the royalties is not a resident of either Contracting State, and the 

royalties are not borne by a permanent establishment in either 

Contracting State, but the royalties relate to the use of, or the 

right to use, in one of the Contracting States, any property or right 

described in paragraph 3, the royalties are deemed to arise in that 

State. 

Paragraph 6 

Paragraph 6 provides that in cases involving special relationships between the payor and beneficial owner of royalties, Article 

12 applies only to the extent the royalties would have been paid 

absent such special relationships (i.e., an arm’s-length royalty). 

Any excess amount of royalties paid remains taxable according to 

the laws of the two Contracting States, with due regard to the 

57 

other provisions of the Convention. If, for example, the excess 

amount is treated as a distribution of corporate profits under domestic law, such excess amount will be taxed as a dividend rather 

than as royalties, but the tax imposed on the dividend payment 

will be subject to the rate limitations of paragraph 2 of Article 10 

(Dividends). 

Relationship to other Articles 

Notwithstanding the foregoing limitations on source country taxation of royalties, the saving clause of paragraph 4 of Article 1 

(General Scope) permits the United States to tax its residents and 

citizens, subject to the special foreign tax credit rules of paragraph 

4 of Article 22 (Relief from Double Taxation), as if the Convention 

had not come into force. 

As with other benefits of the Convention, the benefits of Article 

12 are available to a resident of the other State only if that resident is entitled to those benefits under Article 21 (Limitation on 

Benefits).Agreement to Reconsider Withholding Rates 

The Convention permits positive rates of taxation on interest and 

royalties. Paragraph 7 of the Protocol evidences the agreement of 

the Contracting States to reconsider the provisions of Article 11 

and Article 12 with respect to interest and royalties arising in Bulgaria where the beneficial owner of the income is a U.S. resident. 

Such reconsideration is permitted to occur at an appropriate time, 

consistent with the December 31, 2014 conclusion of the transition 

period applicable to interest and royalties deemed to arise in Bulgaria that are beneficially owned by a resident of the European 

Union pursuant to Council Directive 2003/49/EC of 3 June 2003, on 

a common system of taxation applicable to interest and royalty 

payments made between associated companies of different Member 

States. 

ARTICLE 13 (CAPITAL GAINS)

Article 13 assigns either primary or exclusive taxing jurisdiction 

over gains from the alienation of property to the State of residence 

or the State of source. 

Paragraph 1 

Paragraph 1 of Article 13 preserves the non-exclusive right of the 

State of source to tax gains attributable to the alienation of real 

property situated in that State. The paragraph therefore permits 

the United States to apply section 897 of the Code to tax gains derived by a resident of Bulgaria that are attributable to the alienation of real property situated in the United States (as defined in 

paragraph 2). Gains attributable to the alienation of real property 

include gains from any other property that is treated as a real 

property interest within the meaning of paragraph 2. 

Paragraph 1 refers to gains ‘‘attributable to the alienation of immovable property (real property)’’ rather than the OECD Model 

phrase ‘‘gains from the alienation’’ to clarify that the United States 

will look through distributions made by a REIT and certain RICs. 

Accordingly, distributions made by a REIT or certain RICs are taxable under paragraph 1 of Article 13 (not under Article 10 (DiviVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00057 Fmt 6602 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
58 

dends)) when they are attributable to gains derived from the alienation of real property. 

Paragraph 2 

This paragraph defines the term ‘‘immovable property (real property) situated in the other Contracting State.’’ The term includes 

real property referred to in Article 6 (i.e., an interest in the real 

property itself), a ‘‘United States real property interest’’ (when the 

United States is the other Contracting State under paragraph 1), 

and, as specified in paragraph 2(c), an equivalent interest in immovable property (real property) situated in Bulgaria. 

Under section 897(c) of the Code the term ‘‘United States real 

property interest’’ includes shares in a U.S. corporation that owns 

sufficient U.S. real property interests to satisfy an asset-ratio test 

on certain testing dates. The term also includes certain foreign corporations that have elected to be treated as U.S. corporations for 

this purpose. Section 897(i). 

Section 897(c)(3) provides that, in certain situations stock regularly traded on an established securities market will not be treated 

as a U.S. real property interest, even if the stock derives its value 

primarily from U.S. real property. With respect to Bulgaria, subparagraph 2(c)(i) of Article 13, provides an analogous carve-out in 

the case of stock regularly traded on an established securities market. The term ‘‘established securities market’’ is defined in paragraph 9 of the Protocol to mean a national securities exchange 

which is officially recognized, sanctioned, or supervised by a governmental authority as well as an over the counter market. An 

over the counter market is any market reflected by the existence 

of an interdealer quotation system. An interdealer quotation system is any system of general circulation to brokers and dealers 

which regularly disseminates quotations of stocks and securities by 

identified brokers or dealers, other than by quotation sheets which 

are prepared and distributed by a broker or dealer in the regular 

course of business and which contain only quotations of such 

broker or dealer. This definition is consistent with the regulations 

under section 897. 

Paragraph 3 

Paragraph 3 of Article 13 deals with the taxation of certain gains 

from the alienation of movable property forming part of the business property of a permanent establishment that an enterprise of 

a Contracting State has in the other Contracting State. This also 

includes gains from the alienation of such a permanent establishment (alone or with the whole enterprise). Such gains may be taxed 

in the State in which the permanent establishment is located. 

A resident of Bulgaria that is a partner in a partnership doing 

business in the United States generally will have a permanent establishment in the United States as a result of the activities of the 

partnership, assuming that the activities of the partnership rise to 

the level of a permanent establishment. Rev. Rul. 91–32, 1991–1 

C.B. 107. Further, under paragraph 3, the United States generally 

may tax a partner’s distributive share of income realized by a partnership on the disposition of movable property forming part of the 

business property of the partnership in the United States. 

59 

The gains subject to paragraph 3 may be taxed in the State in 

which the permanent establishment is located, regardless of whether the permanent establishment exists at the time of the alienation. This rule incorporates the rule of section 864(c)(6) of the 

Code. Accordingly, income that is attributable to a permanent establishment, but that is deferred and received after the permanent 

establishment no longer exists, may nevertheless be taxed by the 

State in which the permanent establishment was located. 

Paragraph 4 

This paragraph limits the taxing jurisdiction of the State of 

source with respect to gains from the alienation of ships or aircraft 

operated in international traffic by the enterprise alienating the 

ship or aircraft and from property (other than real property) pertaining to the operation or use of such ships or aircraft. 

Under paragraph 4, such income is taxable only in the Contracting State in which the alienator is resident. Notwithstanding 

paragraph 3, the rules of this paragraph apply even if the income 

is attributable to a permanent establishment maintained by the enterprise in the other Contracting State. This result is consistent 

with the allocation of taxing rights under Article 8 (International 

Traffic). 

Paragraph 5 

Paragraph 5 provides a rule similar to paragraph 4 with respect 

to gains from the alienation of containers and related personal 

property. Such gains derived by an enterprise of a Contracting 

State shall be taxable only in that Contracting State unless the 

containers were used for the transport of goods or merchandise 

solely within the other Contracting State. The other Contracting 

State may not tax such gain even if it is attributable to a permanent establishment maintained by the enterprise in that other Contracting State. 

Paragraph 6 

Paragraph 6 provides that, if certain conditions are met, a Contracting State can tax gains from the alienation of shares of a resident company that are derived by a resident of the other Contracting State. This provision permits Bulgaria to continue to impose its tax on the gain derived by U.S. residents on the alienation 

of shares in Bulgarian companies in a narrow set of cases. The first 

requirement is that the alienation occurs within 12 months of the 

date that the shares are acquired. The second requirement is that 

the recipient of the gain must have owned, directly or indirectly, 

at least 25 percent of the capital of the company at some time within the 12-month period preceding the alienation. Finally, the provision provides that a Contracting State may not in any case tax 

gains derived by a resident of the other Contracting State from the 

alienation of shares of stock of public companies traded on an established securities market. 

As described above, the term ‘‘established securities market’’ is 

a national securities exchange which is officially recognized, sanctioned, or supervised by a governmental authority as well as an 

over the counter market. An over the counter market is any market 

60 

reflected by the existence of an interdealer quotation system, and 

an interdealer quotation system is any system of general circulation to brokers and dealers which regularly disseminates 

quotations of stocks and securities by identified brokers or dealers, 

other than by quotation sheets which are prepared and distributed 

by a broker or dealer in the regular course of business and which 

contain only quotations of such broker or dealer. 

The United States will treat gain taxed by Bulgaria under this 

paragraph as of Bulgarian source to the extent necessary to permit 

a credit for the Bulgarian tax, subject to the limitations of U.S. 

law. 

Paragraph 6 is reciprocal. If the United States were to introduce 

such a tax, it could be imposed in accordance with the rules of this 

paragraph. 

Paragraph 7 

Paragraph 7 clarifies the interrelationship between Articles 12 

(Royalties) and 13 with respect to certain gains treated as royalties. Under subparagraph 3(b) of Article 12, the term royalties includes gain derived from the alienation of property that would give 

rise to royalties, to the extent the gain is contingent on the productivity, use, or further alienation thereof. Therefore, such royalties 

are governed by the provisions of Article 12 and not by this Article. 

Paragraph 8 

Paragraph 8 grants to the State of residence of the alienator the 

exclusive right to tax gains from the alienation of property other 

than property referred to in paragraphs 1 through 7. For example, 

gain derived from shares, other than shares described in paragraphs 2, 3, or 6, debt instruments and various financial instruments, may be taxed only in the State of residence, to the extent 

such income is not otherwise characterized as income taxable 

under another article (e.g., Article 10 (Dividends) or Article 11 (Interest)). Similarly gain derived from the alienation of tangible personal property, other than tangible personal property described in 

paragraph 3, may be taxed only in the State of residence of the 

alienator. 

Gains derived by a resident of a Contracting State from real 

property located in a third state are not taxable in the other Contracting State, even if the sale is attributable to a permanent establishment located in the other Contracting State. 

Relationship to other Articles 

Notwithstanding the foregoing limitations on taxation of certain 

gains by the State of source, the saving clause of paragraph 4 of 

Article 1 (General Scope) permits the United States to tax its citizens and residents as if the Convention had not come into effect. 

Thus, any limitation in this Article on the right of the United 

States to tax gains does not apply to gains of a U.S. citizen or resident. 

The benefits of this Article are also subject to the provisions of 

Article 21 (Limitation on Benefits). Thus, only a resident of a Contracting State that satisfies one of the conditions in Article 21 is 

entitled to the benefits of this Article. 

61 

ARTICLE 14 (INCOME FROM EMPLOYMENT)

Article 14 apportions taxing jurisdiction over remuneration derived by a resident of a Contracting State as an employee between 

the States of source and residence. 

Paragraph 1 

The general rule of Article 14 is contained in paragraph 1. Remuneration derived by a resident of a Contracting State as an employee may be taxed by the State of residence, and the remuneration also may be taxed by the other Contracting State to the extent 

derived from employment exercised (i.e., services performed) in 

that other Contracting State. Paragraph 1 also provides that the 

more specific rules of Articles 15 (Directors’ Fees), 17 (Pensions, Social Security Payments, Annuities, Alimony, and Child Support), 

and 18 (Government Service) apply in the case of employment income described in one of those articles. Thus, even though the 

State of source has a right to tax employment income under Article 

14, it may not have the right to tax that income under the Convention if the income is described, for example, in Article 17 (Pensions, 

Social Security Payments, Annuities, Alimony, and Child Support) 

and is not taxable in the State of source under the provisions of 

that article. 

Article 14 applies to any form of compensation for employment, 

including payments in kind. Paragraph 1.1 of the Commentary to 

Article 16 of the OECD Model now confirms that interpretation. 

Consistent with section 864(c)(6) of the Code, Article 14 also applies regardless of the timing of actual payment for services. Consequently, a person who receives the right to a future payment in 

consideration for services rendered in a Contracting State would be 

taxable in that State even if the payment is received at a time 

when the recipient is a resident of the other Contracting State. 

Thus, a bonus paid to a resident of a Contracting State with respect to services performed in the other Contracting State with respect to a particular taxable year would be subject to Article 14 

even if it was paid after the close of the year. An annuity received 

for services performed in a taxable year could be subject to Article 

14 despite the fact that it was paid in subsequent years. In that 

case, it would be necessary to determine whether the payment constitutes deferred compensation, taxable under Article 14, or a 

qualified pension subject to the rules of Article 17 (Pensions, Social 

Security Payments, Annuities, Alimony, and Child Support). Article 

14 also applies to income derived from the exercise of stock options 

granted with respect to services performed in the host State, even 

if those stock options are exercised after the employee has left the 

source country. If Article 14 is found to apply, whether such payments were taxable in the State where the employment was exercised would depend on whether the tests of paragraph 2 were satisfied in the year in which the services to which the payment relates 

were performed. 

Paragraph 2 

Paragraph 2 sets forth an exception to the general rule that employment income may be taxed in the State where it is exercised. 

62 

Under paragraph 2, the State where the employment is exercised 

may not tax the income from the employment if three conditions 

are satisfied: (a) the individual is present in the other Contracting 

State for a period or periods not exceeding 183 days in any 12- 

month period that begins or ends during the relevant taxable year 

(i.e., in the United States, the calendar year in which the services 

are performed); (b) the remuneration is paid by, or on behalf of, an 

employer who is not a resident of that other Contracting State; and 

(c) the remuneration is not borne as a deductible expense by a permanent establishment that the employer has in that other State. 

In order for the remuneration to be exempt from tax in the source 

State, all three conditions must be satisfied. This exception is identical to that set forth in the OECD Model. 

The 183-day period in condition (a) is to be measured using the 

‘‘days of physical presence’’ method. Under this method, the days 

that are counted include any day in which a part of the day is 

spent in the host country. (Rev. Rul. 56–24, 1956–1 C.B. 851.) 

Thus, days that are counted include the days of arrival and departure; weekends and holidays on which the employee does not work 

but is present within the country; vacation days spent in the country before, during or after the employment period, unless the individual’s presence before or after the employment can be shown to 

be independent of his presence there for employment purposes; and 

time during periods of sickness, training periods, strikes, etc., when 

the individual is present but not working. If illness prevented the 

individual from leaving the country in sufficient time to qualify for 

the benefit, those days will not count. Also, any part of a day spent 

in the host country while in transit between two points outside the 

host country is not counted. If the individual is a resident of the 

host country for part of the taxable year concerned and a non-resident for the remainder of the year, the individual’s days of presence as a resident do not count for purposes of determining whether the 183-day period is exceeded. 

Conditions (b) and (c) are intended to ensure that a Contracting 

State will not be required to allow a deduction to the payor for 

compensation paid and at the same time to exempt the employee 

on the amount received. Accordingly, if a foreign person pays the 

salary of an employee who is employed in the host State, but a host 

State corporation or permanent establishment reimburses the 

payor with a payment that can be identified as a reimbursement, 

neither condition (b) nor (c), as the case may be, will be considered 

to have been fulfilled. 

The reference to remuneration ‘‘borne by’’ a permanent establishment is understood to encompass all expenses that economically 

are incurred and not merely expenses that are currently deductible 

for tax purposes. Accordingly, the expenses referred to include expenses that are capitalizable as well as those that are currently deductible. Further, salaries paid by residents that are exempt from 

income taxation may be considered to be borne by a permanent establishment notwithstanding the fact that the expenses will be neither deductible nor capitalizable since the payor is exempt from 

tax. 

63 

Paragraph 3 

Paragraph 3 contains a special rule applicable to remuneration 

for services performed by a resident of a Contracting State as an 

employee aboard a ship or aircraft operated in international traffic. 

Such remuneration may be taxed only in the State of residence of 

the employee if the services are performed as a member of the crew 

of the ship or aircraft or as other personnel regularly employed to 

serve aboard the ship or aircraft. In the case of a cruise ship, for 

example, paragraph 3 applies to the crew and others, such as entertainers, lecturers, etc., employed by the shipping company to 

serve on the ship throughout its voyage. The use of the phrase 

‘‘regularly employed to serve’’ is intended to clarify that a person 

who exercises his employment as, for example, an insurance salesman while aboard a ship or aircraft is not covered by this paragraph. 

Relationship to other Articles 

If a U.S. citizen who is resident in Bulgaria performs services as 

an employee in the United States and meets the conditions of paragraph 2 for source country exemption, he nevertheless is taxable in 

the United States by virtue of the saving clause of paragraph 4 of 

Article 1 (General Scope), subject to the special foreign tax credit 

rule of paragraph 4 of Article 22 (Relief from Double Taxation). 

ARTICLE 15 (DIRECTORS’ FEES)

This Article provides that a Contracting State may tax the fees 

and other compensation paid by a company that is a resident of 

that State for services performed by a resident of the other Contracting State in his capacity as a member of the board of directors 

or a functionally similar body. This rule is an exception to the more 

general rules of Articles 7 (Business Profits) and 14 (Income from 

Employment). Thus, for example, in determining whether a director’s fee paid to a non-employee director is subject to tax in the 

country of residence of the corporation, it is not relevant to establish whether the fee is attributable to a permanent establishment 

in that State. 

Under this Article, a resident of one Contracting State who is a 

director of a corporation that is resident in the other Contracting 

State is subject to tax in that other State in respect of his directors’ 

fees regardless of where the services are performed. This provision 

of the Convention is identical in substance to the analogous provision in the OECD Model. 

ARTICLE 16 (ENTERTAINERS AND SPORTSMEN)

This Article deals with the taxation in a Contracting State of entertainers and sportsmen resident in the other Contracting State 

from the performance of their services as such. The Article applies 

both to the income of an entertainer or sportsman who performs 

services on his own behalf and one who performs services on behalf 

of another person, either as an employee of that person, or pursuant to any other arrangement. The rules of this Article take precedence, in some circumstances, over those of Articles 7 (Business 

Profits) and 14 (Income from Employment). 

64 

This Article applies only with respect to the income of entertainers and sportsmen. Others involved in a performance or athletic event, such as producers, directors, technicians, managers, 

coaches, etc., remain subject to the provisions of Articles 7 and 14. 

In addition, except as provided in paragraph 2, income earned by 

juridical persons is not covered by Article 16. 

Paragraph 1 

Paragraph 1 describes the circumstances in which a Contracting 

State may tax the performance income of an entertainer or sportsman who is a resident of the other Contracting State. Under the 

paragraph, income derived by an individual resident of a Contracting State from activities as an entertainer or sportsman exercised in the other Contracting State may be taxed in that other 

State if the amount of the gross receipts derived by the performer 

exceeds $15,000 (or its equivalent in Bulgarian currency) for the 

taxable year. The $15,000 includes expenses reimbursed to the individual or borne on his behalf. If the gross receipts exceed 

$15,000, the full amount, not just the excess, may be taxed in the 

State of performance. 

This Convention introduces a monetary threshold to distinguish 

between two groups of entertainers and athletes—those who are 

paid relatively large sums of money for very short periods of service, and who would, therefore, normally be exempt from host country tax under the standard personal services income rules, and 

those who earn relatively modest amounts and are, therefore, not 

easily distinguishable from those who earn other types of personal 

service income. 

Tax may be imposed under paragraph 1 even if the performer 

would have been exempt from tax under Article 7 (Business Profits) or 14 (Income from Employment). On the other hand, if the 

performer would be exempt from host-country tax under Article 16, 

but would be taxable under either Article 7 or 14, tax may be imposed under either of those Articles. Thus, for example, if a performer derives remuneration from his activities in an independent 

capacity, and the performer does not have a permanent establishment in the host State, he may be taxed by the host State in accordance with Article 16 if his remuneration exceeds $15,000 annually, despite the fact that he generally would be exempt from host 

State taxation under Article 7. However, a performer who receives 

less than the $15,000 threshold amount and therefore is not taxable under Article 16 nevertheless may be subject to tax in the host 

country under Article 7 or 14 if the tests for host-country taxability 

under the relevant Article are met. For example, if an entertainer 

who is an independent contractor earns $14,000 of income in a 

State for the calendar year, but the income is attributable to his 

permanent establishment in the State of performance, that State 

may tax his income under Article 7. 

Since it frequently is not possible to know until year-end whether 

the income an entertainer or sportsman derived from performances 

in a Contracting State will exceed $15,000, nothing in the Convention precludes that Contracting State from withholding tax during 

the year and refunding it after the close of the year if the taxability 

threshold has not been met. 

65 

As explained in paragraph 9 of the Commentary to Article 17 of 

the OECD Model, Article 16 of the Convention applies to all income 

connected with a performance by the entertainer, such as appearance fees, award or prize money, and a share of the gate receipts. 

Income derived from a Contracting State by a performer who is a 

resident of the other Contracting State from other than actual performance, such as royalties from record sales and payments for 

product endorsements, is not covered by this Article, but by other 

articles of the Convention, such as Article 12 (Royalties) or Article 

7 (Business Profits). For example, if an entertainer receives royalty 

income from the sale of live recordings, the royalty income would 

be subject to the provisions of Article 12, even if the performance 

was conducted in the source country, although the entertainer 

could be taxed in the source country with respect to income from 

the performance itself under Article 16 if the dollar threshold is exceeded. 

