U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

1

85–197 2003 JCS–6–03

[JOINT COMMITTEE PRINT]

EXPLANATION OF PROPOSED PROTOCOL 

TO THE INCOME TAX TREATY BETWEEN 

THE UNITED STATES AND MEXICO

SCHEDULED FOR A HEARING

BEFORE THE

COMMITTEE ON FOREIGN RELATIONS 

UNITED STATES SENATE

ON MARCH 5, 2003

PREPARED BY THE STAFF

OF THE

JOINT COMMITTEE ON TAXATION

March 3, 2003 


E:\Seals\Congress.#13
(II)

JOINT COMMITTEE ON TAXATION 

108TH CONGRESS, 1ST SESSION

HOUSE SENATE 

WILLIAM M. THOMAS, California, 

Chairman 

PHILIP M. CRANE, Illinois 

E. CLAY SHAW, JR., Florida 

CHARLES B. RANGEL, New York 

FORTNEY PETE STARK, California 

CHARLES E. GRASSLEY, Iowa, 

Vice Chairman 

ORRIN G. HATCH, Utah 

DON NICKLES, Oklahoma 

MAX BAUCUS, Montana 

JOHN D. ROCKEFELLER IV, West Virginia 

MARY M. SCHMITT, Acting Chief of Staff 

BERNARD A. SCHMITT, Deputy Chief of Staff 

(III)

C O N T E N T S 

Page 

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

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

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

AND INVESTMENT AND U.S. TAX TREATIES ...................... 3

A. U.S. Tax Rules ......................................................... 3

B. U.S. Tax Treaties .................................................... 4

III. EXPLANATION OF PROPOSED PROTOCOL .............................. 7

Article 1. General Scope .............................................. 7

Article 2. Dividends ..................................................... 8

Article 3. Branch Tax .................................................. 14

Article 4. Capital Gains ............................................... 16 

Article 5. Relief From Double Taxation ..................... 16

Article 6. Entry Into Force .......................................... 17

Article 7. Remaining in Force ..................................... 18

IV. ISSUES ................................................................................... 19

A. Zero Rate of Withholding Tax on Dividends from 

80-Percent-Owned Subsidiaries ............................ 19

B. Visiting Teachers and Professors ........................... 22

(1)

1This pamphlet may be cited as follows: Joint Committee on Taxation, Explanation of Proposed Protocol to the Income Tax Treaty Between the United States and Mexico (JCS–6–03), 

March 3, 2003. 

INTRODUCTION 

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

Taxation, describes the proposed protocol to the income tax treaty 

between the United States of America and Mexico (‘‘the proposed 

protocol’’). The proposed protocol was signed on November 26, 2002. 

The Senate Committee on Foreign Relations has scheduled a public 

hearing on the proposed treaty for March 5, 2003. 

Part I of the pamphlet provides a summary of the proposed protocol. Part II provides a brief overview of U.S. tax laws relating to 

international trade and investment and of U.S. income tax treaties 

in general. Part III contains an article-by-article explanation of the 

proposed protocol. Part IV contains a discussion of issues relating 

to the proposed protocol. 

(2)

I. SUMMARY 

The principal purposes of the proposed protocol are to reduce or 

eliminate the double taxation of income earned by residents of either country from sources within the other country and to prevent 

avoidance or evasion of the taxes of the two countries. The proposed protocol also is intended to promote close economic cooperation between the two countries and to eliminate possible barriers 

to trade and investment caused by overlapping taxing jurisdictions 

of the two countries. 

As in other U.S. tax treaties, these objectives principally are 

achieved through each country’s agreement to limit, in certain 

specified situations, its right to tax income derived from its territory by residents of the other country. In the case of dividends, the 

proposed protocol contains provisions that would eliminate sourcecountry tax on certain intercompany dividends in which certain 

ownership thresholds and other requirements are satisfied. In addition, the proposed protocol would provide a parallel exemption from 

the U.S. branch profits tax (Articles 2 and 3 of the proposed protocol). 