In determining whether income falls under Article 16 or another 

article, the controlling factor will be whether the income in question is predominantly attributable to the performance itself or to 

other activities or property rights. For instance, a fee paid to a performer for endorsement of a performance in which the performer 

will participate would be considered to be so closely associated with 

the performance itself that it normally would fall within Article 16. 

Similarly, a sponsorship fee paid by a business in return for the 

right to attach its name to the performance would be so closely associated with the performance that it would fall under Article 16 

as well. As indicated in paragraph 9 of the Commentary to Article 

17 of the OECD Model, however, a cancellation fee would not be 

considered to fall within Article 16 but would be dealt with under 

Article 7 (Business Profits) or 14 (Income from Employment). 

As indicated in paragraph 4 of the Commentary to Article 17 of 

the OECD Model, where an individual fulfills a dual role as performer and non-performer (such as a player-coach or an actor-director), but his role in one of the two capacities is negligible, the predominant character of the individual’s activities should control the 

characterization of those activities. In other cases there should be 

an apportionment between the performance-related compensation 

and other compensation. 

Consistent with Article 14 (Income from Employment), Article 16 

also applies regardless of the timing of actual payment for services. 

Thus, a bonus paid to a resident of a Contracting State with respect to a performance in the other Contracting State during a particular taxable year would be subject to Article 16 even if it was 

paid after the close of the year. The determination as to whether 

the $15,000 threshold has been exceeded is determined separately 

with respect to each year of payment. Accordingly, if an actor who 

is a resident of one Contracting State receives residual payments 

over time with respect to a movie that was filmed in the other Contracting State, the payments do not have to be aggregated from one 

year to another to determine whether the total payments have finally exceeded $15,000. Otherwise, residual payments received 

many years later could retroactively subject all earlier payments to 

tax by the other Contracting State. 

66 

Paragraph 2 

Paragraph 2 is intended to address the potential for circumvention of the rule in paragraph 1 when a performer’s income does not 

accrue directly to the performer himself, but to another person. 

Foreign performers frequently perform in the United States as employees of, or under contract with, a company or other person. 

The relationship may truly be one of employee and employer, 

with no circumvention of paragraph 1 either intended or realized. 

On the other hand, the ‘‘employer’’ may, for example, be a company 

established and owned by the performer, which is merely acting as 

the nominal income recipient in respect of the remuneration for the 

performance (a ‘‘star company’’). The performer may act as an ‘‘employee,’’ receive a modest salary, and arrange to receive the remainder of the income from his performance from the company in 

another form or at a later time. In such case, absent the provisions 

of paragraph 2, the income arguably could escape host-country tax 

because the company earns business profits but has no permanent 

establishment in that country. The performer may largely or entirely escape host-country tax by receiving only a small salary, perhaps small enough to place him below the dollar threshold in paragraph 1. The performer might arrange to receive further payments 

in a later year, when he is not subject to host-country tax, perhaps 

as dividends or liquidating distributions. 

Paragraph 2 seeks to prevent this type of abuse while at the 

same time protecting the taxpayers’ rights to the benefits of the 

Convention when there is a legitimate employee-employer relationship between the performer and the person providing his services. 

Under paragraph 2, when the income accrues to a person other 

than the performer, the income may be taxed in the Contracting 

State where the performer’s services are exercised, without regard 

to the provisions of the Convention concerning business profits (Article 7) or income from employment (Article 14), but only if one of 

two conditions is met. The first condition is that the contract pursuant to which the personal activities are performed designates the 

entertainer or sportsman (by name or description). The second condition is that the contract allows the other party to the contract (or 

a person other than the entertainer, sportsman or the person to 

whom the income accrues) to designate the individual who is to 

perform the personal activities. This rule is consistent with the 

U.S. domestic law provision characterizing income from certain personal service contracts as foreign personal holding company income. 

The premise of this rule is that, in a case where a performer is 

using another person in an attempt to circumvent the provisions of 

paragraph 1, the recipient of the services of the performer would 

contract with a person other than that performer (i.e., a company 

employing the performer) only if the recipient of the services were 

certain that the performer himself would perform the services (i.e., 

the contract mentioned the performer by name or description or 

else allowed the recipient of the services to designate who is to perform the services). If instead the person to whom the income accrues is allowed to designate the individual who is to perform the 

services, then likely that person is a service company not formed 

67 

to circumvent the provisions of paragraph 1. The following example 

illustrates the operation of this rule. 

Example. Company O, a resident of Bulgaria, is engaged in the 

business of operating an orchestra. Company O enters into a contract with Company A pursuant to which Company O agrees to 

carry out two performances in the United States in consideration 

of which Company A will pay Company O $200,000. The contract 

designates two individuals, a conductor and a flutist, that must 

perform as part of the orchestra, and allows Company O to designate the other members of the orchestra. Because the contract 

mentions by name the conductor and the flutist, the portion of the 

$200,000 that is attributable to the personal services of the conductor and the flutist may be taxed by the United States pursuant 

to paragraph 2. However, because Company A is not allowed to 

designate the other performers the remaining portion of the 

$200,000, is not subject to tax by the United States pursuant to 

paragraph 2. 

In cases where paragraph 2 is applicable, the income of the ‘‘employer’’ may be subject to tax in the host Contracting State even 

if it has no permanent establishment in the host country. Taxation 

under paragraph 2 is on the person providing the services of the 

performer. This paragraph does not affect the rules of paragraph 

1, which apply to the performer himself. The income taxable by virtue of paragraph 2 is reduced to the extent of salary payments to 

the performer, which fall under paragraph 1. 

For purposes of paragraph 2, income is deemed to accrue to another person (i.e., the person providing the services of the performer) if that other person has control over, or the right to receive, 

gross income in respect of the services of the performer. 

Pursuant to Article 1 (General Scope) the Convention only applies to persons who are residents of one of the Contracting States. 

Thus, income of a star company that is not a resident of one of the 

Contracting States would not be eligible for the benefits of the Convention. 

Relationship to other Articles 

This Article is subject to the provisions of the saving clause of 

paragraph 4 of Article 1 (General Scope). Thus, if an entertainer 

or a sportsman who is resident in Bulgaria is a citizen of the 

United States, the United States may tax all of his income from 

performances in the United States without regard to the provisions 

of this Article, subject, however, to the special foreign tax credit 

provisions of paragraph 4 of Article 22 (Relief from Double Taxation). In addition, benefits of this Article are subject to the provisions of Article 21 (Limitation on Benefits). 

ARTICLE 17 (PENSIONS, SOCIAL SECURITY, ANNUITIES, ALIMONY, AND

CHILD SUPPORT)

This Article deals with the taxation of private (i.e., non-government service) pensions and annuities, social security benefits, alimony and child support payments. 

68 

Paragraph 1 

Paragraph 1 provides that distributions from pensions and other 

similar remuneration beneficially owned by a resident of a Contracting State in consideration of past employment are taxable only 

in the State of residence of the beneficiary. The term ‘‘pensions and 

other similar remuneration’’ includes both periodic and single sum 

payments. 

The phrase ‘‘pensions and other similar remuneration’’ is intended to encompass payments made by qualified private retirement plans. In the United States, the plans encompassed by paragraph 1 include: qualified plans under section 401(a), individual retirement plans (including individual retirement plans that are part 

of a simplified employee pension plan that satisfies section 408(k), 

individual retirement accounts and section 408(p) accounts), section 

403(a) qualified annuity plans, and section 403(b) plans. Distributions from section 457 plans may also fall under Paragraph 1 if 

they are not paid with respect to government services covered by 

Article 18. 

Pensions in respect of government services covered by Article 18 

are not covered by this paragraph. They are covered either by paragraph 2 of this Article, if they are in the form of social security 

benefits, or by paragraph 2 of Article 18 (Government Service). 

Thus, Article 18 generally covers section 457, 401(a), 403(b) plans 

established for government employees, and the Thrift Savings Plan 

(section 7701(j)). 

Paragraph 2 

The treatment of social security benefits is dealt with in paragraph 2. This paragraph provides that, notwithstanding the provision of paragraph 1 under which private pensions are taxable exclusively in the State of residence of the beneficial owner, payments made by one of the Contracting States under the provisions 

of its social security or similar legislation to a resident of Bulgaria 

or to a citizen of the United States will be taxable only in the Contracting State making the payment. The reference to U.S. citizens 

is necessary to ensure that a social security payment by Bulgaria 

to a U.S. citizen who is not resident in the United States will not 

be taxable by the United States. 

This paragraph applies to social security beneficiaries whether 

they have contributed to the system as private sector or Government employees. The phrase ‘‘similar legislation’’ is intended to 

refer to United States tier 1 Railroad Retirement benefits. 

Paragraph 3 

Under paragraph 3, annuities that are derived and beneficially 

owned by a resident of a Contracting State are taxable only in that 

State. An annuity, as the term is used in this paragraph, means 

a stated sum paid periodically at stated times during a specified 

number of years, under an obligation to make the payment in return for adequate and full consideration (other than for services 

rendered). An annuity received in consideration for services rendered would be treated as either deferred compensation that is taxable in accordance with Article 14 (Income from Employment) or a 

pension that is subject to the rules of paragraph 1. 

69 

Paragraph 4 

Paragraph 4 deals with alimony and child support payments. 

Under paragraph 4, alimony and child support payments paid by 

a resident of a Contracting State to a resident of the other Contracting State are not taxable in the recipient’s State of residence. 

In addition, such payments are not taxable in the payor’s State of 

residence unless he is entitled to a deduction for such payments in 

computing taxable income in his State of residence. The term alimony is defined as periodic payments made pursuant to a written 

separation agreement or a decree of divorce, separate maintenance, 

or compulsory support. 

Paragraph 5 

Paragraph 5 provides that, if a resident of a Contracting State 

participates in a pension fund established in the other Contracting 

State, the State of residence will not tax the income of the pension 

fund with respect to that resident until a distribution is made from 

the pension fund. Thus, 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 Bulgaria, paragraph 5 prevents Bulgaria from taxing currently the plan’s earnings and accretions with 

respect to that individual. When the resident receives a distribution from the pension fund, that distribution may be subject to tax 

in the State of residence under paragraph 1. 

Relationship to other Articles 

Paragraphs 1, 3, and 4 of Article 17 are subject to the saving 

clause of paragraph 4 of Article 1 (General Scope). Thus, a U.S. citizen who is resident in Bulgaria, and receives a pension, annuity 

or alimony payment from the United States, may be subject to U.S. 

tax on the payment, notwithstanding the rules in paragraphs 1, 3 

and 4. Paragraphs 2 and 5 are excepted from the saving clause by 

virtue of subparagraph 5(a) of Article 1. Thus, the United States 

will not tax U.S. citizens and residents on the income described in 

paragraph 2, even if such amounts otherwise would be subject to 

tax under U.S. law, and the United States will allow U.S. citizens 

and residents the benefits of paragraph 5. 

ARTICLE 18 (GOVERNMENT SERVICE) PARAGRAPH 1

Paragraph 1 deals with the taxation of government compensation 

(other than a pension addressed in paragraph 2). Subparagraph (a) 

provides that remuneration paid to any individual who is rendering 

services to that State, political subdivision or local authority is exempt from tax by the other State. Under subparagraph (b), such 

payments are, however, taxable exclusively in the other State (i.e., 

the host State) if the services are rendered in that other State and 

the individual is a resident of that State who is either a national 

of that State or a person who did not become resident of that State 

solely for purposes of rendering the services. The paragraph applies 

to anyone performing services for a government, whether as a government employee, an independent contractor, or an employee of 

an independent contractor. 

70 

Paragraph 2 

Paragraph 2 deals with the taxation of pensions paid by, or out 

of funds created by, one of the States, or a political subdivision or 

a local authority thereof, to an individual in respect of services rendered to that State or subdivision or authority. Subparagraph (a) 

provides that such pensions are taxable only in that State. Subparagraph (b) provides an exception under which such pensions are 

taxable only in the other State if the individual is a resident of, 

and a national of, that other State. 

Pensions paid to retired civilian and military employees of a Government of either State are intended to be covered under paragraph 2. When benefits paid by a State in respect of services rendered to that State or a subdivision or authority are in the form 

of social security benefits, however, those payments are covered by 

paragraph 2 of Article 17 (Pensions, Social Security Payments, Annuities, Alimony, and Child Support). As a general matter, the result will be the same whether Article 17 or 18 applies, since social 

security benefits are taxable exclusively by the source country and 

so are government pensions. The result will differ only when the 

payment is made to a citizen and resident of the other Contracting 

State, who is not also a citizen of the paying State. In such a case, 

social security benefits continue to be taxable at source while government pensions become taxable only in the residence country. 

Paragraph 3 

Paragraph 3 provides that the remuneration described in paragraph 1 will be subject to the rules of Articles 14 (Income from Employment), 15 (Directors’ Fees), 16 (Entertainers and Sportsmen) or 

17 (Pensions, Social Security Payments, Annuities, Alimony, and 

Child Support) if the recipient of the income is employed by a business conducted by a government. 

Relationship to other Articles 

Under paragraph 5(b) of Article 1 (General Scope), the saving 

clause (paragraph 4 of Article 1) does not apply to the benefits conferred by one of the States under Article 18 if the recipient of the 

benefits is neither a citizen of that State, nor a person who has 

been admitted for permanent residence there (i.e., in the United 

States, a ‘‘green card’’ holder). Thus, a resident of a Contracting 

State who in the course of performing functions of a governmental 

nature becomes a resident of the other State (but not a permanent 

resident), would be entitled to the benefits of this Article. An individual who receives a pension paid by the Government of Bulgaria 

in respect of services rendered to the Government of Bulgaria shall 

be taxable on this pension only in Bulgaria unless the individual 

is a U.S. citizen or acquires a U.S. green card. 

ARTICLE 19 (STUDENTS, TRAINEES, TEACHERS AND RESEARCHERS)

This Article provides rules for host-country taxation of visiting 

students, business trainees, teachers and researchers. Persons who 

meet the tests of the Article will be exempt from tax in the State 

that they are visiting with respect to designated classes of income. 

Paragraph 1 addresses payments received by a student or business 

71 

trainee, while paragraph 2 addresses teachers and researchers 

temporarily present in the host country. 

Paragraph 1 

Subparagraph (a) addresses the situation where a student or 

business trainee that is a resident of a Contracting State receives 

designated classes of payments while present in the host State. 

Several conditions must be satisfied for such an individual to be 

entitled to the benefits of paragraph 1.First, the student or business trainee must have been, either at the time of his arrival in 

the host State or immediately before, a resident of the other Contracting State. 

Second, the purpose of the visit must be the full-time education 

(at a college, university, or other recognized educational institution 

of a similar nature) or full-time training of the visitor. Thus, if the 

visitor comes principally to work in the host State but also is a 

part-time student, he would not be entitled to the benefits of paragraph 1, even with respect to any payments he may receive from 

abroad for his maintenance or education, and regardless of whether 

or not he is in a degree program. Whether a student is to be considered full-time will be determined by the rules of the educational institution at which he is studying. 

The host-country exemption in paragraph 1 applies to payments 

received by the student or business trainee for the purpose of his 

maintenance, education or training that arise outside the host 

State. A payment will be considered to arise outside the host State 

if the payor is located outside the host State. Thus, if an employer 

from one of the Contracting States sends an employee to the other 

Contracting State for training, the payments the trainee receives 

from abroad from his employer for his maintenance or training 

while he is present in the host State will be exempt from tax in 

the host State. Where appropriate, substance prevails over form in 

determining the identity of the payor. Thus, for example, payments 

made directly or indirectly by a U.S. person with whom the visitor 

is training, but which have been routed through a source outside 

the United States (e.g., a foreign subsidiary), are not treated as 

arising outside the United States for this purpose. 

Paragraph 1 also provides a limited exemption for remuneration 

from personal services rendered in the host State with a view to 

supplementing the resources available to him for such purposes to 

the extent of $9,000 United States dollars (or its equivalent in the 

currency of Bulgaria) per taxable year. The competent authorities 

are instructed to adjust this amount every five years, if appropriate. 

In the case of a business trainee, the benefits of paragraph 1 will 

extend only for a period of two years from the time that the visitor 

first arrives in the host country for the purpose of training. If, however, a trainee remains in the host country for a third year, thus 

losing the benefits of paragraph 1, he would not retroactively lose 

the benefits of the paragraph 1 for the first two years. The term 

‘‘business trainee’’ is defined as a person who is in the country temporarily either for the purpose of securing training that is necessary to qualify to pursue a profession or professional specialty, or 

as an employee of, or under contract with, a resident of the other 

72 

Contracting State, for the primary purpose of acquiring technical, 

professional, or business experience, from someone who is not his 

employer or related to his employer. Thus, a business trainee 

might include a lawyer employed by a law firm in one Contracting 

State who works for one year as a stagiare in an unrelated law 

firm in the other Contracting State. However, the term would not 

include a manager who normally is employed by a parent company 

in one Contracting State who is sent to the other Contracting State 

to run a factory owned by a subsidiary of the parent company. 

Paragraph 2 

Paragraph 2 provides a limited exemption from host State taxation for certain teachers and researchers temporarily present in 

the host State for the purpose of teaching or carrying on research 

at a school, college, university or other recognized educational or 

research institution. The teacher or researcher must be a resident 

of the other Contracting State at the beginning of his visit to the 

host State. The income eligible for exemption is the person’s remuneration received in consideration of teaching or carrying on research. The host-country exemption will extend to payments received by a teacher or researcher only for a period of two years 

from the time that the visitor first arrives in the host country. A 

teacher or researcher remaining in the host country for more than 

2 years becomes subject to tax on remuneration with respect to 

teaching and researching, but does not retroactively lose the benefits of paragraph 2 for the first two years. Paragraph 2 does not 

apply to exempt income in consideration of carrying on research if 

the research is primarily for the private benefit of a specific person 

or persons rather than in the public interest. 

Relationship to other Articles 

The saving clause of paragraph 4 of Article 1 (General Scope) 

does not apply to this Article with respect to an individual who is 

neither a citizen of the host State nor has been admitted for permanent residence there. The saving clause, however, does apply 

with respect to citizens and permanent residents of the host State. 

Thus, for example, a U.S. citizen who is a resident of Bulgaria and 

who visits the United States as a full-time student at an accredited 

university will not be exempt from U.S. tax on remittances from 

abroad that otherwise constitute U.S. taxable income. A person, 

however, who is not a U.S. citizen, and who visits the United 

States as a student and remains long enough to become a resident 

under U.S. law, but does not become a permanent resident (i.e., 

does not acquire a green card), will be entitled to the full benefits 

of the Article. 

ARTICLE 20 (OTHER INCOME)

Article 20 generally assigns taxing jurisdiction over income not 

dealt with in the other articles (Articles 6 through 19) of the Convention to the State of residence of the beneficial owner of the income. In order for an item of income to be ‘‘dealt with’’ in another 

article it must be the type of income described in the article and, 

in most cases, it must have its source in a Contracting State. For 

example, all royalty income that arises in a Contracting State and 

73 

that is beneficially owned by a resident of the other Contracting 

State is ‘‘dealt with’’ in Article 12 (Royalties). However, profits derived in the conduct of a business are ‘‘dealt with’’ in Article 7 

(Business Profits) whether or not they have their source in one of 

the Contracting States. 

Examples of items of income covered by Article 20 include income 

from gambling, punitive (but not compensatory) damages and covenants not to compete. The Article would also apply to income from 

a variety of financial transactions, where such income does not 

arise in the course of the conduct of a trade or business. For example, income from notional principal contracts and other derivatives 

would fall within Article 20 if derived by persons not engaged in 

the trade or business of dealing in such instruments, unless such 

instruments were being used to hedge risks arising in a trade or 

business. It would also apply to securities lending fees derived by 

an institutional investor. Further, in most cases guarantee fees 

paid within an intercompany group would be covered by Article 20, 

unless the guarantor were engaged in the business of providing 

such guarantees to unrelated parties. 

Article 20 also applies to items of income that are not dealt with 

in the other articles because of their source or some other characteristic. For example, Article 11 (Interest) addresses only the taxation of interest arising in a Contracting State. Interest arising in 

a third State that is not attributable to a permanent establishment, therefore, is subject to Article 20. 

Distributions from partnerships are not generally dealt with 

under Article 20 because partnership distributions generally do not 

constitute income. Under the Code, partners include in income 

their distributive share of partnership income annually, and partnership distributions themselves generally do not give rise to income. This would also be the case under U.S. law with respect to 

distributions from trusts. Trust income and distributions that, 

under the Code, have the character of the associated distributable 

net income would generally be covered by another article of the 

Convention. See Code section 641 et seq. 

Paragraph 1 

The general rule of Article 20 is contained in paragraph 1. Items 

of income not dealt with in other articles and beneficially owned by 

a resident of a Contracting State will be taxable only in the State 

of residence. This exclusive right of taxation applies whether or not 

the residence State exercises its right to tax the income covered by 

the Article. 

The reference in this paragraph to ‘‘items of income beneficially 

owned by a resident of a Contracting State’’ rather than simply 

‘‘items of income of a resident of a Contracting State,’’ as in the 

OECD Model, is intended merely to make explicit the implicit understanding in other treaties that the exclusive residence taxation 

provided by paragraph 1 applies only when a resident of a Contracting State is the beneficial owner of the income. Thus, source 

taxation of income not dealt with in other articles of the Convention is not limited by paragraph 1 if it is nominally paid to a resident of the other Contracting State, but is beneficially owned by a 

resident of a third State. However, income received by a nominee 

74 

on behalf of a resident of that other State would be entitled to benefits. 

The term ‘‘beneficially owned’’ is not defined in the Convention, 

and is, therefore, defined as under the internal law of the country 

imposing tax (i.e., the source country). The person who beneficially 

owns the income for purposes of Article 20 is the person to which 

the income is attributable for tax purposes under the laws of the 

source State. 

Paragraph 2 

This paragraph provides an exception to the general rule of paragraph 1 for income that is attributable to a permanent establishment maintained in a Contracting State by a resident of the other 

Contracting State. The taxation of such income is governed by the 

provisions of Article 7 (Business Profits). Therefore, income arising 

outside the United States that is attributable to a permanent establishment maintained in the United States by a resident of Bulgaria generally would be taxable by the United States under the 

provisions of Article 7. This would be true even if the income is 

sourced in a third State. 

Relationship to other Articles 

This Article is subject to the saving clause of paragraph 4 of Article 1 (General Scope). Thus, the United States may tax the income 

of a resident of Bulgaria that is not dealt with elsewhere in the 

Convention, if that resident is a citizen of the United States. The 

Article is also subject to the provisions of Article 21 (Limitation on 

Benefits). Thus, if a resident of Bulgaria earns income that falls 

within the scope of paragraph 1 of Article 20, but that is taxable 

by the United States under U.S. law, the income would be exempt 

from U.S. tax under the provisions of Article 20 only if the resident 

satisfies one of the tests of Article 21 for entitlement to benefits. 

ARTICLE 21 (LIMITATION ON BENEFITS)

Article 21 contains anti-treaty-shopping provisions that are intended to prevent residents of third countries from benefiting from 

what is intended to be a reciprocal agreement between two countries. In general, the provision does not rely on a determination of 

purpose or intention but instead sets forth a series of objective 

tests. A resident of a Contracting State that satisfies one of the 

tests will receive benefits regardless of its motivations in choosing 

its particular business structure. 

The structure of the Article is as follows: Paragraph 1 states the 

general rule that residents are entitled to benefits otherwise accorded to residents only to the extent provided in the Article. Paragraph 2 lists a series of attributes of a resident of a Contracting 

State, the presence of any one of which will entitle that person to 

all the benefits of the Convention. Paragraph 3 provides a so-called 

‘‘derivative benefits’’ test under which certain categories of income 

may qualify for benefits. Paragraph 4 provides that, regardless of 

whether a person qualifies for benefits under paragraph 2 or 3, 

benefits may be granted to that person with regard to certain income earned in the conduct of an active trade or business. Paragraph 5 provides special rules for so-called ‘‘triangular cases’’ notVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00074 Fmt 6602 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
75 

withstanding paragraphs 1 through 4 of Article 21. Paragraph 6 

provides that benefits also may be granted if the competent authority of the State from which benefits are claimed determines that it 

is appropriate to provide benefits in that case. Paragraph 7 defines 

certain terms used in the Article. 

Paragraph 1 

Paragraph 1 provides that a resident of a Contracting State will 

be entitled to the benefits otherwise accorded to residents of a Contracting State under the Convention only to the extent provided in 

the Article. The benefits otherwise accorded to residents under the 

Convention include all limitations on source-based taxation under 

Articles 6 through 20, the treaty-based relief from double taxation 

provided by Article 22 (Relief from Double Taxation), and the protection against discrimination afforded to residents of a Contracting State under Article 23 (Non-Discrimination). Some provisions do not require that a person be a resident in order to enjoy 

the benefits of those provisions. Article 24 (Mutual Agreement Procedure) is not limited to residents of the Contracting States, and 

Article 26 applies to diplomatic agents or consular officials regardless of residence. Article 21 accordingly does not limit the availability of treaty benefits under these provisions. 

Article 21 and the anti-abuse provisions of domestic law complement each other, as Article 21 effectively determines whether an 

entity has a sufficient nexus to the Contracting State to be treated 

as a resident for treaty purposes, while domestic anti-abuse provisions (e.g., business purpose, substance-over-form, step transaction 

or conduit principles) determine whether a particular transaction 

should be recast in accordance with its substance. Thus, internal 

law principles of the source Contracting State may be applied to 

identify the beneficial owner of an item of income, and Article 21 

then will be applied to the beneficial owner to determine if that 

person is entitled to the benefits of the Convention with respect to 

such income. 

Paragraph 2 

Paragraph 2 has five subparagraphs, each of which describes a 

category of residents that are entitled to all benefits of the Convention. 

It is intended that the provisions of paragraph 2 will be self executing. Unlike theprovisions of paragraph 6, discussed below, 

claiming benefits under paragraph 2 does not require an advance 

competent authority ruling or approval. The tax authorities may, 

of course, on review, determine that the taxpayer has improperly 

interpreted the paragraph and is not entitled to the benefits 

claimed. 

Individuals—Subparagraph 2(a) 

Subparagraph (a) provides that individual residents of a Contracting State will be entitled to all treaty benefits. If such an individual receives income as a nominee on behalf of a third country 

resident, benefits may be denied under the respective articles of 

the Convention by the requirement that the beneficial owner of the 

income be a resident of a Contracting State. 

76 

Governments—Subparagraph 2(b) 

Subparagraph (b) provides that the Contracting States and any 

political subdivision or local authority thereof will be entitled to all 

benefits of the Convention. 

Publicly-Traded Corporations—Subparagraph 2(c)(i) 

Subparagraph (c) applies to two categories of companies: publicly 

traded companies and subsidiaries of publicly traded companies. A 

company resident in a Contracting State is entitled to all the benefits of the Convention under clause (i) of subparagraph (c) if the 

principal class of its shares, and any disproportionate class of 

shares, is regularly traded on one or more recognized stock exchanges and the company satisfies at least one of the following additional requirements: first, the company’s principal class of shares 

is primarily traded on one or more recognized stock exchanges located in the Contracting State of which the company is a resident; 

or, second, the company’s primary place of management and control 

is in its State of residence. 

The term ‘‘recognized stock exchange’’ is defined in subparagraph 

7(a). It includes (i) the NASDAQ System and any stock exchange 

registered with the Securities and Exchange Commission as a national securities exchange for purposes of the Securities Exchange 

Act of 1934; (ii) the Bulgarian Stock Exchange—Sofia, and any 

other stock exchange licensed to trade securities and financial instruments under the Bulgarian law; and (iii) any other stock exchange agreed upon by the competent authorities of the Contracting States. 

If a company has only one class of shares, it is only necessary 

to consider whether the shares of that class meet the relevant trading requirements. If the company has more than one class of 

shares, it is necessary as an initial matter to determine which class 

or classes constitute the ‘‘principal class of shares’’. The term ‘‘principal class of shares’’ is defined in subparagraph 7(b) to mean 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 class of ordinary or common shares representing the majority of the aggregate voting power and value of 

the company, then the ‘‘principal class of shares’’ is that class or 

any combination of classes of shares that represents, in the aggregate, a majority of the voting power and value of the company. Although in a particular case involving a company with several classes of shares it is conceivable that more than one group of classes 

could be identified that account for more than 50% of the shares, 

it is only necessary for one such group to satisfy the requirements 

of this subparagraph in order for the company to be entitled to benefits. Benefits would not be denied to the company even if a second, 

non-qualifying, group of shares with more than half of the company’s voting power and value could be identified. 

A company whose principal class of shares is regularly traded on 

a recognized stock exchange will nevertheless not qualify for benefits under subparagraph 2(c) if it has a disproportionate class of 

shares that is not regularly traded on a recognized stock exchange. 

The term ‘‘disproportionate class of shares’’ is defined in subparagraph 7(c). A company has a disproportionate class of shares if it 

77 

has outstanding a class of shares that 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 other Contracting State than 

that to which the holder would be entitled in the absence of such 

terms or arrangements. Thus, for example, a company resident in 

Bulgaria has a disproportionate class of shares 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. 

The following example illustrates this result. 

Example. BulCo is a corporation resident in Bulgaria. BulCo has 

two classes of shares: Common and Preferred. The Common shares 

are listed and regularly traded on the principal stock exchange of 

Bulgaria. The Preferred shares have no voting rights and are entitled to receive dividends equal in amount to interest payments that 

BulCo receives from unrelated borrowers in the United States. The 

Preferred shares are owned entirely by a single investor that is a 

resident of a country with which the United States does not have 

a tax treaty. The Common shares account for more than 50 percent 

of the value of BulCo and for 100 percent of the voting power. Because the owner of the Preferred shares is entitled to receive payments corresponding to the U.S. source interest income earned by 

BulCo, the Preferred shares are a disproportionate class of shares. 

Because the Preferred shares are not regularly traded on a recognized stock exchange, BulCo will not qualify for benefits under subparagraph 2(c). 

A class of shares will be ‘‘regularly traded’’ on one or more recognized stock exchanges in a taxable year, under subparagraph 7(g), 

if the aggregate number of shares of that class traded on one or 

more recognized exchanges during the twelve months ending on the 

day before the beginning of that taxable year is at least six percent 

of the average number of shares outstanding in that class during 

that twelve-month period. The regular trading requirement can be 

met by trading on any recognized exchange or exchanges located in 

either State. Trading on one or more recognized stock exchanges 

may be aggregated for purposes of this requirement. Thus, a U.S. 

company could satisfy the regularly traded requirement through 

trading, in whole or in part, on a recognized stock exchange located 

in Bulgaria. 

The term ‘‘primarily traded’’ is not defined in the Convention. In 

accordance with paragraph 2 of Article 3 (General Definitions), this 

term will have the meaning it has under the laws of the State concerning the taxes to which the Convention applies, generally the 

source State. In the case of the United States, this term is understood to have the meaning it has under Treas. Reg. section 1. 884– 

5(d)(3), relating to the branch tax provisions of the Code. Accordingly, stock of a corporation is ‘‘primarily traded’’ if the number of 

shares in the company’s principal class of shares that are traded 

during the taxable year on all recognized stock exchanges in the 

Contracting State of which the company is a resident exceeds the 

number of shares in the company’s principal class of shares that 

are traded during that year on established securities markets in 

any other single foreign country. 

78 

A company whose principal class of shares is regularly traded on 

a recognized exchange but cannot meet the primarily traded test 

may claim treaty benefits if its primary place of management and 

control is in its country of residence. This test should be distinguished from the ‘‘place of effective management’’ test which is 

used in the OECD Model and by many other countries to establish 

residence. In some cases, 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 looks to where day-to-day responsibility for the management of the company (and its subsidiaries) is exercised. The company’s primary place of management and control will be located in 

the State 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 that State than in the other State or any third 

state, and the staff that support the management in making those 

decisions are also based in that State. Thus, the test looks to the 

overall activities of the relevant persons to see where those activities are conducted. In most cases, it will be a necessary, but not 

a sufficient, condition that the headquarters of the company (that 

is, the place at which the CEO and other top executives normally 

are based) be located in the Contracting State of which the company is a resident. 

To apply the test, it will be necessary to determine which persons 

are to be considered ‘‘executive officers and senior management employees’’. In most cases, it will not be necessary to look beyond the 

executives who are members of the Board of Directors (the ‘‘inside 

directors’’) in the case of a U.S. company. That will not always be 

the case, however; in fact, the relevant persons may be employees 

of subsidiaries if those persons make the strategic, financial and 

operational policy decisions. Moreover, it would be necessary to 

take into account any special voting arrangements that result in 

certain board members making certain decisions without the participation of other board members. 

Subsidiaries of Publicly-Traded Corporations—Subparagraph 2(c)(ii) 

A company resident in a Contracting State is entitled to all the 

benefits of the Convention under clause (ii) of subparagraph 2(c) if 

five or fewer publicly traded companies described in clause (i) are 

the direct or indirect owners of at least 50 percent of the aggregate 

vote and value of the company’s shares (and at least 50 percent of 

any disproportionate class of shares). If the publicly-traded companies are indirect owners, however, each of the intermediate companies must be a resident of one of the Contracting States. 

Thus, for example, a company that is a resident of Bulgaria, all 

the shares of which are owned by another company that is a resident of Bulgaria, would qualify for benefits under the Convention 

if the principal class of shares (and any disproportionate classes of 

shares) of the parent company are regularly and primarily traded 

on a recognized stock exchange in Bulgaria. However, such a subsidiary would not qualify for benefits under clause (ii) if the pubVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00078 Fmt 6602 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
79 

licly traded parent company were a resident of a third state, for example, and not a resident of the United States or Bulgaria. Furthermore, if a parent company in Bulgaria indirectly owned the 

bottom-tier company through a chain of subsidiaries, each such 

subsidiary in the chain, as an intermediate owner, must be a resident of the United States or Bulgaria in order for the subsidiary 

to meet the test in clause (ii). 

Tax Exempt Organizations—Subparagraph 2(d) 

Subparagraph 2(d) provides rules by which the tax exempt organizations described in paragraph 2 of Article 4 (Resident) will be 

entitled to all the benefits of the Convention. A pension fund will 

qualify for benefits if more than fifty percent of the beneficiaries, 

members or participants of the organization are individuals resident in either Contracting State. For purposes of this provision, the 

term ‘‘beneficiaries’’ should be understood to refer to the persons 

receiving benefits from the organization. On the other hand, a taxexempt organization other than a pension fund automatically qualifies for benefits, without regard to the residence of its beneficiaries 

or members. Entities qualifying under this rule are those that are 

generally exempt from tax in their State of residence and that are 

organized and operated exclusively to fulfill religious, charitable, 

scientific, artistic, cultural, or educational purposes. 

Ownership/Base Erosion—Subparagraph 2(e) 

Subparagraph 2(e) provides an additional method to qualify for 

treaty benefits that applies to any form of legal entity that is a 

resident of a Contracting State. The test provided in subparagraph 

(e), the so-called ownership and base erosion test, is a two-part 

test. Both prongs of the test must be satisfied for the resident to 

be entitled to treaty benefits under subparagraph 2(e). 

The ownership prong of the test, under clause (i), requires that 

at least 50 percent of the aggregate voting power and value (and 

at least 50 percent of any disproportionate class of shares) of 

shares or other beneficial interests in the person is owned, directly 

or indirectly, on at least half the days of the person’s taxable year 

by persons who are residents of the Contracting State of which that 

person is a resident and that are themselves entitled to treaty benefits under subparagraphs 2(a), (b), (c)(i), or (d). In the case of indirect owners, each of the intermediate owners must be a resident of 

that Contracting State. 

Trusts may be entitled to benefits under this provision if they 

are treated as residents under Article 4 (Resident) and they otherwise satisfy the requirements of this subparagraph. For purposes 

of this subparagraph, the beneficial interests in a trust will be considered to be owned by its beneficiaries in proportion to each beneficiary’s actuarial interest in the trust. The interest of a remainder 

beneficiary will be equal to 100 percent less the aggregate percentages held by income beneficiaries. A beneficiary’s interest in a trust 

will not be considered to be owned by a person entitled to benefits 

under the other provisions of paragraph 2 if it is not possible to determine the beneficiary’s actuarial interest. Consequently, if it is 

not possible to determine the actuarial interest of the beneficiaries 

in a trust, the ownership test under clause i) cannot be satisfied, 

80 

unless all possible beneficiaries are persons entitled to benefits 

under subparagraphs 2(a), (b), (c)(i), or (d). 

The base erosion prong of clause (ii) of subparagraph (e) is satisfied with respect to a person if less than 50 percent of the person’s 

gross income for the taxable year, as determined under the tax law 

in the person’s State of residence, is paid or accrued, directly or indirectly, to persons who are not residents of either Contracting 

State entitled to benefits under subparagraphs (a), (b), (c)(i), or (d), 

in the form of payments deductible for tax purposes in the payor’s 

State of residence. These amounts do not include arm’s-length payments in the ordinary course of business for services or tangible 

property. To the extent they are deductible from the taxable base, 

trust distributions are deductible payments. However, depreciation 

and amortization deductions, which do not represent payments or 

accruals to other persons, are disregarded for this purpose. 

Paragraph 3 

Paragraph 3 sets forth a derivative benefits test that is potentially applicable to all treaty benefits, although the test is applied 

to individual items of income. In general, a derivative benefits test 

entitles the resident of a Contracting State to treaty benefits if the 

owner of the resident would have been entitled to the same benefit 

had the income in question flowed directly to that owner. To qualify under this paragraph, the company must meet an ownership 

test and a base erosion test. 

Subparagraph (a) sets forth the ownership test. Under this test, 

seven or fewer equivalent beneficiaries must own shares representing at least 95 percent of the aggregate voting power and 

value of the company and at least 50 percent of any disproportionate class of shares. Ownership may be direct or indirect. The 

term ‘‘equivalent beneficiary’’ is defined in subparagraph (e) of 

paragraph 7. This definition may be met in two alternative ways, 

the first of which has two requirements. 

Under the first alternative, a person may be an equivalent beneficiary because it is entitled to equivalent benefits under a treaty 

between the country of source and the country in which the person 

is a resident. This alternative has two requirements. 

The first requirement is that the person must be a resident of 

a member state of the European Union, or of a European Economic 

Area state, or of a party to the North American Free Trade Agreement (collectively, ‘‘qualifying States’’). 

The second requirement of the definition of ‘‘equivalent beneficiary’’ is that the person must be entitled to equivalent benefits 

under an applicable treaty. To satisfy the second requirement, the 

person must be entitled to all the benefits of a comprehensive treaty between the Contracting State from which benefits of the Convention are claimed and a qualifying State under provisions that 

are analogous to the rules in paragraph 2 (a), (b), (c)(i), and (d) of 

this Article. If the treaty in question does not have a comprehensive limitation on benefits article, this requirement is met only if 

the person would be entitled to treaty benefits under the tests in 

subparagraphs 2(a), (b), (c)(i), and (d) of this Article if the person 

were a resident of one of the Contracting States. 

81 

In order to satisfy the second requirement necessary to qualify 

as an ‘‘equivalent beneficiary’’ under subparagraph 7(e)(i)(B) with 

respect to dividends, interest, royalties or branch tax, the person 

must be entitled to a rate of tax that is at least as low as the tax 

rate that would apply under the Convention to such income. Thus, 

the rates to be compared are: (1) the rate of tax that the source 

State would have imposed if a qualified resident of the other Contracting State was the beneficial owner of the income; and (2) the 

rate of tax that the source State would have imposed if the third 

State resident received the income directly from the source State. 

Subparagraph 7(f) provides a special rule to take account of the 

fact that withholding taxes on many inter-company 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 Bulgarian 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. 

This rule is necessary because many European Union member 

countries have not re-negotiated their tax treaties to reflect the exemptions available under the directives. 

The requirement that a person be entitled to ‘‘all the benefits’’ of 

a comprehensive tax treaty eliminates those persons that qualify 

for benefits with respect to only certain types of income. Accordingly, the fact that a French parent of a Bulgarian company is engaged in the active conduct of a trade or business in France and 

therefore would be entitled to the benefits of the U.S.-France treaty 

if it received dividends directly from a U.S. subsidiary of the Bulgarian company is not sufficient for purposes of this paragraph. 

Further, the French company cannot be an equivalent beneficiary 

if it qualifies for benefits only with respect to certain income as a 

result of a ‘‘derivative benefits’’ provision in the U.S.-France treaty. 

However, it would be possible to look through the French company 

to its parent company to determine whether the parent company 

is an equivalent beneficiary. 

The second alternative for satisfying the ‘‘equivalent beneficiary’’ 

test is available only to residents of one of the two Contracting 

States. U.S. or Bulgarian residents who are eligible for treaty benefits by reason of subparagraphs 2(a), (b), (c)(i), or (d) are equivalent 

beneficiaries for purposes of the relevant tests in Article 21. Thus, 

a Bulgarian individual will be an equivalent beneficiary without regard to whether the individual would have been entitled to receive 

the same benefits if it received the income directly. A resident of 

a third country cannot qualify for treaty benefits under these provisions by reason of those paragraphs or any other rule of the treaty, 

and therefore does not qualify as an equivalent beneficiary under 

this alternative. Thus, a resident of a third country can be an 

equivalent beneficiary only if it would have been entitled to equivalent benefits had it received the income directly. 

The second alternative was included in order to clarify that ownership by certain residents of a Contracting State would not disqualify a U.S. or Bulgarian company under this paragraph. Thus, 

for example, if 90 percent of a Bulgarian company is owned by five 

82 

companies that are resident in member states of the European 

Union who satisfy the requirements of subparagraph 7(e)(i), and 10 

percent of the Bulgarian company is owned by a U.S. or Bulgarian 

individual, then the Bulgarian company still can satisfy the requirements of subparagraph 3(a). 

Subparagraph 3(b) sets forth the base erosion test. A company 

meets this base erosion test if less than 50 percent of its gross income (as determined in the company’s State of residence) for the 

taxable period is paid or accrued, directly or indirectly, to a person 

or persons who are not equivalent beneficiaries in the form of payments deductible for tax purposes in company’s State of residence. 

These amounts do not include arm’s-length payments in the ordinary course of business for services or tangible property. This test 

is the same as the base erosion test in subparagraph 2(e)(ii), except 

that the test in paragraph 3(b) focuses on base-eroding payments 

to persons who are not equivalent beneficiaries. 