In situations in which the country of source retains the right 

under the proposed treaty to tax income derived by residents of the 

other country, the proposed protocol generally provides for relief 

from the potential double taxation through the allowance by the 

country of residence of a tax credit for certain foreign taxes paid 

to the other country (Articles 4 and 5 of the proposed protocol). 

The United States and Mexico have an income tax treaty currently in force (signed September 18, 1992, together with a protocol 

of the same date and a second protocol signed September 8, 1994). 

The proposed protocol includes provisions similar to those of other 

recent U.S. income tax treaties, the 1996 U.S. model income tax 

treaty (‘‘U.S. model’’), and the 1992 model income tax treaty of the 

Organization for Economic Cooperation and Development, as updated (‘‘OECD model’’). However, the proposed protocol contains 

certain substantive deviations from these treaties and models. 

(3)

II. OVERVIEW OF U.S. TAXATION OF INTERNATIONAL 

TRADE AND INVESTMENT AND U.S. TAX TREATIES 

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

foreign income and foreign persons that apply in the absence of a 

U.S. tax treaty. This overview also discusses the general objectives 

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

tax rules made by treaties. 

A. U.S. Tax Rules 

The United States taxes U.S. citizens, residents, and corporations on their worldwide income, whether derived in the United 

States or abroad. The United States generally taxes nonresident 

alien individuals and foreign corporations on all their income that 

is effectively connected with the conduct of a trade or business in 

the United States (sometimes referred to as ‘‘effectively connected 

income’’). The United States also taxes nonresident alien individuals and foreign corporations on certain U.S.-source income that is 

not effectively connected with a U.S. trade or business. 

Income of a nonresident alien individual or foreign corporation 

that is effectively connected with the conduct of a trade or business 

in the United States generally is subject to U.S. tax in the same 

manner and at the same rates as income of a U.S. person. Deductions are allowed to the extent that they are related to effectively 

connected income. A foreign corporation also is subject to a flat 30–

percent branch profits tax on its ‘‘dividend equivalent amount,’’ 

which is a measure of the effectively connected earnings and profits 

of the corporation that are removed in any year from the conduct 

of its U.S. trade or business. In addition, a foreign corporation is 

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

excess of the amount of interest that is deducted by the foreign corporation in computing its effectively connected income over the 

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

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

a nonresident alien individual or foreign corporation (including, for 

example, interest, dividends, rents, royalties, salaries, and annuities) that is not effectively connected with the conduct of a U.S. 

trade or business is subject to U.S. tax at a rate of 30 percent of 

the gross amount paid. Certain insurance premiums earned by a 

nonresident alien individual or foreign corporation are subject to 

U.S. tax at a rate of 1 or 4 percent of the premiums. These taxes 

generally are collected by means of withholding. 

Specific statutory exemptions from the 30–percent withholding 

tax are provided. For example, certain original issue discount and 

certain interest on deposits with banks or savings institutions are 

exempt from the 30–percent withholding tax. An exemption also is 

provided for certain interest paid on portfolio debt obligations. In 

4

addition, income of a foreign government or international organization from investments in U.S. securities is exempt from U.S. tax. 

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

foreign corporation that are not effectively connected with a U.S. 

trade or business generally are exempt from U.S. tax, with two exceptions: (1) gains realized by a nonresident alien individual who 

is present in the United States for at least 183 days during the taxable year, and (2) certain gains from the disposition of interests in 

U.S. real property. 

Rules are provided for the determination of the source of income. 

For example, interest and dividends paid by a U.S. citizen or resident or by a U.S. corporation generally are considered U.S.-source 

income. Conversely, dividends and interest paid by a foreign corporation generally are treated as foreign-source income. Special 

rules apply to treat as foreign-source income (in whole or in part) 

interest paid by certain U.S. corporations with foreign businesses 

and to treat as U.S.-source income (in whole or in part) dividends 

paid by certain foreign corporations with U.S. businesses. Rents 

and royalties paid for the use of property in the United States are 

considered U.S.-source income. 