Paragraph 4 

Paragraph 4 sets forth an alternative test under which a resident 

of a Contracting State may receive treaty benefits with respect to 

certain items of income that are connected to an active trade or 

business conducted in its State of residence. A resident of a Contracting State may qualify for benefits under paragraph 4 whether 

or not it also qualifies under paragraph 2 or 3. 

Subparagraph (a) sets forth the general rule that a resident of 

a Contracting State engaged in the active conduct of a trade or 

business in that State may obtain the benefits of the Convention 

with respect to an item of income derived in the other Contracting 

State. The item of income, however, must be derived in connection 

with or incidental to that trade or business. 

The term ‘‘trade or business’’ is not defined in the Convention. 

Pursuant to paragraph 2 of Article 3 (General Definitions), when 

determining whether a resident of Bulgaria is entitled to the benefits of the Convention under paragraph 4 of this Article with respect to an item of income derived from sources within the United 

States, the United States will ascribe to this term the meaning 

that it has under the law of the United States. Accordingly, the 

U.S. competent authority will refer to the regulations issued under 

section 367(a) for the definition of the term ‘‘trade or business.’’ In 

general, therefore, a trade or business will be considered to be a 

specific unified group of activities that constitute or could constitute an independent economic enterprise carried on for profit. 

Furthermore, a corporation generally will be considered to carry on 

a trade or business only if the officers and employees of the corporation conduct substantial managerial and operational activities. 

The business of making or managing investments for the resident’s own account will be considered to be a trade or business only 

when part of banking, insurance or securities activities conducted 

by a bank, an insurance company, or a registered securities dealer. 

Such activities conducted by a person other than a bank, insurance 

company or registered securities dealer will not be considered to be 

the conduct of an active trade or business, nor would they be considered to be the conduct of an active trade or business if conducted 

by a bank, insurance company or registered securities dealer but 

83 

not as part of the company’s banking, insurance or dealer business. 

Because a headquarters operation is in the business of managing 

investments, a company that functions solely as a headquarters 

company will not be considered to be engaged in an active trade or 

business for purposes of paragraph 4. 

An item of income is derived in connection with a trade or business if the income-producing activity in the State of source is a line 

of business that ‘‘forms a part of’’ or is ‘‘complementary’’ to the 

trade or business conducted in the State of residence by the income 

recipient. 

A business activity generally will be considered to form part of 

a business activity conducted in the State 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 State of residence may be upstream, downstream, or parallel to the activity conducted in the State of source. 

Thus, the line of business may provide inputs for a manufacturing 

process that occurs in the State 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 State of source. 

Example 1. USCo is a corporation resident in the United States. 

USCo is engaged in an active manufacturing business in the 

United States. USCo owns 100 percent of the shares of BulCo, a 

corporation resident in Bulgaria. BulCo distributes USCo products 

in Bulgaria. Since the business activities conducted by the two corporations involve the same products, BulCo’s distribution business 

is considered to form a part of USCo’s manufacturing business. 

Example 2. The facts are the same as in Example 1, except that 

USCo does not manufacture. Rather, USCo operates a large research and development facility in the United States that licenses 

intellectual property to affiliates worldwide, including BulCo. 

BulCo and other USCo affiliates then manufacture and market the 

USCo-designed products in their respective markets. Since the activities conducted by BulCo and USCo involve the same product 

lines, these activities are considered to form a part of the same 

trade or business. 

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 State 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 State of residence, it is necessary to identify the trade or business to which an item of income 

is attributable. Royalties generally will be considered to be derived 

in connection with the trade or business to which the underlying 

intangible property is attributable. Dividends will be 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. 

84 

Example 3. Americair is a corporation resident in the United 

States that operates an international airline. BulSub is a whollyowned subsidiary of Americair resident in Bulgaria. BulSub operates a chain of hotels in Bulgaria that are located near airports 

served by Americair flights. Americair frequently sells tour packages that include air travel to Bulgaria and lodging at BulSub hotels. Although both companies are engaged in the active conduct of 

a trade or business, the businesses of operating a chain of hotels 

and operating an airline are distinct trades or businesses. Therefore BulSub’s business does not form a part of Americair’s business. 

However, BulSub’s business is considered to be complementary to 

Americair’s business because they are part of the same overall industry (travel) and the links between their operations tend to make 

them interdependent. 

Example 4. The facts are the same as in Example 3, except that 

BulSub owns an office building in Bulgaria instead of a hotel chain. 

No part of Americair’s business is conducted through the office 

building. BulSub’s business is not considered to form a part of or 

to be complementary to Americair’s business. They are engaged in 

distinct trades or businesses in separate industries, and there is no 

economic dependence between the two operations. 

Example 5. USFlower is a corporation resident in the United 

States. USFlower produces and sells flowers in the United States 

and other countries. USFlower owns all the shares of BulHolding, 

a corporation resident in Bulgaria. BulHolding is a holding company that is not engaged in a trade or business. BulHolding owns 

all the shares of three corporations that are resident in Bulgaria: 

BulFlower, BulLawn, and BulFish. BulFlower distributes 

USFlower flowers under the USFlower trademark in Bulgaria. 

BulLawn markets a line of lawn care products in Bulgaria under 

the USFlower trademark. In addition to being sold under the same 

trademark, BulLawn and BulFlower products are sold in the same 

stores and sales of each company’s products tend to generate increased sales of the other’s products. BulFish imports fish from the 

United States and distributes it to fish wholesalers in Bulgaria. 

For purposes of paragraph 4, the business of BulFlower forms a 

part of the business of USFlower, the business of BulLawn is complementary to the business of USFlower, and the business of 

BulFish is neither part of nor complementary to that of USFlower. 

An item of income derived from the State of source is ‘‘incidental 

to’’ the trade or business carried on in the State of residence if production of the item facilitates the conduct of the trade or business 

in the State of residence. An example of incidental income is the 

temporary investment of working capital of a person in the State 

of residence in securities issued by persons in the State of source. 

Subparagraph 4(b) states a further condition to the general rule 

in subparagraph (a) in cases where the trade or business generating the item of income in question is carried on either by the person deriving the income or by any associated enterprises. Subparagraph (b) states that the trade or business carried on in the State 

of residence, under these circumstances, must be substantial in relation to the activity in the State of source. The substantiality requirement is intended to prevent a narrow case of treaty-shopping 

abuses in which a company attempts to qualify for benefits by enVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00084 Fmt 6602 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
85 

gaging 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 Contracting State, the nature of the activities performed in each Contracting State, and the 

relative contributions made to that trade or business in each Contracting State. 

The determination in subparagraph (b) also is made separately 

for each item of income derived from the State of source. It therefore is possible that a person would be entitled to the benefits of 

the Convention with respect to one item of income but not with respect to another. If a resident of a Contracting State is entitled to 

treaty benefits with respect to a particular item of income under 

paragraph 4, the resident is entitled to all benefits of the Convention insofar as they affect the taxation of that item of income in 

the State of source. 

The application of the substantiality requirement only to income 

from related parties focuses only on potential abuse cases, and does 

not hamper certain other kinds of non-abusive activities, even 

though the income recipient resident in a Contracting State may be 

very small in relation to the entity generating income in the other 

Contracting State. For example, if a small U.S. research firm develops a process that it licenses to a very large, unrelated, pharmaceutical manufacturer in Bulgaria, the size of the U.S. research 

firm would not have to be tested against the size of the manufacturer. Similarly, a small U.S. bank that makes a loan to a very 

large unrelated company operating a business in Bulgaria would 

not have to pass a substantiality test to receive treaty benefits 

under paragraph 4. 

Subparagraph 4(c) provides special attribution rules for purposes 

of applying the substantive rules of subparagraphs (a) and (b). 

These rules apply for purposes of determining whether a person 

meets the requirement in subparagraph (a) that it be engaged in 

the active conduct of a trade or business and that the item of income is derived in connection with that active trade or business, 

and for making the comparison required by the ‘‘substantiality’’ requirement in subparagraph (b). Subparagraph (c) attributes to a 

person activities conducted by persons ‘‘connected’’ to such person. 

A person (‘‘X’’) is connected to another person (‘‘Y’’) if X possesses 

50 percent or more of the beneficial interest in Y (or if Y possesses 

50 percent or more of the beneficial interest in X). For this purpose, 

X is connected to a company if X owns shares representing fifty 

percent or more of the aggregate voting power and value of the 

company or fifty percent or more of the beneficial equity interest 

in the company. X also is connected to Y if a third person possesses, directly or indirectly, fifty percent or more of the beneficial 

interest in both X and Y. For this purpose, if X or Y is a company, 

the threshold relationship with respect to such company or companies is fifty percent or more of the aggregate voting power and 

value or fifty percent or more of the beneficial equity interest. Finally, X is connected to Y if, based upon all the facts and cirVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00085 Fmt 6602 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
86 

cumstances, X controls Y, Y controls X, or X and Y are controlled 

by the same person or persons. 

Paragraph 5 

Paragraph 5 deals with the treatment of interest or royalty income in the context of a so-called ‘‘triangular case.’’ The paragraph 

provides special rules applicable to U.S. source interest or royalties 

that are attributable to a permanent establishment that a Bulgarian company has in a third state, and that are otherwise exempt from taxation in Bulgaria. 

The term ‘‘triangular case’’ refers to the use of the following 

structure by a resident of Bulgaria to earn, in this case, interest 

income from the United States. The resident of Bulgaria, who is assumed to qualify for benefits under one or more of the provisions 

of Article 21 (Limitation on Benefits), sets up a permanent establishment in a third jurisdiction that imposes only a low rate of tax 

on the income of the permanent establishment. The Bulgarian resident lends funds into the United States through the permanent establishment. The permanent establishment, despite its third-jurisdiction location, is an integral part of a Bulgarian resident. Therefore, the income earned on those loans, absent the provisions of 

paragraph 5, may be entitled to a reduced rate of U.S. withholding 

tax under the Convention. Under a current Bulgarian income tax 

treaty with the host jurisdiction of the permanent establishment, 

the income of the permanent establishment is exempt from Bulgarian tax. Alternatively, Bulgaria may choose to exempt the income of the permanent establishment from Bulgarian income tax. 

Thus, the interest income is subject to a reduced rate of U.S. tax, 

is subject to little tax in the host jurisdiction of the permanent establishment, and is exempt from Bulgarian tax. 

Because the United States does not exempt the profits of a thirdjurisdiction permanent establishment of a U.S. resident from U.S. 

tax, either by statute or by treaty, the paragraph only applies with 

respect to U.S. source interest or royalties that are attributable to 

a third-jurisdiction permanent establishment of a Bulgarian resident. 

Paragraph 5 replaces the otherwise applicable rules in the Convention for interest and royalties with a 15 percent withholding tax 

for interest and royalties if the actual tax paid on the income in 

the third state is less than 60 percent of the tax that would have 

been payable in Bulgaria if the income were earned in Bulgaria by 

the enterprise and were not attributable to the permanent establishment in the third state. 

In general, the principles employed under Code section 954(b) (4) 

will be employed to determine whether the profits are subject to an 

effective rate of taxation that is above the specified threshold. Notwithstanding the level of tax on interest and royalty income of the 

permanent establishment, paragraph 5 will not apply under certain 

circumstances. In the case of interest (as defined in Article 11 (Interest)), paragraph 5 will not apply if the interest is derived in connection with, or is incidental to, the active conduct of a trade or 

business carried on by the permanent establishment in the third 

state. The business of making, managing or simply holding investments is not considered to be an active trade or business, unless 

87 

these are banking or securities activities carried on by a bank or 

registered securities dealer. In the case of royalties (as defined in 

Article 12 (Royalties)), paragraph 5 will not apply if the royalties 

are received as compensation for the use of, or the right to use, intangible property produced or developed by the permanent establishment itself. 

Paragraph 6 

Paragraph 6 provides that a resident of one of the States that is 

not entitled to the benefits of the Convention as a result of paragraphs 2 through 4 still may be granted benefits under the Convention at the discretion of the competent authority of the State from 

which benefits are claimed. Under paragraph 6, that competent authority will determine whether the establishment, acquisition, or 

maintenance of the person seeking benefits under the Convention, 

or the conduct of such person’s operations, has or had as one of its 

principal purposes the obtaining of benefits under the Convention. 

Benefits will not be granted, however, solely because a company 

was established prior to the effective date of a treaty or protocol. 

In that case a company would still be required to establish to the 

satisfaction of the Competent Authority clear non-tax business reasons for its formation in a Contracting State, or that the allowance 

of benefits would not otherwise be contrary to the purposes of the 

treaty. Thus, persons that establish operations in one of the States 

with a principal purpose of obtaining the benefits of the Convention 

ordinarily will not be granted relief under paragraph 6. 

The competent authority’s discretion is quite broad. It may grant 

all of the benefits of the Convention to the taxpayer making the request, or it may grant only certain benefits. For instance, it may 

grant benefits only with respect to a particular item of income in 

a manner similar to paragraph 4. Further, the competent authority 

may establish conditions, such as setting time limits on the duration of any relief granted. 

For purposes of implementing paragraph 6, a taxpayer will be 

permitted to present his case to the relevant competent authority 

for an advance determination based on the facts. In these circumstances, it is also expected that, if the competent authority determines that benefits are to be allowed, they will be allowed retroactively to the time of entry into force of the relevant treaty provision or the establishment of the structure in question, whichever 

is later. 

Finally, there may be cases in which a resident of a Contracting 

State may apply for discretionary relief to the competent authority 

of his State of residence. This would arise, for example, if the benefit the resident is claiming is provided by the residence country, 

and not by the source country. So, for example, if a company that 

is a resident of the United States would like to claim the benefit 

of the re-sourcing rule of paragraph 3 of Article 22, but it does not 

meet any of the objective tests of this Article, it may apply to the 

U.S. competent authority for discretionary relief. 

88 

Paragraph 7 

Paragraph 7 defines several key terms for purposes of Article 21. 

Each of the defined terms is discussed above in the context in 

which it is used. 

ARTICLE 22 (RELIEF FROM DOUBLE TAXATION)

This Article describes the manner in which each Contracting 

State undertakes to relieve double taxation. The United States 

uses the foreign tax credit method under its internal law, and by 

treaty. 

Paragraph 1 

Paragraph 1 provides that Bulgaria will provide relief from double taxation through a mixture of the credit and exemption methods. 

Subparagraph 1(a) states the general rule that Bulgaria will exempt income derived by a resident if the income may be taxed in 

the United States in accordance with the Convention. Subparagraph 1(c), permits Bulgaria to include the income corresponding to 

the U.S. tax in the resident’s tax base in calculating the Bulgarian 

tax on the remaining income of the resident. This rule provides for 

‘‘exemption with progression.’’ Under subparagraph 1(b), Bulgaria 

provides for a tax credit rather than an exemption with respect to 

limited classes of income. If the income may be taxed by the United 

States under the provisions of Article 10 (Dividends), Article 11 (Interest), or Article 12 (Royalties), Bulgaria will relieve double taxation by allowing a credit against Bulgarian tax in an amount 

equal to the tax paid in the United States on such income, but limited to the amount of Bulgarian tax attributable to such dividends, 

interest, and royalty income. 

Paragraph 2 

The United States agrees, in paragraph 2, to allow to its citizens 

and residents a credit against U.S. tax for income taxes paid or accrued to Bulgaria. Paragraph 2 also provides that Bulgaria’s covered taxes are income taxes for U.S. purposes. This provision is 

based on the Treasury Department’s review of Bulgaria’s laws. 

Subparagraph (b) provides for a deemed-paid credit, consistent 

with section 902 of the Code, to a U.S. corporation in respect of 

dividends received from a corporation resident in Bulgaria of which 

the U.S. corporation owns at least 10 percent of the voting stock. 

This credit is for the tax paid by the corporation to Bulgaria on the 

profits out of which the dividends are considered paid. 

The credits allowed under paragraph 2 are allowed in accordance 

with the provisions and subject to the limitations of U.S. law, as 

that law may be amended over time, so long as the general principle of the Article, that is, the allowance of a credit, is retained. 

Thus, although the Convention provides for a foreign tax credit, the 

terms of the credit are determined by the provisions, at the time 

a credit is given, of the U.S. statutory credit. 

Therefore, the U.S. credit under the Convention is subject to the 

various limitations of U.S. law (see, e.g., Code sections 901–908). 

For example, the credit against U.S. tax generally is limited to the 

89 

amount of U.S. tax due with respect to net foreign source income 

within the relevant foreign tax credit limitation category (see Code 

section 904(a) and (d)), and the dollar amount of the credit is determined in accordance with U.S. currency translation rules (see, e.g., 

Code section 986). Similarly, U.S. law applies to determine carryover periods for excess credits and other inter-year adjustments. 

Paragraph 3 

Paragraph 3 provides a re-sourcing rule for gross income covered 

by paragraph 2. Paragraph 3 is intended to ensure that a U.S. resident can obtain an appropriate amount of U.S. foreign tax credit 

for income taxes paid to Bulgaria when the Convention assigns to 

Bulgaria primary taxing rights over an item of gross income. 

Accordingly, if the Convention allows Bulgaria to tax an item of 

gross income (as defined under U.S. law) derived by a resident of 

the United States, the United States will treat that item of gross 

income as gross income from sources within Bulgaria for U.S. foreign tax credit purposes. In the case of a U.S.-owned foreign corporation, however, section 904(h)(10) may apply for purposes of determining the U.S. foreign tax credit with respect to income subject 

to this re-sourcing rule. Section 904(h)(10) generally applies the 

foreign tax credit limitation separately to re-sourced income. Furthermore, the paragraph 3 re-sourcing rule applies to gross income, 

not net income. Accordingly, U.S. expense allocation and apportionment rules, see, e.g., Treas. Reg. section 1.861–9, continue to apply 

to income resourced under paragraph 3. 

Paragraph 4 

Paragraph 4 provides special rules for the tax treatment in both 

States of certain types of income derived from U.S. sources by U.S. 

citizens who are residents of Bulgaria. Since U.S. citizens, regardless of residence, are subject to United States tax at ordinary progressive rates on their worldwide income, the U.S. tax on the U.S. 

source income of a U.S. citizen resident in Bulgaria may exceed the 

U.S. tax that may be imposed under the Convention on an item of 

U.S. source income derived by a resident of Bulgaria who is not a 

U.S. citizen. The provisions of paragraph 4 ensure that Bulgaria 

does not bear the cost of U.S. taxation of its citizens who are residents of Bulgaria. 

Subparagraph (a) provides, with respect to items of income from 

sources within the United States, special credit rules for Bulgaria. 

These rules apply to items of U.S.-source income that would be either exempt from U.S. tax or subject to reduced rates of U.S. tax 

under the provisions of the Convention if they had been received 

by a resident of Bulgaria who is not a U.S. citizen. The tax credit 

allowed by Bulgaria under paragraph 4 with respect to such items 

need not exceed the U.S. tax that may be imposed under the Convention, other than tax imposed solely by reason of the U.S. citizenship of the taxpayer under the provisions of the saving clause of 

paragraph 4 of Article 1 (General Scope). 

For example, if a U.S. citizen resident in Bulgaria receives portfolio dividends from sources within the United States, the foreign 

tax credit granted by Bulgaria would be limited to 10 percent of the 

dividend—the U.S. tax that may be imposed under subparagraph 

90 

2(b) of Article 10 (Dividends)—even if the shareholder is subject to 

U.S. net income tax because of his U.S. citizenship. 

Subparagraph 4(b) eliminates the potential for double taxation 

that can arise because subparagraph 4(a) provides that Bulgaria 

need not provide full relief for the U.S. tax imposed on its citizens 

resident in Bulgaria. The subparagraph provides that the United 

States will credit the income tax paid or accrued to Bulgaria, after 

the application of subparagraph 4(a). It further provides that in allowing the credit, the United States will not reduce its tax below 

the amount that is taken into account in Bulgaria in applying subparagraph 4(a). 

Since the income described in paragraph 4(a) generally will be 

U.S. source income, special rules are required to re-source some of 

the income to Bulgaria in order for the United States to be able to 

credit the tax paid to Bulgaria. This re-sourcing is provided for in 

subparagraph 4(c), which deems the items of income referred to in 

subparagraph 4(a) to be from foreign sources to the extent necessary to avoid double taxation under subparagraph 4(b). Subparagraph 3(e) of Article 24 (Mutual Agreement Procedure) provides a 

mechanism by which the competent authorities can resolve any disputes regarding whether income is from sources within the United 

States. 

The following two examples illustrate the application of paragraph 4 in the case of aU.S.-source portfolio dividend received by 

a U.S. citizen resident in Bulgaria. In both examples, the U.S. rate 

of tax on residents of Bulgaria, under subparagraph 2(b) of Article 

10 (Dividends) of the Convention, is 10 percent. In both examples, 

the U.S. income tax rate on the U.S. citizen is 35 percent. In example 1, the rate of income tax imposed in Bulgaria on its resident 

(the U.S. citizen) is 25 percent (below the U.S. rate), and in example 2, the rate imposed on its resident is 40 percent (above the U.S. 

rate). 

Example 1 Example 2 

Subparagraph (a) 

U.S. dividend declared ....................... $100.00 $100.00 

Notional U.S. withholding tax (Article 10(2)(b)) ...................................... 10.00 10.00 

Taxable income in Bulgaria .............. 100.00 100.00 

Bulgaria tax before credit .................. 25.00 40.00 

Less: tax credit for notional U.S. 

withholding tax ............................... 10.00 10.00 

Net post-credit tax paid to Bulgaria 15.00 30.00 

Subparagraphs (b) and (c) 

U.S. pre-tax income ............................ $100.00 $100.00 

U.S. pre-credit citizenship tax ........... 35.00 35.00 

Notional U.S. withholding tax .......... 10.00 10.00 

U.S. tax eligible to be offset by credit 25.00 25.00 

Tax paid to Bulgaria .......................... 15.00 30.00 

91 

Example 1 Example 2 

Income re-sourced from U.S. to foreign source (see below) ................... 42.86 71.43 

U.S. pre-credit tax on re-sourced income ................................................. 15.00 25.00 

U.S. credit for tax paid to Bulgaria 

15.00 25.00.

Net post-credit U.S. tax ..................... 10.00 0.00 

Total U.S. tax ..................................... 20.00 10.00 

In both examples, in the application of subparagraph (a), Bulgaria credits a 10 percent U.S. tax against its residence tax on the 

U.S. citizen. In the first example, the net tax paid to Bulgaria after 

the foreign tax credit is $15.00; in the second example, it is $30.00. 

In the application of subparagraphs (b) and (c), from the U.S. tax 

due before credit of $35.00, the United States subtracts the amount 

of the U.S. source tax of $10.00, against which no U.S. foreign tax 

credit is allowed. This subtraction ensures that the United States 

collects the tax that it is due under the Convention as the State 

of source. 

In both examples, given the 35 percent U.S. tax rate, the maximum amount of U.S. tax against which credit for the tax paid to 

Bulgaria may be claimed is $25 ($35 U.S. tax minus $10 U.S. withholding tax). Initially, all of the income in both examples was from 

sources within the United States. For a U.S. foreign tax credit to 

be allowed for the full amount of the tax paid to Bulgaria, an appropriate amount of the income must be re-sourced to Bulgaria 

under subparagraph (c). 

The amount that must be re-sourced depends on the amount of 

tax for which the U.S. citizen is claiming a U.S. foreign tax credit. 

In example 1, the tax paid to Bulgaria was $15. For this amount 

to be creditable against U.S. tax, $42.86 ($15 tax divided by 35 percent U.S. tax rate) must be resourced to Bulgaria. There is a net 

U.S. tax of $10 due after credit ($25 U.S. tax eligible to be offset 

by credit, minus $15 tax paid to Bulgaria). Thus, in example 1, 

there is a total of $20 in U.S. tax ($10 U.S. withholding tax plus 

$10 residual U.S. tax). 

In example 2, the tax paid to Bulgaria was $30, but, because the United States subtracts the U.S. withholding tax of $10 from the 

total U.S. tax of $35, only $25 of U.S. taxes may be offset by taxes 

paid to Bulgaria. Accordingly, the amount that must be resourced 

to Bulgaria is limited to the amount necessary to ensure a U.S. foreign tax credit for $25 of tax paid to Bulgaria, or $71.43 ($25 tax 

paid to Bulgaria divided by 35 percent U.S. tax rate). When the tax 

paid to Bulgaria is credited against the U.S. tax on this re-sourced 

income, there is no residual U.S. tax ($25 U.S. tax minus $30 tax 

paid to Bulgaria, subject to the U.S. limit of $25). Thus, in example 

2, there is a total of $10 in U.S. tax ($10 U.S. withholding tax plus 

$0 residual U.S. tax). Because the tax paid to Bulgaria was $30 

and the U.S. tax eligible to be offset by credit was $25, there is $5 

of excess foreign tax credit available for carryover. 

92 

Relationship to other Articles 

By virtue of subparagraph 5(a) of Article 1 (General Scope), Article 22 is not subject to the saving clause of paragraph 4 of Article 

1. Thus, the United States will allow a credit to its citizens and 

residents in accordance with the Article, even if such credit were 

to provide a benefit not available under the Code (such as the resourcing provided by paragraph 3 and subparagraph 4(c)). 

ARTICLE 23 (NON-DISCRIMINATION)

This Article ensures that nationals of a Contracting State, in the 

case of paragraph 1, and residents of a Contracting State, in the 

case of paragraphs 2 through 5, will not be subject, directly or indirectly, to discriminatory taxation in the other Contracting State. 

Not all differences in tax treatment, either as between nationals of 

the two States, or between residents of the two States, are violations of the prohibition against discrimination. Rather, the non-discrimination obligations of this Article apply only if the nationals or 

residents of the two States are comparably situated. 

Each of the relevant paragraphs of the Article provides that two 

persons that are comparably situated must be treated similarly. Although the actual words differ from paragraph to paragraph (e.g., 

paragraph 1 refers to two nationals ‘‘in the same circumstances,’’ 

paragraph 2 refers to two enterprises ‘‘carrying on the same activities’’ and paragraph 4 refers to two enterprises that are ‘‘similar’’), 

the common underlying premise is that if the difference in treatment is directly related to a tax-relevant difference in the situations of the domestic and foreign persons being compared, that difference is not to be treated as discriminatory (i.e., if one person is 

taxable in a Contracting State on worldwide income and the other 

is not, or tax may be collectible from one person at a later stage, 

but not from the other, distinctions in treatment would be justified 

under paragraph 1). Other examples of such factors that can lead 

to non-discriminatory differences in treatment are noted in the discussions of each paragraph.The operative paragraphs of the Article 

also use different language to identify the kinds of differences in 

taxation treatment that will be considered discriminatory. For example, paragraphs 1 and 4 speak of ‘‘any taxation or any requirement connected therewith that is more burdensome,’’ while paragraph 2 specifies that a tax ‘‘shall not be less favorably levied.’’ Regardless of these differences in language, only differences in tax 

treatment that materially disadvantage the foreign person relative 

to the domestic person are properly the subject of the Article. 

Paragraph 1 

Paragraph 1 provides that a national of one Contracting State 

may not be subject to taxation or connected requirements in the 

other Contracting State that are more burdensome than the taxes 

and connected requirements imposed upon a national of that other 

State in the same circumstances. The OECD Model language would 

prohibit taxation that is ‘‘other than or more burdensome’’ than 

that imposed on U.S. persons. This Convention omits the reference 

to taxation that is ‘‘other than’’ that imposed on U.S. persons because the only relevant question under this provision should be 

93 

whether the requirement imposed on a national of the other Contracting State is more burdensome. A requirement may be different 

from the requirements imposed on U.S. nationals without being 

more burdensome. 

The term ‘‘national’’ in relation to a Contracting State is defined 

in subparagraph 1(l) of Article 3 (General Definitions). The term includes both individuals and juridical persons. A national of a Contracting State is afforded protection under this paragraph even if 

the national is not a resident of either Contracting State. Thus, a 

U.S. citizen who is resident in a third country is entitled, under 

this paragraph, to the same treatment in Bulgaria as a national of 

Bulgaria who is in similar circumstances (i.e., presumably one who 

is resident in a third State). 

As noted above, whether or not the two persons are both taxable 

on worldwide income is a significant circumstance for this purpose. 

For this reason, paragraph 1 specifically states that the United 

States is not obligated to apply the same taxing regime to a national of Bulgaria who is not resident in the United States as it applies to a U.S. national who is not resident in the United States. 

United States citizens who are not residents of the United States 

but who are, nevertheless, subject to United States tax on their 

worldwide income are not in the same circumstances with respect 

to United States taxation as citizens of Bulgaria who are not 

United States residents. Thus, for example, Article 23 would not 

entitle a national of Bulgaria resident in a third country to taxation at graduated rates on U.S. source dividends or other investment income that applies to a U.S. citizen resident in the same 

third country. 

Paragraph 2 

Paragraph 2 of the Article, provides that a Contracting State 

may not tax a permanent establishment of an enterprise of the 

other Contracting State less favorably than an enterprise of that 

first-mentioned State that is carrying on the same activities. 

The fact that a U.S. permanent establishment of an enterprise 

of Bulgaria is subject to U.S. tax only on income that is attributable to the permanent establishment, while a U.S. corporation 

engaged in the same activities is taxable on its worldwide income 

is not, in itself, a sufficient difference to provide different treatment 

for the permanent establishment. There are cases, however, where 

the two enterprises would not be similarly situated and differences 

in treatment may be warranted. For instance, it would not be a violation of the non-discrimination protection of paragraph 2 to require the foreign enterprise to provide information in a reasonable 

manner that may be different from the information requirements 

imposed on a resident enterprise, because information may not be 

as readily available to the Internal Revenue Service from a foreign 

as from a domestic enterprise. Similarly, it would not be a violation 

of paragraph 2 to impose penalties on persons who fail to comply 

with such a requirement (see, e.g., sections 874(a) and 882(c)(2)). 

Further, a determination that income and expenses have been attributed or allocated to a permanent establishment in conformity 

with the principles of Article 7 (Business Profits) implies that the 

attribution or allocation was not discriminatory. 

94 

Section 1446 of the Code imposes on any partnership with income that is effectively connected with a U.S. trade or business the 

obligation to withhold tax on amounts allocable to a foreign partner. In the context of the Convention, this obligation applies with 

respect to a share of the partnership income of a partner resident 

in Bulgaria, and attributable to a U.S. permanent establishment. 

There is no similar obligation with respect to the distributive 

shares of U.S. resident partners. It is understood, however, that 

this distinction is not a form of discrimination within the meaning 

of paragraph 2 of the Article. No distinction is made between U.S. 

and non-U.S. partnerships, since the law requires that partnerships of both U.S. and non-U.S. domicile withhold tax in respect of 

the partnership shares of non-U.S. partners. Furthermore, in distinguishing between U.S. and non-U.S. partners, the requirement 

to withhold on the non-U.S. but not the U.S. partner’s share is not 

discriminatory taxation, but, like other withholding on nonresident 

aliens, is merely a reasonable method for the collection of tax from 

persons who are not continually present in the United States, and 

as to whom it otherwise may be difficult for the United States to 

enforce its tax jurisdiction. If tax has been over-withheld, the partner can, as in other cases of over-withholding, file for a refund. 

Paragraph 3 

Paragraph 3 makes clear that the provisions of paragraphs 1 and 

2 do not obligate a Contracting State to grant to a resident of the 

other Contracting State any tax allowances, reliefs, etc., that it 

grants to its own residents on account of their civil status or family 

responsibilities. Thus, if a sole proprietor who is a resident of Bulgaria has a permanent establishment in the United States, in assessing income tax on the profits attributable to the permanent establishment, the United States is not obligated to allow to the resident of Bulgaria the personal allowances for himself and his family 

that he would be permitted to take if the permanent establishment 

were a sole proprietorship owned and operated by a U.S. resident, 

despite the fact that the individual income tax rates would apply. 

Paragraph 4 

Paragraph 4 prohibits discrimination in the allowance of deductions. When a resident or an enterprise of a Contracting State pays 

interest, royalties or other disbursements to a resident of the other 

Contracting State, the first-mentioned Contracting State must 

allow a deduction for those payments in computing the taxable 

profits of the resident or enterprise as if the payment had been 

made under the same conditions to a resident of the first-mentioned Contracting State. Paragraph 4, however, does not require 

a Contracting State to give non-residents more favorable treatment 

than it gives to its own residents. Consequently, a Contracting 

State does not have to allow non-residents a deduction for items 

that are not deductible under its domestic law (for example, expenses of a capital nature). 

The term ‘‘other disbursements’’ is understood to include a reasonable allocation of executive and general administrative expenses, research and development expenses and other expenses inVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00094 Fmt 6602 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
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curred for the benefit of a group of related persons that includes 

the person incurring the expense. 

An exception to the rule of paragraph 4 is provided for cases 

where the provisions of paragraph 1 of Article 9 (Associated Enterprises), paragraph 7 of Article 11 (Interest) or para-graph 6 of Article 12 (Royalties) apply. All of these provisions permit the denial 

of deductions in certain circumstances in respect of transactions between related persons. Neither State is forced to apply the non-discrimination principle in such cases. The exception with respect to 

paragraph 7 of Article 11 would include the denial or deferral of 

certain interest deductions under Code section 163(j). 

Paragraph 4 also provides that any debts of an enterprise of a 

Contracting State to a resident of the other Contracting State are 

deductible in the first-mentioned Contracting State for purposes of 

computing the capital tax of the enterprise under the same conditions as if the debt had been contracted to a resident of the firstmentioned Contracting State. Even though, for general purposes, 

the Convention covers only income taxes, under paragraph 7 of this 

Article, the nondiscrimination provisions apply to all taxes levied 

in both Contracting States, at all levels of government. Thus, this 

provision may be relevant for both States. Bulgaria may have capital taxes and in the United States such taxes frequently are imposed by local governments. 

Paragraph 5 

Paragraph 5 requires that a Contracting State not impose more 

burdensome taxation or connected requirements on an enterprise of 

that State that is wholly or partly owned or controlled, directly or 

indirectly, by one or more residents of the other Contracting State 

than the taxation or connected requirements that it imposes on 

other similar enterprises of that first-mentioned Contracting State. 

For this purpose it is understood that ‘‘similar’’ refers to similar activities or ownership of the enterprise. 

This rule, like all non-discrimination provisions, does not prohibit 

differing treatment of entities that are in differing circumstances. 

Rather, a protected enterprise is only required to be treated in the 

same manner as other enterprises that, from the point of view of 

the application of the tax law, are in substantially similar circumstances both in law and in fact. The taxation of a distributing 

corporation under section 367(e) on an applicable distribution to 

foreign shareholders does not violate paragraph 5 of the Article because a foreign-owned corporation is not similar to a domesticallyowned corporation that is accorded non-recognition treatment 

under sections 337 and 355. 

For the reasons given above in connection with the discussion of 

paragraph 2 of the Article, it is also understood that the provision 

in section 1446 of the Code for withholding of tax on non-U.S. partners does not violate paragraph 5 of the Article. 

It is further understood that the ineligibility of a U.S. corporation with nonresident alien shareholders to make an election to be 

an ‘‘S’’ corporation does not violate paragraph 5 of the Article. If 

a corporation elects to be an S corporation, it is generally not subject to income tax and the shareholders take into account their pro 

rata shares of the corporation’s items of income, loss, deduction or 

96 

credit. (The purpose of the provision is to allow an individual or 

small group of individuals the protections of conducting business in 

corporate form while paying taxes at individual rates as if the business were conducted directly.) A nonresident alien does not pay 

U.S. tax on a net basis, and, thus, does not generally take into account items of loss, deduction or credit. Thus, the S corporation 

provisions do not exclude corporations with nonresident alien 

shareholders because such shareholders are foreign, but only because they are not net-basis taxpayers. Similarly, the provisions exclude corporations with other types of shareholders where the purpose of the provisions cannot be fulfilled or their mechanics implemented. For example, corporations with corporate shareholders are 

excluded because the purpose of the provision to permit individuals 

to conduct a business in corporate form at individual tax rates 

would not be furthered by their inclusion. 

Finally, it is understood that paragraph 5 does not require a 

Contracting State to allow foreign corporations to join in filing a 

consolidated return with a domestic corporation or to allow similar 

benefits between domestic and foreign enterprises. 

Paragraph 6 

Paragraph 6 of the Article confirms that no provision of the Article will prevent either Contracting State from imposing either the 

branch profits tax described in paragraph 8 of Article 10 (Dividends) or the branch-level interest tax described in paragraph 9 of 

Article 11 (Interest). 

Paragraph 7 

As noted above, notwithstanding the specification of taxes covered by the Convention in Article 2 (Taxes Covered) for general 

purposes, for purposes of providing nondiscrimination protection 

this Article applies to taxes of every kind and description imposed 

by a Contracting State or a political subdivision or local authority 

thereof. Customs duties are not considered to be taxes for this purpose. 

Relationship to other Articles 

The saving clause of paragraph 4 of Article 1 (General Scope) 

does not apply to this Article by virtue of the exceptions in paragraph 5(a) of Article 1. Thus, for example, a U.S. citizen who is a 

resident of Bulgaria may claim benefits in the United States under 

this Article. 

Nationals of a Contracting State may claim the benefits of paragraph 1 regardless of whether they are entitled to benefits under 

Article 21 (Limitation on Benefits), because that paragraph applies 

to nationals and not residents. They may not claim the benefits of 

the other paragraphs of this Article with respect to an item of income unless they are generally entitled to treaty benefits with respect to that income under a provision of Article 21. 

ARTICLE 24 (MUTUAL AGREEMENT PROCEDURE)

This Article provides the mechanism for taxpayers to bring to the 

attention of competent authorities issues and problems that may 

arise under the Convention. It also provides the authority for coVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00096 Fmt 6602 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
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operation between the competent authorities of the Contracting 

States to resolve disputes and clarify issues that may arise under 

the Convention and to resolve cases of double taxation not provided 

for in the Convention. The competent authorities of the two Contracting States are identified in paragraph 1(k) of Article 3 (General Definitions). 

Paragraph 1 

This paragraph provides that where a resident of a Contracting 

State considers that the actions of one or both Contracting States 

will result in taxation that is not in accordance with the Convention he may present his case to the competent authority of either 

Contracting State. This rule is more generous than in most treaties, which generally allow taxpayers to bring competent authority 

cases only to the competent authority of their country of residence, 

or citizen-ship/nationality. Under this more generous rule, a U.S. 

permanent establishment of a corporation resident in the treaty 

partner that faces inconsistent treatment in the two countries 

would be able to bring its request for assistance to the U.S. competent authority. If the U.S. competent authority can resolve the 

issue on its own, then the taxpayer need never involve the Bulgarian competent authority. Thus, the rule provides flexibility that 

might result in greater efficiency. 

Although the typical cases brought under this paragraph will involve economic double taxation arising from transfer pricing adjustments, the scope of this paragraph is not limited to such cases. For 

example, a taxpayer could request assistance from the competent 

authority if one Contracting State determines that the taxpayer 

has received deferred compensation taxable at source under Article 

14 (Income from Employment), while the taxpayer believes that 

such income should be treated as a pension that is taxable only in 

his country of residence pursuant to Article 17 (Pensions, Social Security Payments, Annuities, Alimony, and Child Support). 

It is not necessary for a person requesting assistance first to 

have exhausted the remedies provided under the national laws of 

the Contracting States before presenting a case to the competent 

authorities, nor does the fact that the statute of limitations may 

have passed for seeking a refund preclude bringing a case to the 

competent authority. Unlike the OECD Model, no time limit is provided within which a case must be brought. 

Paragraph 2 

Paragraph 2 sets out the framework within which the competent 

authorities will deal with cases brought by taxpayers under paragraph 1. It provides that, if the competent authority of the Contracting State to which the case is presented judges the case to 

have merit, and cannot reach a unilateral solution, it shall seek an 

agreement with the competent authority of the other Contracting 

State pursuant to which taxation not in accordance with the Convention will be avoided. 

Any agreement is to be implemented even if such implementation otherwise would be barred by the statute of limitations or by 

some other procedural limitation, such as a closing agreement. 

Paragraph 2, however, does not prevent the application of domesVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00097 Fmt 6602 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
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tic-law procedural limitations that give effect to the agreement 

(e.g., a domestic-law requirement that the taxpayer file a return reflecting the agreement within one year of the date of the agreement). Where the taxpayer has entered a closing agreement (or 

other written settlement) with the United States before bringing a 

case to the competent authorities, the U.S. competent authority 

will endeavor only to obtain a correlative adjustment from Bulgaria. See Rev. Proc. 2006–54, 2006–2 C.B. 1035, Section 7.05. 

Because, as specified in paragraph 2 of Article 1 (General Scope), 

the Convention cannot operate to increase a taxpayer’s liability, 

temporal or other procedural limitations can be overridden only for 

the purpose of making refunds and not to impose additional tax. 

Under Bulgarian law, a taxpayer may secure payment of any tax 

due (for example, using a letter of credit) and need not pay the entire amount of tax due until the competent authorities resolve the 

case, while under U.S. law with respect to U.S. initiated adjustments the United States generally will postpone further administrative action with respect to the issues under competent authority 

consideration. See Rev. Proc. 2006–54, 2006–2 C.B. 1035, Section 

7.01. 

Paragraph 10 of the Protocol to the Convention sets forth two additional clarifications to the application of paragraph 2 of Article 

24. First, the Protocol notes that an agreement reached would not 

affect any court proceedings or any final court decisions or final tax 

assessment acts. This provision of the paragraph is intended to address certain aspects of the relationship of mutual agreement procedures and judicial or assessment proceedings in Bulgaria. 

Under Bulgarian law, a taxpayer may begin court proceedings either before or after it has made a request for assistance under this 

Article. The Protocol confirms that Bulgarian judicial proceedings 

involving mutual agreement procedure issues in question will not 

be inhibited merely by the initiation of a request for competent authority assistance. Moreover, any final judicial determination involving mutual agreement procedure issues may be set aside only 

if the requirements under Bulgarian law for revision or repeal of 

final acts are fulfilled. Similarly, if the Bulgarian revenue authority has finalized its tax assessment, irrespective of any judicial activity, a mutual agreement procedure cannot change that assessment unless the requirements under Bulgarian law for revision or 

repeal of final acts are fulfilled. 