Because the United States taxes U.S. citizens, residents, and corporations on their worldwide income, double taxation of income can 

arise when income earned abroad by a U.S. person is taxed by the 

country in which the income is earned and also by the United 

States. The United States seeks to mitigate this double taxation 

generally by allowing U.S. persons to credit foreign income taxes 

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

A fundamental premise of the foreign tax credit is that it may not 

offset the U.S. tax liability on U.S.-source income. Therefore, the 

foreign tax credit provisions contain a limitation that ensures that 

the foreign tax credit offsets only the U.S. tax on foreign-source income. The foreign tax credit limitation generally is computed on a 

worldwide basis (as opposed to a ‘‘per-country’’ basis). The limitation is applied separately for certain classifications of income. In 

addition, a special limitation applies to the credit for foreign taxes 

imposed on foreign oil and gas extraction income. 

For foreign tax credit purposes, a U.S. corporation that owns 10 

percent or more of the voting stock of a foreign corporation and receives a dividend from the foreign corporation (or is otherwise required to include in its income earnings of the foreign corporation) 

is deemed to have paid a portion of the foreign income taxes paid 

by the foreign corporation on its accumulated earnings. The taxes 

deemed paid by the U.S. corporation are included in its total foreign taxes paid and its foreign tax credit limitation calculations for 

the year in which the dividend is received.

B. U.S. Tax Treaties 

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

avoidance of international double taxation and the prevention of 

tax avoidance and evasion. Another related objective of U.S. tax 

treaties is the removal of the barriers to trade, capital flows, and 

commercial travel that may be caused by overlapping tax jurisdictions and by the burdens of complying with the tax laws of a jurisdiction when a person’s contacts with, and income derived from, 

5

that jurisdiction are minimal. To a large extent, the treaty provisions designed to carry out these objectives supplement U.S. tax 

law provisions having the same objectives; treaty provisions modify 

the generally applicable statutory rules with provisions that take 

into account the particular tax system of the treaty partner. 

The objective of limiting double taxation generally is accomplished in treaties through the agreement of each country to limit, 

in specified situations, its right to tax income earned from its territory by residents of the other country. For the most part, the various rate reductions and exemptions agreed to by the source country in treaties are premised on the assumption that the country of 

residence will tax the income at levels comparable to those imposed 

by the source country on its residents. Treaties also provide for the 

elimination of double taxation by requiring the residence country 

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

to impose under the treaty. In addition, in the case of certain types 

of income, treaties may provide for exemption by the residence 

country of income taxed by the source country. 

Treaties define the term ‘‘resident’’ so that an individual or corporation generally will not be subject to tax as a resident by both 

the countries. Treaties generally provide that neither country will 

tax business income derived by residents of the other country unless the business activities in the taxing jurisdiction are substantial 

enough to constitute a permanent establishment or fixed base in 

that jurisdiction. Treaties also contain commercial visitation exemptions under which individual residents of one country performing personal services in the other will not be required to pay 

tax in that other country unless their contacts exceed certain specified minimums (e.g., presence for a set number of days or earnings 

in excess of a specified amount). Treaties address passive income 

such as dividends, interest, and royalties from sources within one 

country derived by residents of the other country either by providing that such income is taxed only in the recipient’s country of 

residence or by reducing the rate of the source country’s withholding tax imposed on such income. In this regard, the United 

States agrees in its tax treaties to reduce its 30–percent withholding tax (or, in the case of some income, to eliminate it entirely) 

in return for reciprocal treatment by its treaty partner. 

In its treaties, the United States, as a matter of policy, generally 

retains the right to tax its citizens and residents on their worldwide income as if the treaty had not come into effect. The United 

States also provides in its treaties that it will allow a credit against 

U.S. tax for income taxes paid to the treaty partners, subject to the 

various limitations of U.S. law. 