Under the Bulgarian law for revision or repeal of final acts, an 

assessment may be changed based on new information. The Treasury Department understands that Bulgaria will interpret broadly 

what constitutes ‘‘new information.’’ For example, if an examination in Bulgaria is completed and closed, the Bulgarian competent 

authority may nonetheless accept a request for assistance based on 

new information, such as an adjustment in the United States. 

Second, paragraph 10 of the Protocol notes that if an examination is completed and closed (and the subject of the mutual agreement procedure request is not a matter pending before a court or 

for which a settlement or court decision has been reached) in a 

Contracting State, that Contracting State’s competent authority 

may nonetheless accept a request for assistance if an adjustment 

causing double taxation is made in the other Contracting State. 

99 

This provision of the Protocol confirms that the Bulgarian competent authority can accept a mutual agreement procedure request 

based upon a US-initiated adjustment and can subsequently implement any resulting competent authority agreement, so long as the 

issue that is the subject of the mutual agreement procedure request is neither an issue presented to and pending before a Bulgarian court, nor one for which a Bulgarian judicial decision or litigation settlement has been concluded. 

Paragraph 3 

Paragraph 3 authorizes the competent authorities to resolve difficulties or doubts that may arise as to the application or interpretation of the Convention. The paragraph includes a non- exhaustive 

list of examples of the kinds of matters about which the competent 

authorities may reach agreement. This list is purely illustrative; it 

does not grant any authority that is not implicitly present as a result of the introductory sentence of paragraph 3. 

The competent authorities may, for example, agree to the same 

allocation of income, deductions, credits or allowances between an 

enterprise in one Contracting State and its permanent establishment in the other or between related persons. These allocations are 

to be made in accordance with the arm’s length principle underlying Article 7 (Business Profits) and Article 9 (Associated Enterprises). Agreements reached under these subparagraphs may include agreement on a methodology for determining an appropriate 

transfer price, on an acceptable range of results under that methodology, or on a common treatment of a taxpayer’s cost sharing arrangement. 

The competent authorities also may agree to settle a variety of 

conflicting applications of the Convention. They may agree to settle 

conflicts regarding the characterization of particular items of income, the characterization of persons, the application of source 

rules to particular items of income, or the meaning of a term. They 

also may agree as to advance pricing arrangements. 

Since the list under paragraph 3 is not exhaustive, the competent 

authorities may reach agreement on issues not enumerated in 

paragraph 3 if necessary to avoid double taxation. For example, the 

competent authorities may seek agreement on a uniform set of 

standards for the use of exchange rates. Agreements reached by 

the competent authorities under paragraph 3 need not conform to 

the internal law provisions of either Contracting State. 

Finally, paragraph 3 authorizes the competent authorities to consult for the purpose of eliminating double taxation in cases not provided for in the Convention and to resolve any difficulties or doubts 

arising as to the interpretation or application of the Convention. 

This provision is intended to permit the competent authorities to 

implement the treaty in particular cases in a manner that is consistent with its expressed general purposes. It permits the competent authorities to deal with cases that are within the spirit of 

the provisions but that are not specifically covered. An example of 

such a case might be double taxation arising from a transfer pricing adjustment between two permanent establishments of a thirdcountry resident, one in the United States and one in Bulgaria. 

Since no resident of a Contracting State is involved in the case, the 

100 

Convention does not apply, but the competent authorities nevertheless may use the authority of this Article to prevent the double taxation of income. 

Paragraph 4 

Paragraph 4 authorizes the competent authorities to increase 

any dollar amounts referred to in the Convention to reflect economic and monetary developments. Under the Convention, this refers only to Article 16 (Entertainers and Sportsmen); Article 19 

(Students, Trainees, Teachers and Researchers) separately instructs the competent authorities to adjust the exemption amount 

for students and trainees in accordance with specified guidelines. 

The rule under paragraph 4 is intended to operate as follows: if, 

for example, after the Convention has been in force for some time, 

inflation rates have been such as to make the $15,000 exemption 

threshold for entertainers unrealistically low in terms of the original objectives intended in setting the threshold, the competent authorities may agree to a higher threshold without the need for formal amendment to the treaty and ratification by the Contracting 

States. This authority can be exercised, however, only to the extent 

necessary to restore those original objectives. This provision can be 

applied only to the benefit of taxpayers (i.e., only to increase 

thresholds, not to reduce them). 

Paragraph 5 

Paragraph 5 provides that the competent authorities may communicate with each other for the purpose of reaching an agreement. This makes clear that the competent authorities of the two 

Contracting States may communicate without going through diplomatic channels. Such communication may be in various forms, including, where appropriate, through face-to-face meetings of representatives of the competent authorities. 

Treaty termination in relation to competent authority dispute resolution 

A case may be raised by a taxpayer after the Convention has 

been terminated with respect to a year for which the Convention 

was in force. In such a case the ability of the competent authorities 

to act is limited. They may not exchange confidential information, 

nor may they reach a solution that varies from that specified in its 

law. 

Triangular competent authority solutions 

International tax cases may involve more than two taxing jurisdictions (e.g., transactions among a parent corporation resident in 

country A and its subsidiaries resident in countries B and C). As 

long as there is a complete network of treaties among the three 

countries, it should be possible, under the full combination of bilateral authorities, for the competent authorities of the three States 

to work together on a three-sided solution. Although country A may 

not be able to give information received under Article 25 (Exchange 

of Information and Administrative Assistance) from country B to 

the authorities of country C, if the competent authorities of the 

three countries are working together, it should not be a problem for 

101 

them to arrange for the authorities of country B to give the necessary information directly to the tax authorities of country C, as 

well as to those of country A. Each bilateral part of the trilateral 

solution must, of course, not exceed the scope of the authority of 

the competent authorities under the relevant bilateral treaty. 

Relationship to other Articles 

This Article is not subject to the saving clause of paragraph 4 of 

Article 1 (General Scope) by virtue of the exceptions in paragraph 

5(a) of that Article. Thus, rules, definitions, procedures, etc. that 

are agreed upon by the competent authorities under this Article 

may be applied by the United States with respect to its citizens 

and residents even if they differ from the comparable Code provisions. Similarly, as indicated above, U.S. law may be overridden to 

provide refunds of tax to a U.S. citizen or resident under this Article. A person may seek relief under Article 24 regardless of whether he is generally entitled to benefits under Article 21 (Limitation 

on Benefits). As in all other cases, the competent authority is vested with the discretion to decide whether the claim for relief is justified. 

ARTICLE 25 (EXCHANGE OF INFORMATION AND ADMINISTRATIVE

ASSISTANCE)

This Article provides for the exchange of information and administrative assistance between the competent authorities of the Contracting States. 

Paragraph 1 

The obligation to obtain and provide information to the other 

Contracting State is set out in paragraph 1. The information to be 

exchanged is that which may be relevant for carrying out the provisions of the Convention or the domestic laws of the United States 

or of Bulgaria concerning taxes of every kind applied at the national level. This language incorporates the standard in 26 U.S.C. 

section 7602 which authorizes the IRS to examine ‘‘any books, papers, records, or other data which may be relevant or material.’’ 

(Emphasis added.) In United States v. Arthur Young & Co., 465 

U.S. 805, 814 (1984), the Supreme Court stated that the language 

‘‘may be’’ reflects Congress’s express intention to allow the IRS to 

obtain ‘‘items of even potential relevance to an ongoing investigation, without reference to its admissibility.’’ (Emphasis in original.) 

However, the language ‘‘may be’’ would not support a request in 

which a Contracting State simply asked for information regarding 

all bank accounts maintained by residents of that Contracting 

State in the other Contracting State, or even all accounts maintained by its residents with respect to a particular bank. 

Exchange of information with respect to each State’s domestic 

law is authorized to the extent that taxation under domestic law 

is not contrary to the Convention. Thus, for example, information 

may be exchanged with respect to a covered tax, even if the transaction to which the information relates is a purely domestic transaction in the requesting State and, therefore, the exchange is not 

made to carry out the Convention. An example of such a case is 

provided in the OECD Commentary: a company resident in the 

102 

United States and a company resident in Bulgaria transact business between themselves through a third-country resident company. Neither Contracting State has a treaty with the third State. 

To enforce their internal laws with respect to transactions of their 

residents with the third-country company (since there is no relevant treaty in force), the Contracting States may exchange information regarding the prices that their residents paid in their transactions with the third-country resident. 

Paragraph 1 clarifies that information may be exchanged that relates to the assessment or collection of, the enforcement or prosecution in respect of, or the determination of appeals in relation to, the 

taxes covered by the Convention. Thus, the competent authorities 

may request and provide information for cases under examination 

or criminal investigation, in collection, on appeals, or under prosecution. 

The taxes covered by the Convention for purposes of this Article 

constitute a broader category of taxes than those referred to in Article 2 (Taxes Covered). Exchange of information is authorized with 

respect to taxes of every kind imposed by a Contracting State at 

the national level. Accordingly, information may be exchanged with 

respect to U.S. estate and gift taxes, excise taxes or, with respect 

to Bulgaria, value added taxes. 

Information exchange is not restricted by paragraph 1 of Article 

1 (General Scope). Accordingly, information may be requested and 

provided under this Article with respect to persons who are not 

residents of either Contracting State. For example, if a third-country resident has a permanent establishment in Bulgaria, and that 

permanent establishment engages in transactions with a U.S. enterprise, the United States could request information with respect 

to that permanent establishment, even though the third-country 

resident is not a resident of either Contracting State. Similarly, if 

a third-country resident maintains a bank account in Bulgaria, and 

the Internal Revenue Service has reason to believe that funds in 

that account should have been reported for U.S. tax purposes but 

have not been so reported, information can be requested from Bulgaria with respect to that person’s account, even though that person is not the taxpayer under examination. 

Although the term ‘‘United States’’ does not encompass U.S. possessions for most purposes of the Convention, section 7651 of the 

Code authorizes the Internal Revenue Service to utilize the provisions of the Internal Revenue Code to obtain information from the 

U.S. possessions pursuant to a proper request made under Article 

25. If necessary to obtain requested information, the Internal Revenue Service could issue and enforce an administrative summons 

to the taxpayer, a tax authority (or a government agency in a U.S. 

possession), or a third party located in a U.S. possession. 

Paragraph 2 

Paragraph 2 provides that the requesting State may specify the 

form in which information is to be provided (e.g., depositions of witnesses and authenticated copies of original documents). The intention is to ensure that the information may be introduced as evidence in the judicial proceedings of the requesting State. The requested State should, if possible, provide the information in the 

103 

form requested to the same extent that it can obtain information 

in that form under its own laws and administrative practices with 

respect to its own taxes. 

Paragraph 3 

Paragraph 3 also provides assurances that any information exchanged will be treated as secret, subject to the same disclosure 

constraints as information obtained under the laws of the requesting State. Information received may be disclosed only to persons, 

including courts and administrative bodies, involved in the assessment, collection, or administration of, the enforcement or prosecution in respect of, or the determination of appeals in relation to, the 

taxes covered by the Convention. The information must be used by 

these persons in connection with the specified functions. Information may also be disclosed to legislative bodies, such as the taxwriting committees of Congress and the Government Accountability 

Office, engaged in the oversight of the preceding activities. Information received by these bodies must be for use in the performance 

of their role in overseeing the administration of U.S. tax laws. Information received may be disclosed in public court proceedings or 

in judicial decisions. 

Paragraph 4 

Paragraph 4 provides that the obligations undertaken in paragraphs 1, 2, and 3 to exchange information do not require a Contracting State to carry out administrative measures that are at 

variance with the laws or administrative practice of either State. 

Nor is a Contracting State required to supply information not obtainable under the laws or administrative practice of either State, 

or to disclose trade secrets or other information, the disclosure of 

which would be contrary to public policy. 

Thus, a requesting State may be denied information from the 

other State if the information would be obtained pursuant to procedures or measures that are broader than those available in the requesting State. However, the statute of limitations of the Contracting State making the request for information should govern a 

request for information. Thus, the Contracting State of which the 

request is made should attempt to obtain the information even if 

its own statute of limitations has passed. In many cases, relevant 

information will still exist in the business records of the taxpayer 

or a third party, even though it is no longer required to be kept 

for domestic tax purposes. 

While paragraph 4 states conditions under which a Contracting 

State is not obligated to comply with a request from the other Contracting State for information, the requested State is not precluded 

from providing such information, and may, at its discretion, do so 

subject to the limitations of its internal law. 

Paragraph 5 

Paragraph 5 provides that when information is requested by a 

Contracting State in accordance with this Article, the other Contracting State is obligated to obtain the requested information as 

if the tax in question were the tax of the requested State, even if 

that State has no direct tax interest in the case to which the reVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00103 Fmt 6602 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
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quest relates. In the absence of such a paragraph, some taxpayers 

have argued that subparagraph 4(a) prevents a Contracting State 

from requesting information from a bank or fiduciary that the Contracting State does not need for its own tax purposes. This paragraph clarifies that paragraph 4 does not impose such a restriction 

and that a Contracting State is not limited to providing only the 

information that it already has in its own files. 

Paragraph 6 

Paragraph 6 provides that a Contracting State may not decline 

to provide information because that information is held by financial 

institutions, nominees or persons acting in an agency or fiduciary 

capacity. Thus, paragraph 6 would effectively prevent a Contracting State from relying on paragraph 4 to argue that its domestic bank secrecy laws (or similar legislation relating to disclosure 

of financial information by financial institutions or intermediaries) 

override its obligation to provide information under paragraph 1. 

This paragraph also requires the disclosure of information regarding the beneficial owner of an interest in a person, such as the 

identity of a beneficial owner of bearer shares. 

Treaty efective dates and termination in relation to exchange of information 

Once the Convention is in force, the competent authority may 

seek information under the Convention with respect to a year prior 

to the entry into force of the Convention. Even though no Convention was in effect during the years in which the transaction at 

issue occurred, the exchange of information provisions of the Convention shall have effect from the date of entry into force of the 

Convention without regard to the taxable period to which the matter relates. In that case, the competent authorities have available 

to them the full range of information exchange provisions afforded 

under this Article. Paragraph 11 of the Protocol, regarding Article 

27 (Entry into Force), confirms this understanding with respect to 

the effective date of the Article. 

A tax administration may also seek information with respect to 

a year for which a treaty was in force after the treaty has been terminated. In such a case the ability of the other tax administration 

to act is limited. The treaty no longer provides authority for the tax 

administrations to exchange confidential information. They may 

only exchange information pursuant to domestic law or other international agreement or arrangement. 

ARTICLE 26 (MEMBERS OF DIPLOMATIC MISSIONS AND CONSULAR

POSTS)

This Article confirms that any fiscal privileges to which diplomatic or consular officials are entitled under general provisions of 

international law or under special agreements will apply notwithstanding any provisions to the contrary in the Convention. The 

agreements referred to include any bilateral agreements, such as 

consular conventions, that affect the taxation of diplomats and consular officials and any multilateral agreements dealing with these 

issues, such as the Vienna Convention on Diplomatic Relations and 

the Vienna Convention on Consular Relations. The U.S. generally 

105 

adheres to the latter because its terms are consistent with customary international law. 

The Article does not independently provide any benefits to diplomatic agents and consular officers. Article 18 (Government Service) 

does so, as do Code section 893 and a number of bilateral and multilateral agreements. In the event that there is a conflict between 

the Convention and international law or such other treaties, under 

which the diplomatic agent or consular official is entitled to greater 

benefits under the latter, the latter laws or agreements shall have 

precedence. Conversely, if the Convention confers a greater benefit 

than another agreement, the affected person could claim the benefit of the tax treaty.Pursuant to subparagraph 5(b) of Article 1, 

the saving clause of paragraph 4 of Article 1 (General Scope) does 

not apply to override any benefits of this Article available to an individual who is neither a citizen of the United States nor has immigrant status in the United States. 

ARTICLE 27 (ENTRY INTO FORCE)

This Article contains the rules for bringing the Convention into 

force and giving effect to its provisions. 

Paragraph 1 

Paragraph 1 provides that the Contracting States shall notify 

each other, through diplomatic channels, when their respective requirements for the entry into force of the Convention have been 

satisfied. The Convention shall enter into force on the date of receipt of the later of these notifications.In the United States, the 

process leading to ratification and entry into force is as follows: 

Once a treaty has been signed by authorized representatives of the 

two Contracting States, the Department of State sends the treaty 

to the President who formally transmits it to the Senate for its advice and consent to ratification, which requires approval by twothirds of the Senators present and voting. Prior to this vote, however, it generally has been the practice for the Senate Committee 

on Foreign Relations to hold hearings on the treaty and make a 

recommendation regarding its approval to the full Senate. Both 

Government and private sector witnesses may testify at these hearings. After the Senate gives its advice and consent to ratification 

of the treaty, an instrument of ratification is drafted for the President’s signature. The President’s signature completes the process 

in the United States. 

Paragraph 2 

The date on which a Convention enters into force is not necessarily the date on which its provisions take effect. Paragraph 2 

contains rules that determine when the provisions of the Convention will have effect. 

Under paragraph 2(a), the Convention will have effect with respect to taxes withheld at source (principally dividends, interest 

and royalties) for amounts paid or credited on or after the first day 

of January in the calendar year following the date on which the 

Convention enters into force. For example, if instruments of ratification are exchanged on April 25th of year 1, the withholding rates 

specified in paragraph 2 of Article 10 (Dividends) would be applicaVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00105 Fmt 6602 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
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ble to any dividends paid or credited on or after January 1 of year 

2. 

For all other taxes, paragraph 2(b) specifies that the Convention 

will have effect for any taxable period beginning on or after January 1 of the year following entry into force. 

As discussed under Article 25 (Exchange of Information), the 

powers afforded under that article apply retroactively to taxable 

periods preceding entry into force. 

ARTICLE 28 (TERMINATION)

The Convention is to remain in effect indefinitely, unless terminated by one of the Contracting States in accordance with the provisions of Article 28. For example, if written notice of termination 

is given through the diplomatic channel not later than June 30th 

of calendar year 1, the provisions of the Convention will cease to 

have effect with respect to taxes withheld at source on income paid 

or credited on or after January 1st of calendar year 2. For other 

taxes, the Convention will cease to have effect for any taxable period beginning on or after January 1st of calendar year 2. 

Article 28 relates only to unilateral termination of the Convention by a Contracting State. Nothing in that Article should be construed as preventing the Contracting States from concluding a new 

bilateral agreement, subject to ratification, that supersedes, 

amends or terminates provisions of the Convention without the notification period. 

Customary international law observed by the United States and 

other countries, as reflected in the Vienna Convention on Treaties, 

allows termination by one Contracting State at any time in the 

event of a ‘‘material breach’’ of the agreement by the other Contracting State. 

107 

X. ANNEX II.—RESPONSES TO ADDITIONAL QUESTIONS

SUBMITTED FOR THE RECORD

RESPONSES OF MICHAEL MUNDACA, DEPUTY ASSISTANT SECRETARY (INTERNATIONAL), 

OFFICE OF TAX POLICY, U.S. DEPARTMENT OF THE TREASURY TO QUESTIONS FOR

THE RECORD FROM SENATOR BIDEN

Question 1. The President’s Letter of Transmittal for the proposed Iceland Tax 

Treaty notes that because the existing treaty with Iceland from 1975 does not contain a Limitation on Benefits (‘‘LOB’’) provision, which is intended to prevent socalled treaty shopping, there has been ‘‘substantial abuse of the existing Treaty’s 

provisions by third country investors.’’ See Treaty Doc. 110–17 at III. Please describe the evidence upon which this statement is based. 

Answer. A Treasury Department report to Congress, ‘‘Earning Stripping, Transfer 

Pricing and U.S. Income Tax Treaties,’’ released in November 2007 (2007 Treasury 

Report), describes abuses of the U.S. tax treaty network by third-country investors, 

particularly through inappropriate reductions in withholding tax. The 2007 Treasury Report presented data, gathered from U.S. tax returns, on deductible payments 

such as interest made by U.S. companies to related foreign companies located in 

treaty jurisdictions. The data suggested that tax treaties that have no LOB provision and a zero rate of withholding tax on deductible payments, such as our treaties 

with Iceland and Hungary, had begun to be abused by third-country investors. In 

particular, the 2007 Treasury Report notes that while in 1996 almost no U.S.-source 

interest was paid by foreign-controlled U.S. companies to related parties in Iceland 

and Hungary, payments of such interest had increased by 2004 to over $2 billion. 

In addition, publicly available information indicates that many of those related parties were ultimately owned by corporations from third countries. This evidence 

strongly suggests the existence of treaty abuse by third-country residents. 

Question 2. Please explain how the LOB provision will be enforced against thirdcountry investors that attempt to benefit from the treaty’s provisions, should the 

new treaty be ratified. In addition, please describe specific enforcement challenges, 

if any, that the United States has faced in the past when attempting to enforce LOB 

provisions in other tax treaties. 

Answer. The Internal Revenue Service has a multipronged approach to enforcing 

compliance with treaty LOB provisions. 

With respect to payments of amounts subject to withholding, such as interest, royalties, and dividends, U.S. withholding agents (e.g., banks, brokers) are obligated to 

obtain, from each foreign payee, documentation on which the withholding agents 

can rely to treat a payment as made to a foreign person entitled to a reduced rate 

of withholding tax under the treaty. Absent such documentation, withholding at 30 

percent is required. More specifically, foreign taxpayers who derive and beneficially 

own the payment must complete a Form W–8BEN (Certificate of Foreign Status of 

Beneficial Owner for U.S. Tax Withholding) to claim a reduced rate of withholding 

tax. Part II of the W–8BEN is entitled ‘‘Claim of Tax Treaty Benefits.’’ On line 9 

the beneficial owner must identify its country of residence and, if the person is not 

an individual, represent that it meets the LOB article of the relevant treaty. 

With respect to claiming treaty benefits other than withholding tax reductions, 

such as a claim that a taxpayer does not have a permanent establishment in the 

United States, the taxpayer must file Form 8833 (Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b)) attached to a Form 1120–F (U.S. Income Tax 

Return of a Foreign Corporation) or Form 1040 NR (U.S. Nonresident Alien Income 

Tax Return). Line 4 of Form 8833 requires the taxpayer to identify the LOB provision that the taxpayer relies upon to be eligible to take the treaty-based return position. 

In addition, the Internal Revenue Service audits LOB compliance as part of its 

general assessment of whether a foreign taxpayer is eligible to claim treaty benefits. 

The Treasury Department understands that the IRS’ audit experience indicates that 

LOB issues most often arise in the context of audits of U.S. corporations that makes 

payments of interest, dividends, or royalties to related foreign persons. 

In the end, however, the simple inclusion of a LOB article in a treaty may by 

itself be largely responsible for limiting treaty shopping. The 2007 Treasury Report 

provides evidence that the mere inclusion of a comprehensive LOB provision is a 

deterrent against treaty shopping. 

Question 3. As set forth in Article 27(3) of the proposed treaty with Iceland, an 

unusual year-long transition period is provided for investors that are entitled to 

greater benefits under the 1975 treaty than the new treaty, during which they can 

108 

elect to continue to benefit from the application of the 1975 treaty, rather than have 

the new treaty’s provisions applied to them. Why was this provision included? How 

does this provision benefit the United States? Is this provision one that might be 

included in future treaties? 

Answer. The transition rule coordinating the entry into force of the proposed Iceland treaty and the termination of benefits of the 1975 treaty is not an uncommon 

practice when an existing treaty is being replaced by a new agreement or is being 

amended by a new protocol. For instance, similar provisions were included in the 

U.S.-Belgium tax treaty (signed November 27, 2006), the U.S.-Germany protocol 

(signed June 1, 2006), the U.S.-U.K. tax treaty (signed July 24, 2001), and the U.S.- 

Denmark tax treaty (signed August 19, 1999). In order to reach agreement in 2007 

with Iceland regarding inclusion of a LOB provision, we agreed to this election. 

Question 4. U.S. income tax treaties with Hungary and Poland provide an exemption from withholding on cross-border interest payments and, as in the case of the 

1975 tax treaty with Iceland, these treaties do not include an LOB provision. Is the 

Treasury Department negotiating protocols with Hungary and Poland in order to 

rectify the omission of an LOB provision? If not, why not? If so, please describe the 

status of those negotiations. 

Answer. Updating the agreements with Hungary and Poland is a key part of the 

Treasury Department’s effort to protect the U.S. tax treaty network from abuse. The 

Treasury Department has had two rounds of negotiations with Hungary already in 

2008 with the aim of concluding a new agreement as soon as possible. The next 

round of negotiations is scheduled for September 2008, and an additional round is 

also scheduled, if necessary, for December 2008. 

As shown in the 2007 Treasury Report, it does not appear that the U.S.-Poland 

tax treaty has yet been extensively exploited by third-country residents. Nevertheless, the Treasury Department has had preliminary discussions with Poland and anticipates continuing those discussions in 2008 with the goal of commencing negotiations to conclude a new agreement to update the 1976 agreement. The United States 

places a very high priority on bringing the proposed treaty with Iceland into force 

and on concluding as soon as possible negotiations with Hungary and Poland. 

Beyond renegotiating the treaties with Hungary and Poland, the Treasury Department reviews the current U.S. tax-treaty network on a continuing basis to identify deficiencies in existing agreements and areas where more beneficial terms for 

the United States and U.S. taxpayers could be negotiated. As part of this process, 

antitreaty-shopping provisions are given special scrutiny to ensure that they are 

functioning appropriately. Those treaties with LOB provisions that are out of date 

or need strengthening are given higher priority in the Treasury Department’s plan 

for negotiations. 

Question 5. The proposed treaty with Iceland includes special antiabuse rules intended to deny benefits in certain circumstances in which an Icelandic-resident company earns U.S.-source income attributable to a third-country permanent establishment and is subject to little or no tax in the third jurisdiction and Iceland. Similar 

antiabuse rules are included in other recent treaties, including the proposed Convention with Bulgaria. The U.S. Model Tax Treaty, however, does not include rules 

addressing so-called ‘‘triangular arrangements.’’ Why? Is this a provision that might 

be added to the U.S. Model Tax Treaty? 

Answer. The Treasury Department’s current policy is to incorporate the so-called 

‘‘triangular rule’’ into tax treaties in which the treaty partner exempts from tax certain foreign source income such that a tax treaty may be used inappropriately in 

conjunction with certain branch structures to exempt fully from tax certain U.S.- 

source payments. The Treasury Department is considering whether it is appropriate 

to include such a rule in the next update of the U.S. Model tax treaty. 

Question 6. The Committee on Taxation of Business Entities of the New York City 

Bar has written to the Committee on Foreign Relations in reference to the so-called 

‘‘derivative benefits’’ test contained in, for example, Article 21(3) of the LOB provision in the proposed treaty with Iceland. In particular, the Bar’s Committee on Taxation of Business Entities has stated that they ‘‘believe that there is a need for guidance in determining the scope of the dividend payment relief under such derivative 

provisions, due to the uncertainties involved in calculating the relevant stock ownership.’’ Has the Office of Tax Policy considered whether it would be useful to publish 

guidance on this topic? 

Answer. The New York City Bar Association’s Committee on Taxation of Business 

Entities, in its May 2008 report (the NYCBA Report), suggests that there is need 

for guidance clarifying how ownership is calculated for purposes of the derivativeVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00108 Fmt 6602 Sfmt 6621 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
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benefits rule in our recent tax treaties. The Office of Tax Policy recognizes the importance of providing published guidance with respect to income tax treaties generally, and is currently considering this and other recommendations made by the 

NYCBA Report. 

Question 7. Under the U.S. Model Tax Treaty child support payments paid to a 

resident of a treaty country is exempt from tax in either country. The proposed treaty with Iceland, however, makes no mention of the tax treatment of child support 

payments. Why is that? 

Answer. The absence of a special rule governing the taxation of child support payments in the proposed Iceland treaty means that the taxation of such payments 

would be governed by Article 20 (Other Income), which assigns the exclusive right 

to tax to the country of residence of the recipient. During the course of the negotiations, the Treasury Department learned that under Iceland’s domestic law, most 

child support payments are not subject to tax. Accordingly, leaving the treatment 

of child support payments to Article 20 (Other Income) achieves a tax result very 

similar to the result under the U.S. Model rule; that is, the residence country will 

have the exclusive right to tax child support, but such payments are in most cases 

exempt from tax under the domestic laws of both the United States and Iceland. 

Question 8. Why doesn’t the proposed treaty with Iceland address the tax treatment of cross-border pension contributions? 

Answer. The proposed treaty with Iceland does not address the tax treatment of 

cross-border pension contributions primarily for two reasons. First, the U.S. Model 

pension funds provision provides for deductibility in one State of contributions to a 

pension fund of the other State only where the pension fund ‘‘generally corresponds’’ 

to a pension fund in the first state. The provision is, therefore, only appropriate if 

the two countries have pension systems that are similar. During the course of negotiations, it became clear that Iceland and the United States have very different pension systems. As a result, the provision was not appropriate to include in the proposed treaty. Second, Iceland had limited flexibility in changing by tax treaty its 

rules for taxing pensions, because those rules are technically under Iceland’s pension law, not its tax law. 

Question 9. Like the U.S. Model Tax Treaty, the Iceland Treaty provides that pension distributions owned by a resident of a contracting country are taxable in the 

recipient’s country of residence. The U.S. Model Tax treaty, however, contains an 

exception to this provision under which a pension beneficiary’s country of residence 

must exempt from tax a pension amount or other similar remuneration that would 

be exempt from tax in the other contracting country where the pension fund is established, as if the beneficiary had been a resident of that other country. Why 

doesn’t the proposed treaty with Iceland contain such an exception? 

Answer. Like other departures from the U.S. Model, the omission in the U.S.-Iceland tax treaty of the exemption from tax for pension benefits that would be exempt 

from tax in the source country was the result of the negotiation process. Moreover, 

Iceland had limited flexibility in changing by tax treaty its rules for taxing pensions, 

because those rules are technically under Iceland’s pension law, not its tax law. 

Question 10. The U.S. Model Tax Treaty allows recipients of ‘‘income, gains, or 

profits’’ from an entity that is fiscally transparent under the tax laws of the recipient’s residence to enjoy the same treaty benefits on that income as they would have 

if the ‘‘income, gains, or profits’’ had been received by them directly, so long as the 

income coming to them through the entity is treated no differently by their resident 

country than it would have been had it been received directly by them. The provision in the Iceland Treaty for fiscally transparent entities closely parallels the provision in the U.S. Model Tax Treaty. Yet, rather than referring to such entities as 

‘‘fiscally transparent,’’ the Iceland Treaty refers instead to entities that are either 

‘‘a partnership, trust, or estate.’’ See Article 1(6). Treasury’s Technical Explanation 

makes clear that this is intended to include U.S. limited liability companies 

(‘‘LLCs’’) that are treated as partnerships or as disregarded entities for U.S. tax purposes, including LLCs with only one member. Although the meaning appears to be 

equivalent, why wasn’t the phrase ‘‘fiscally transparent’’ used in Article 1(6)? 

Answer. Paragraph 6 of Article 1 of the proposed treaty with Iceland does not use 

the U.S. Model’s phrase ‘‘fiscally transparent’’ because that term does not have 

meaning under the domestic law of Iceland. During the course of the negotiations, 

the Treasury Department obtained agreement in principle with Iceland over the intent and application of paragraph 6 of Article 1. Accordingly, the Treasury Department believes that the rule will be interpreted and applied by Iceland consistent 

with the language in the U.S. Model Tax Treaty. 

110 

Question 11. The Convention Between the United States and the Republic of Bulgaria for the avoidance of Double Taxation and the Prevention of Fiscal Evasion 

With Respect to Taxes on Income, with accompanying Protocol, was signed on February 23, 2007. Before transmitting this treaty to the Senate, however, a Protocol 

amending the 2007 treaty was negotiated with Bulgaria. This Protocol was signed 

on February 26, 2008 and only after its completion, did the executive branch transmit the original treaty to the Senate for advice and consent. Why was the 2008 Protocol needed? What changed between February 2007 and February 2008 to necessitate amending the 2007 treaty? What is the most important correction made by 

the 2008 Protocol to the underlying treaty? 

Answer. The 2008 Protocol made certain technical corrections to the 2007 Convention and accompanying Protocol, and addressed features of the Bulgarian tax system 

and treaty network that could result in a Bulgarian tax exemption for U.S. source 

income attributable to offshore branches of the Bulgarian company receiving the 

U.S. source income. To address the potential ‘‘double exemption’’ issue, the proposed 

2008 Protocol would add a so-called ‘‘triangular rule’’ to the LOB provision of the 

proposed treaty, which is the most important addition to be made by the 2008 Protocol. 

Question 12. Under the Bulgaria Convention, with limited exceptions, the withholding tax on cross-border royalty and interest payments would be imposed at a 

maximum rate of five percent. Under the accompanying protocol, the United States 

and Bulgaria are to reconsider source-taxation of interest and royalties arising in 

Bulgaria and beneficially owned by a resident of the United States, at a time that 

is ‘‘consistent with the conclusion of the transition period’’ under a European Union 

Council Directive applicable to interest and royalties deemed to arise in Bulgaria 

and beneficially owned by a resident of the European Union. The conclusion of the 

transition period is due to occur on December 31, 2014. Please explain the reason 

for including this commitment to reconsider source-taxation of interest and royalties 

arising in Bulgaria and beneficially owned by a resident of the United States. Is it 

fair to say that when you consult, you expect to negotiate an amendment to the Bulgaria Convention that would further reduce the maximum rate of withholding that 

can be imposed on cross-border interest and royalties arising in Bulgaria and beneficially owned by a resident of the United States? 

Answer. At the conclusion of the transition period under the European Union 

Council Directive, Bulgaria is expected to adopt rates of withholding on cross-border 

interest and royalties for residents of European Union member states that are lower 

than the rate provided for in the proposed treaty. The provision of the 2007 Protocol 

is intended to memorialize the understanding between Bulgaria and the United 

States that the United States will have the opportunity at the conclusion of the 

transition period to negotiate a further protocol to the proposed treaty with Bulgaria 

that could reduce the maximum rate of withholding that may be imposed on crossborder interest and royalties arising in Bulgaria. 

Question 13. Both the Bulgaria Convention and the Canada Protocol include a 

special rule that broadens the typical definition of a ‘‘Permanent Establishment’’ 

such that a service enterprise may still be deemed to have a Permanent Establishment in a treaty country, even if it does not have a fixed place of business in that 

country (the ‘‘services country’’). See Article 5(8) of the Bulgaria Convention and Article 3(2) of the Canada Protocol. 

• 13A. A number of the terms used in this rule are somewhat ambiguous and although the Technical Explanations for the Bulgaria Convention and the Canadian Protocol help to resolve some of that ambiguity, there is still work to be 

done. Please describe the steps you are taking with Canada, Bulgaria, and internally to further clarify the application and operation of this provision, including the specific terms you are focused on clarifying. In particular, is work being 

done to further clarify what constitutes ‘‘presen[ce]’’ in the services country and 

what constitutes a ‘‘connected project’’? What about the ‘‘provision of services’’? 

Is this term, for example, intended to include preparatory work or the collection 

of data from an office in one country in order to provide services in the other 

country? 

Answer. In preparing the agreed Technical Explanation of the proposed Protocol 

with Canada, the Treasury Department had many discussions with Canada regarding the interpretation and application of the new rule concerning the taxation of 

services. 

If the proposed Protocol is approved by the Senate, the Treasury Department will 

continue these discussions with Canada. The Treasury Department’s discussions 

with Canada to date have encompassed the interpretation of a number of terms, inVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00110 Fmt 6602 Sfmt 6621 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
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cluding ‘‘presen[ce]’’ in the services country, what constitutes ‘‘connected projects,’’ 

and the meaning of ‘‘provision of services.’’ For example, the Technical Explanation 

to the proposed Protocol clarifies that paragraph 6 of Article V (Permanent Establishment) of the existing U.S.-Canada treaty applies notwithstanding the new rule 

for taxation of services. Paragraph 6 identifies activities with respect to which a 

fixed place of business will not give rise to a permanent establishment, which includes activities that have a preparatory or auxiliary character. Accordingly, days 

spent on preparatory or auxiliary activities shall not be taken into account for purposes of applying the services rule described in subparagraph 9(b) of Article V. 

The Treasury Department recognizes that additional guidance with respect to the 

services rule included in both the proposed Canada Protocol and the Bulgaria Convention is needed to provide more certainty to taxpayers, and we welcome further 

input regarding application of the rule. 

• 13B. Article 14(1) of the Bulgaria Convention, with certain exceptions, sets forth 

a general rule that if an employee who is a resident of one treaty country (the 

‘‘residence country’’) is working in the other treaty country (the ‘‘employment 

country’’), his or her salaries, wages, and other remuneration derived from the 

exercise of employment in that country may be taxed by that country—i.e., the 

employment country. Notwithstanding this general rule, Article 14(2) of the 

treaty provides that the remuneration derived by the employee from the exercise of employment in the employment country shall be taxed only by the residence country (and not the employment country) if (1) the employee is present 

in the employment country for 183 days or less in any 12-month period commencing or ending in the taxable year concerned; (2) the remuneration is paid 

by, or on behalf of, an employer who is not a resident of the employment country; and (3) the remuneration is not ‘‘borne’’ by a permanent establishment that 

the employer has in the employment country. The Canada Protocol has a variation of this provision in Article 10(2), which amends Article XV of the Canada 

Tax Treaty. In both treaties, the final requirement (i.e., that the remuneration 

is not ‘‘borne’’ by a permanent establishment that the employer has in the employment country), interacts with the special rule expanding the definition of 

a permanent establishment in a potentially problematic way. 

For example, in the case of the Bulgaria Convention, it appears that the salaries, 

wages, and other remuneration derived by an employee performing services through 

a permanent establishment arising under Article 5(8) of the treaty would be subject 

under Article 14 to being taxed by the employment country, even if the other requirements of the test in Article 14(2) had been met (i.e., the employee had been 

present in the employment country for less than 183 days during any 12-month period commencing or ending in the taxable year concerned and the employee’s remuneration was paid by an employer who is a resident of the other country). Is this 

correct? If so, the interaction of these two provisions would increase the complexities 

associated with the special rule contained in Article 5(8). For example, such a scenario would mean that an employer and the relevant employees would need to fulfill 

several tax-related obligations, including obtaining tax identification numbers and 

providing for the withholding of income taxes and other taxes as appropriate that 

would cover the period beginning on the first day such services were performed by 

such employee during the affected year. Please explain how the Department intends 

to address the problems presented by this result for taxpayers that may not know 

whether they will be deemed to have a permanent establishment under the treaty 

until perhaps 6 months into the relevant 12-month period, and will therefore be 

subject to various taxes, including employment taxes, by the services country reaching back to the beginning of the relevant 12-month period. 

Answer. It is correct that a permanent establishment arising under Article 5(8) 

of the proposed Bulgaria Convention is a permanent establishment for purposes of 

Article 14 of the Convention, and therefore the salaries, wages, and other remuneration of an employee borne by a permanent establishment of the employer arising 

under Article 5(8) of the treaty would be subject under Article 14 to being taxed 

by the source country, even if the other requirements of the test in Article 14(2) had 

been met. 

The Treasury Department recognizes that the rule for taxation of services in the 

proposed Canada Protocol raises compliance and administrative concerns for companies and their employees. The Treasury Department and Internal Revenue Service 

have met with a number of U.S. taxpayers, including professional services firms, to 

discuss the interpretation and application of this rule, focusing on administrative 

issues. The Treasury Department has discussed with Canada and, if the proposed 

Protocol is approved by the Senate, will continue to discuss with Canada, possible 

methods of easing the administrative burden on businesses associated with comVerDate Aug 31 2005 15:29 Sep 16, 2008 Jkt 000000 PO 00000 Frm 00111 Fmt 6602 Sfmt 6621 H:\DOCS\EXEC~1.REP\EX110-16.TXT sfrela2 PsN: MIKEB
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plying with this new rule, the effective date of which is delayed until the third taxable year ending after the proposed Protocol enters into force. The Technical Explanation to the proposed Canada Protocol, the contents of which the Government of 

Canada has subscribed to, provides that ‘‘[t]he competent authorities are encouraged 

to consider adopting rules to reduce the potential for excess withholding or estimated tax payments with respect to employee wages that may result from the application of [the services rule].’’ 

• 13C. A version of this special rule appears in the 2008 OECD draft update to 

the OECD Model Tax Convention as an alternative services permanent establishment provision. There are, however, a few differences in language between 

the OECD rule and the one used in the Bulgaria Convention and the Canada 

Protocol. In particular, the OECD language clarifies that services performed by 

an individual on behalf of an enterprise may be considered as performed by that 

enterprise only if the enterprise supervises, directs, or controls the manner in 

which the services are performed by the individual. The language in the text 

of the Bulgaria Convention and the Canada Protocol are silent on this point, 

apparently leaving open the question of whether, and if so, under what circumstances, the use of a subcontractor might give rise to a permanent establishment of a general contractor. Is it Treasury’s view that services performed 

by an individual on behalf of an enterprise may be considered as performed by 

that enterprise only if the enterprise supervises, directs, or controls the manner 

in which the services are performed by the individual? Does Canada share this 

view? Does Bulgaria? 

Answer. For a number of years, the OECD has debated whether to include an alternative rule for the taxation of services in the OECD Model or its Commentary. 

The 2008 Update to the OECD Model, released on July 18, 2008, includes a version 

of the services rule as an alternative in the Model Commentary. The language of 

the OECD provision does not match in all respects the language of provision included in the proposed Bulgaria Convention and the Canada Protocol. For example, 

the language of the Bulgarian and Canadian provision requires that the services be 

provided ‘‘for customers who are either residents of that other State or who maintain a permanent establishment in that other State.’’ That language regarding the 

provision of services to customers is not included in the OECD provision, and thus 

the issue of whether the use of a subcontractor might give rise to a permanent establishment is especially important in applying the OECD provision. If the Senate 

approves the proposed the Bulgaria Convention and Canada Protocol, the Treasury 

Department will continue to discuss with Bulgaria and Canada the interpretation 

and application of the version of the rule for taxation of services included in our 

agreements. 

• 13D. One aspect of the rule in both the Bulgaria Convention and the Canada 

Protocol that would appear to be difficult to manage is the fact that the 12- 

month period isn’t tied to a fiscal year. Is this something you considered and 

rejected during the course of negotiations? Is this something that might be considered in the future, should you include this special rule in future treaties? 

Answer. The rule for taxation of services in the proposed agreements with Bulgaria and Canada refers to an aggregate of 183 days or more in ‘‘any 12-month period’’ as opposed to, for example, 183 days or more in a fiscal or calendar year. The 

reference to ‘‘any 12-month period’’ addresses potential situations in which, for example, work has been artificially divided into two separate fiscal years in order to 

avoid meeting the 183-day threshold. For instance, a taxpayer could circumvent a 

threshold based on 183 days in a fiscal year by providing services in the other state 

for the last 5 months of 1 fiscal year and the first 5 months of the following fiscal 

year. 

The Treasury Department recognizes the administrative and compliance concerns 

of companies and their employees regarding the rule’s reference to ‘‘any 12-month 

period.’’ If the proposed agreements with Bulgaria and Canada are approved by the 

Senate, the Treasury Department will continue to discuss the interpretation and application of this rule with Bulgaria and Canada in the context of exploring ways to 

alleviate administrative and compliance burdens. 

The inclusion of a rule for taxation of services in the proposed agreements with 

Bulgaria and Canada does not reflect a change in U.S. tax treaty policy, and inclusion of such a provision in the U.S. Model is not being considered. However, it is 

a provision that the Treasury Department will consider in the context of negotiating 

a particular agreement in exchange for significant concessions in other areas, and 

the inclusion of such a provision in the proposed agreements with Bulgaria and 

Canada was a key element to achieving overall agreements that provide benefits to 

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the United States and to U.S. taxpayers. At the same time, the Treasury Department recognizes the concerns raised by the Joint Committee on Taxation’s ‘‘Explanation of Proposed Protocol to the Income Tax Treaty between the United States 

and Canada’’ about the appropriateness of including a services rule in a tax treaty 

with a developed country. 

In the context of negotiating a particular agreement in the future, the Treasury 

Department may consider referring to an alternative 12-month period. The Treasury 

Department welcomes input concerning this issue. 

Question 14. Mandatory arbitration was included in the Protocol with Canada, but 

not in the treaty with Iceland or Bulgaria. Please explain why. In negotiating future 

treaties, what are the factors considered by Treasury when deciding whether or not 

to include binding arbitration in a new tax treaty or in an amendment to an existing 

tax treaty? Are you currently negotiating mandatory arbitration mechanisms with 

other countries? If so, which countries? 

Answer. The Treasury Department believes that mandatory binding arbitration, 

as an extension of the competent authority process, is an effective tool to strengthen 

the Mutual Agreement Procedure in the U.S. treaty network as a whole. Even in 

the best competent authority relationships, there are, on occasion, difficult treaty interpretation questions and disputes that arise. The Treasury Department believes 

that the arbitration mechanism included in the proposed agreement with Canada 

will help resolve cases in a timely manner and enhance the working relationship 

of the competent authorities. 

The Treasury Department has been discussing mandatory binding arbitration in 

general terms with our treaty partners, and intends to continue to raise inclusion 

of a mandatory binding arbitration provision with our treaty partners in future negotiations. The Treasury Department welcomes further input from the Committee 

concerning the factors that should be taken into account when considering whether 

to include an arbitration provision in the context of the negotiation of a particular 

agreement, as well as ways that the arbitration provision in future agreements 

might be improved or varied. 

Question 15. When considering the mandatory arbitration provisions in the Belgium and Germany tax treaties, which were approved by the Senate last year, the 

committee focused on, among other things, the selection of fair, objective, and independent arbiters. In answer to a question for the record regarding your process for 

selecting arbiters, it was noted that the Treasury Department ‘‘expect[s] to have further discussions with our treaty partners concerning the [selection of arbiters], with 

a view toward achieving the best balance of the concerns expressed and providing 

to taxpayers an efficient and effective resolution of their double taxation.’’ Please describe the status of such discussions with Belgium and Germany. Does the Department expect to have discussions with Canada on this topic as well? Specifically, 

what work has been done to ensure that the United States and all three treaty partners will select fair, objective, and independent arbiters for service on arbitration 

boards constituted by the mechanisms provided in these treaties? 

Answer. The U.S. competent authority has formally begun discussions with Belgium and Germany on a number of procedural matters to ensure the effective implementation of the arbitration provision, including regarding the qualifications for arbiters, especially those qualifications required to ensure that arbiters are sufficiently 

independent. In those discussions, the U.S. competent authority has expressed the 

concerns raised by the committee in its considerations of the Belgian and German 

agreements regarding the selection of Government employees as arbiters. We hope 

that similar discussions with Canada begin soon. While we do not yet have formal 

agreements with any of these treaty partners, they understand and agree with the 

need for fair, objective, and independent arbitration boards. 

Question 16. The Canada Protocol, as in the case of the Belgium and Germany 

tax treaties, does not identify the procedural rules that will be used by arbitration 

boards constituted in accordance with the mandatory arbitration provision included 

in each treaty. In answer to a question for the record on this topic in relation to 

the Belgium and Germany tax treaties, the Treasury Department noted that ‘‘after 

studying the details of the [procedural] rules commonly used in commercial arbitration, we concluded that most of these rules relate to evidentiary procedures not relevant to the simplified arbitration format proposed in the agreements with Belgium 

and Germany, primarily because the decision of the arbitration board is to be based 

upon a record rather than a presentation of evidence.’’ Has the Treasury Department had discussions with Canada, Belgium, and Germany regarding what procedural rules would be appropriate for the arbitration format provided for in these 

114 

treaties? In particular, has there been any discussion regarding conflict of interest 

rules that might apply to arbiters? 

Answer. The U.S. competent authority has formally begun discussions with Belgium and Germany, and informally with Canada, on a number of procedural matters to ensure the effective implementation of the arbitration provision. The objective of these discussions is to have the procedures in place with respect to Belgium 

and Germany no later than December 31, 2008. As part of the discussions with Belgium and Germany, the U.S. competent authority has also begun discussing the 

need for conflict-of-interest rules to govern arbiters. For example, the U.S. competent authority has discussed whether safeguards might be built into the necessary 

procurement arrangements between the United States and the arbiter. While the 

U.S. competent authority does not yet have formal agreements with any of these 

treaty partners, they understand and agree with the need for fair, objective, and 

independent arbitration boards. 

Question 17. The Committee Report on the Germany and Belgium treaties raised 

certain concerns regarding the mandatory arbitration mechanism, including concerns regarding treaty interpretation and the selection of arbiters. Other Members 

have indicated related concerns regarding these provisions. None of these are addressed in the Canada Protocol arbitration provision, but presumably that is because the Canada Protocol was already negotiated when these concerns were raised. 

Can you, however, confirm that these concerns will be considered and addressed in 

future tax treaties with similar arbitration mechanisms? 

Answer. The arbitration provision in the proposed Protocol with Canada was already negotiated at the time the Senate considered the agreements with Germany 

and Belgium in 2007. It is for this reason that the concerns expressed by the Committee on the agreements with Germany and Belgium are not reflected in the proposed Canada Protocol. 

The Treasury Department greatly appreciates the input received from the committee on several aspects of the German and Belgian arbitration provisions, and 

similarly with the Canadian Protocol. The committee’s concerns have been and will 

continue to be considered in any arbitration negotiations the Treasury Department 

conducts. 

Question 18. The exchange of notes between the United States and Canada that 

accompanies the Canada Protocol includes many of the details that would govern 

the binding arbitration mechanism to be included in the treaty. Among other things, 

the notes make clear that the arbitration mechanism would only apply to certain 

articles in the treaty, which are listed, unless otherwise agreed to by the parties. 

• 18A. How were the articles to which arbitration applies, selected? 

Answer. The Treasury Department believes that mandatory binding arbitration, 

as an extension of the competent authority process, is an effective tool to strengthen 

the Mutual Agreement Procedure in the U.S. treaty network as a whole. However, 

the scope of an arbitration provision in a particular agreement is a matter that 

must be negotiated with the treaty partner. Some countries may be willing to cover 

only specific articles in the treaty. It should be noted that while the mandatory 

binding arbitration provision in the proposed Canada Protocol is limited to certain 

articles, other issues are eligible for arbitration if the competent authorities agree 

that the particular case is suitable for arbitration. 

• 18B. Why isn’t Article 3 (Definitions) among the articles included in this list? 

Answer. Article III of the existing Canada treaty provides definitions and general 

rules of interpretation for the treaty. Paragraph 1 of Article III defines a number 

of terms for purposes of the treaty. Certain other terms are defined in other articles 

of the treaty. Paragraph 2 of Article III provides that, in the case of a term not defined in the treaty, the domestic tax law of the Contracting State applying the treaty shall control, unless the context in which the term is used requires a definition 

independent of domestic tax law or the competent authorities reach agreement on 

a meaning. 

To the extent that an issue concerning the definition of a term is part of a case 

regarding the application of one or more articles explicitly within the scope of the 

mandatory arbitration provision, such definitional issue will be considered during 

the arbitration process. 

• 18C. If a dispute focuses on a term that is defined in Article 3 and appears in 

another Article that is within the scope of the arbitration mechanism, would 

such a dispute be subject to arbitration under the Protocol? 

115 

Answer. To the extent that an issue concerning the definition of a term defined 

in Article III is part of a case regarding the application of one or more articles explicitly within the scope of the mandatory arbitration provision, such definitional 

issue will be considered during the arbitration process 

Question 19. Article 2(1) of the proposed Canada Protocol addresses the issue of 

so-called ‘‘dual-resident corporations.’’ It provides that if such a company is created 

under the laws in force in a treaty country but not under the laws in force in the 

other treaty country, the company is deemed to be a resident only of the first treaty 

country. Have you considered whether this rule is equitable, for example, in circumstances in which a corporation was organized under the laws of the United 

States many years ago and has long since ceased to have significant contacts with 

the United States, but instead is managed and controlled in Canada? Have you considered whether it might be appropriate to provide discretion to the Competent Authorities in such a case to determine, for example, that the company is in fact a 

resident of Canada? 

Answer. To address abuses of the existing treaty by U.S. companies continuing 

into Canada, the proposed Protocol replaces the existing treaty’s rule for resolving 

dual-residency conflicts for corporations with an updated rule that is similar to the 

rule in the U.S. Model. It has been a longstanding treaty policy of the United States 

to place significant weight on the place of incorporation when addressing questions 

of dual corporate residence. However, we have included in other agreements, for example in our agreement with the United Kingdom and the proposed Bulgaria and 

Iceland agreements, provisions directing the Competent Authorities to endeavor to 

determine for treaty purposes the residence of dual resident corporations. 

Question 20. Article 2(2) of the Canada Protocol would amend Article IV of the 

Canada Tax Treaty to include a new paragraph 6 and 7, setting forth specific rules 

for the treatment of certain income, profit, or gain derived through or paid by fiscally transparent entities. The new paragraph 6 would set forth a ‘‘positive’’ rule, 

which identifies scenarios in which ‘‘income, profit or gain shall be considered to be 

derived by a person who is a resident of a Contracting State.’’ The new paragraph 

7 would set forth a ‘‘negative’’ rule intended to prevent the use of such entities to 

claim the benefits where the investors are not subject to tax on the income in their 

state of residence. In particular, paragraph 7 is aimed largely at curtailing the use 

of certain legal entity structures that include hybrid fiscally transparent entities, 

which, when combined with the selective use of debt and equity, may facilitate the 

allowance of either (1) duplicated interest deductions in the United States and Canada, or (2) a single, internally generated, interest deduction in one country without 

offsetting interest income in the other country. As noted by the Joint Committee on 

Taxation in its explanation of the Canada Protocol, commentators have raised a 

question as to whether subparagraph 7(b) is too broad, because it could prevent legitimate business structures that are not engaging in potentially abusive transactions from taking advantage of benefits that would otherwise be available to them 

under the treaty. Please explain whether you agree or disagree with the assertion 

that subparagraph 7(b) is overbroad. If so, has there been any discussion regarding 

what might be done to improve the situation? In addition, does the Treasury Department expect to include such a rule in future tax treaties? If so, has the Treasury 

Department considered alternate versions that might provide for a narrower exception from the rule in paragraph 6? 

Answer. Subparagraph 7(b) essentially denies benefits in cases in which the residence country treats a payment differently than the source country and other conditions are met. The rule is broader than an analogous rule in Treasury regulations 

issued pursuant to section 894 of the Internal Revenue Code. The Treasury Department is aware that the scope of subparagraph 7(b) is potentially overbroad, especially in the case of nondeductible payments. The Treasury Department has been 

discussing, and will continue to discuss with Canada, whether to address this issue. 

The Treasury Department does not contemplate incorporating such a rule in future 

tax treaties. 

Question 21. The Treasury Department’s Technical Explanation provides several 

examples of the application of subparagraph 7(b) to certain legal entity structures. 

But, the Technical Explanation does not provide an example of a payment made by 

a U.S. domestic reverse hybrid entity that is treated as a partnership for Canadian 

tax purposes to one of its owners. Although the partnership example in the Technical Explanation should apply reciprocally to a payment treated as a dividend for 

U.S. tax purposes and a partnership distribution for Canadian tax purposes, the 

Technical Explanation does not state so explicitly. Can you confirm that this is the 

case? 

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1 Under section 707(a) and Treas. Reg. section 1.707–1(a), if a partner engages in a transaction with a partnership other than in the capacity as a member of the partnership, the transaction is, in general, considered as occurring between the partnership and one who is not a partner. See Rev. Rul. 73–301, 1973–2 C.B. 215. 

In addition, the Technical Explanation does not include examples relating to a deductible interest (or royalty) payment from a hybrid partnership entity to one of its 

owners. In the case of such a payment from a Canadian hybrid partnership entity, 

the U.S. recipient of the payment would generally treat it as a payment of interest 

(or royalties) for U.S. tax purposes.1 One might expect that subparagraph 7(b) would 

not apply in this case because the fiscal transparency of the partnership would generally not be relevant for residence-country tax purposes, but there is no discussion 

of this case in the Technical Explanation. Can you confirm that this is a reasonable 

reading of subparagraph 7(b)? Also, please clarify whether subparagraph 7(b) applies with respect to deductible payments by a domestic reverse hybrid partnership 

entity to one of its Canadian owners. 

Answer. Page 10 of the agreed Technical Explanation provides an example of the 

application of subparagraph 7(b): 

‘‘[Assume] in the above example, USCo (as well as other persons) are owners of 

CanCo, a Canadian entity that is considered under Canadian tax law to be a corporation that is resident in Canada but is considered under U.S. tax law to be a 

partnership (as opposed to being disregarded). Assume that USCo is considered 

under Canadian tax law to have received a dividend from CanCo. Such payment is 

viewed under Canadian tax law as a dividend, but under U.S. tax law is viewed 

as a partnership distribution. In such a case, Canada views USCo as receiving income (i.e., a dividend) from an entity that is a resident of Canada (CanCo), CanCo 

is viewed as fiscally transparent under the laws of the United States, the residence 

State, and by reason of CanCo being treated as a partnership under U.S. tax law, 

the treatment under U.S. tax law of the payment (as a partnership distribution) is 

not the same as the treatment would be if CanCo were not fiscally transparent 

under U.S. tax law (as a dividend). As a result, subparagraph 7(b) would apply to 

provide that such amount is not considered paid to or derived by the U.S. resident.’’ 

The provisions of subparagraph 7(b) apply reciprocally. Assume, for example, that 

CanCo (as well as other persons) are owners of USCo, a U.S entity that is considered under U.S. tax law to be a corporation resident in the United States, but is 

considered under Canadian tax law to be a partnership (a so-called ‘‘domestic reverse hybrid’’). Assume that CanCo is considered under U.S. tax law to have received a dividend from USCo. Such payment is viewed under U.S. tax law as a dividend, but under Canadian tax law is viewed as a partnership distribution. In such 

a case, the United States views CanCo as receiving income (i.e., a dividend) from 

an entity that is a resident of the United States (USCo), USCo is viewed as fiscally 

transparent under the laws of Canada, the residence State, and by reason of USCo 

being treated as a partnership under Canadian tax law, the treatment under Canadian tax law of the payment (as a partnership distribution) is not the same as the 

treatment would be if USCo were not fiscally transparent under Canadian tax law 

(as a dividend). As a result, subparagraph 7(b) would apply to provide that such 

amount is not considered paid to or derived by the Canadian resident. 

As noted in the agreed Technical Explanation: ‘‘Paragraphs 6 and 7 apply to determine whether an amount is considered to be derived by (or paid to) a person who 

is a resident of Canada or the United States. If, as a result of paragraph 7, a person 

is not considered to have derived or received an amount of income, profit or gain, 

that person shall not be entitled to the benefits of the Convention with respect to 

such amount. Additionally, for purposes of application of the Convention by the 

United States, the treatment of such payments under Code section 894(c) and the 

regulations thereunder would not be relevant.’’ Thus, subparagraph 7(b) applies 

with respect to deductible payments by a domestic reverse hybrid to its Canadian 

owners. 

Although not specifically addressed in the Technical Explanation, the Treasury 

Department and Canada agree that subparagraph 7(b) does not apply to deny benefits to interest and royalty payments by an entity that is treated as a partnership 

by one country and a corporation by the other if the treatment of such amount by 

the country of the person deriving the income would be the same if such amount 

had been derived directly by such person (interest or royalties). 

Question 22. Does the Treasury Department intend to formally share its Technical 

Explanation regarding the Bulgaria and Iceland Treaties with each country, as a 

courtesy? 

117 

Answer. As a courtesy, the Treasury Department has sent copies of its Technical 

Explanation to each country. Unlike the Technical Explanation to the proposed Canada Protocol, however, the Technical Explanations to the proposed Bulgaria and Iceland Conventions have not been reviewed by or subscribed to by the relevant country. 

RESPONSES OF DEPUTY ASSISTANT SECRETARY MICHAEL MUNDACA TO QUESTIONS

SUBMITTED FOR THE RECORD FROM SENATOR LUGAR

Question 1. Please give an overview of current cases that have not been resolved 

and the anticipated case load that would be addressed by the Arbitration Provision 

in the Protocol with Canada, including number of cases, length of time unresolved, 

and country of origin breakdowns. 

Answer. There are currently 192 active cases with Canada. Of those, approximately 90 percent are transfer-pricing cases, with the remainder involving interpretive issues, such as residency and permanent-establishment determinations. The 

Canadian tax authorities initiated the adjustment in 85 percent of the cases caused 

by a transfer pricing adjustment. 

Fifty-three of the 192 total cases have been unresolved for over two years. Of 

those 53 cases, the ‘‘oldest’’ case is 2,289 days old and the ‘‘youngest’’ case is 762 

days old. Four of the 53 cases involve interpretive issues, the oldest of which is 

1,657 days and the youngest of which is 1085 days. 

We should note that different countries track their outstanding competent authority cases differently. For example, concepts such as the definition of a case may vary 

by country. Thus, we have observed that where a treaty partner has aggregate information regarding its case load with the United States the numbers sometimes 

notably diverge from the numbers used by the United States. 

Question 2. Traditionally, tax treaties agreements have been seen as facilitating 

cross-border trade and investment of multinational businesses. However, increasing 

globalization also affects small businesses. Is the current model for U.S. Tax Treaties clear, understandable and usable for smaller businesses? Give examples of how 

small business can take advantage of these treaties. 

Answer. The current U.S. Model Tax Treaty and Technical Explanation are available on the Treasury Department Web site. The Treaty and especially the Technical 

Explanation are drafted to be as clear and understandable as possible, but we recognize that technical international tax rules and issues may appear opaque to many 

taxpayers. IRS publications, especially Publication 901 on Tax Treaties, provide 

international tax guidance in less technical terms and may be more accessible to 

individuals who do not have significant tax experience. 

We further recognize that in our increasingly global economy, small businesses 

and individuals may, and perhaps must, address cross-border tax issues. Because 

our tax treaties provide generally uniform and clear rules regarding such important 

issues as withholding tax rates and tax jurisdictional thresholds, we think they can 

be especially useful to small businesses and individuals, who may not have access 

to multinational advisors or foreign tax advice. More specifically, tax treaties generally allow U.S. businesses to engage in trade in goods and services of greater 

value and duration with foreign clients without incurring foreign taxes than would 

be the case in the absence of treaties. Treaties may also facilitate access to foreign 

skilled workers and researchers, and to foreign capital via reduced withholding 

rates. 

We welcome further input from the committee regarding how best to serve small 

businesses in this regard. 

118 

Question 3. Please describe the current U.S. position on reciprocal elimination of 

withholding taxes on cross-border dividends paid between a subsidiary and its parent company. Has there been a change in the U.S. policy position? 

Answer. The policy of the Treasury Department continues to be that the elimination of source-country taxation of dividends should be considered only on a caseby-case basis. Such a provision is not part of the U.S. Model because we do not believe that it is appropriate to include in every treaty. We must consider the interaction of our tax system with our treaty partner’s, as well as the overall balance 

of the treaty before deciding whether inclusion is appropriate. 

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