The objective of preventing tax avoidance and evasion generally 

is accomplished in treaties by the agreement of each country to exchange tax-related information. Treaties generally provide for the 

exchange of information between the tax authorities of the two 

countries when such information is necessary for carrying out provisions of the treaty or of their domestic tax laws. The obligation 

to exchange information under the treaties typically does not require either country to carry out measures contrary to its laws or 

administrative practices or to supply information that is not obtainable under its laws or in the normal course of its administration 

6

or that would reveal trade secrets or other information the disclosure of which would be contrary to public policy. The Internal Revenue Service (the ‘‘IRS’’), and the treaty partner’s tax authorities, 

also can request specific tax information from a treaty partner. 

This can include information to be used in a criminal investigation 

or prosecution. 

Administrative cooperation between countries is enhanced further under treaties by the inclusion of a ‘‘competent authority’’ 

mechanism to resolve double taxation problems arising in individual cases and, more generally, to facilitate consultation between 

tax officials of the two governments. 

Treaties generally provide that neither country may subject nationals of the other country (or permanent establishments of enterprises of the other country) to taxation more burdensome than that 

it imposes on its own nationals (or on its own enterprises). Similarly, in general, neither treaty country may discriminate against 

enterprises owned by residents of the other country. 

At times, residents of countries that do not have income tax treaties with the United States attempt to use a treaty between the 

United States and another country to avoid U.S. tax. To prevent 

third-country residents from obtaining treaty benefits intended for 

treaty country residents only, treaties generally contain an ‘‘antitreaty shopping’’ provision that is designed to limit treaty benefits 

to bona fide residents of the two countries. 

(7)

III. EXPLANATION OF PROPOSED PROTOCOL 

Article 1. General Scope 

Article 1 of the proposed protocol restates Article 1 of the U.S.-

Mexico treaty, with the exception of Paragraphs 3, 6, 7, and 8. 

Paragraph 3 relates to the interaction of the treaty with other 

agreements. As amended by the proposed protocol, Paragraph 3 

provides two exceptions to the rule of Paragraph 2 that the treaty 

shall not restrict in any manner any exclusion, exemption, deduction, credit or other allowance now or hereafter accorded by the 

laws of either Contracting State or by any other agreement between the Contracting States. Paragraphs 6, 7, and 8 relate to the 

countries’ rights to tax certain former citizens and former longterm residents. 

The treaty entered into force on December 28, 1993, before the 

entry into force of certain other agreements to which the Contracting States are parties (such as the General Agreement on 

Trade in Services (‘‘GATS’’)). Consequently, the provisions of Paragraph 3 serve to clarify and update the rules for determining the 

interaction of the treaty with other agreements with respect to the 

scope of the treaty. With respect to taxation measures, the provisions of Paragraph 3 generally have the effect of resolving which 

agreement applies in favor of the treaty (not another agreement), 

except in cases in which the competent authorities agree that the 

treaty should not be applied. 

Under the first provision of Paragraph 3, any question or dispute 

concerning the interpretation or application of the treaty, in particular whether a taxation measure is within the scope of the treaty, is to be determined or resolved only as provided by Article 26 

of the treaty (Mutual Agreement Procedure). Article 26 authorizes 

the competent authorities of the United States and Mexico to consult together to attempt to alleviate individual cases of double taxation not in accordance with the treaty. The Technical Explanation 

notes that as a result, dispute resolution procedures under other 

agreements do not apply in determining the interpretation or application of the treaty (including whether a taxation measure is within the scope of the treaty). 

Under the second provision of Paragraph 3, no other agreement 

applies to a taxation measure unless the competent authorities 

agree that the measure is not within the scope of Article 25 of the 

treaty (Non-Discrimination). For this purpose, a measure is defined 

inclusively to mean a law, regulation, rule, procedure, decision, administrative action, or any similar provision or action. Article 25 of 

the treaty provides a comprehensive nondiscrimination provision 

relating to all taxes of every kind imposed at the national, state, 

or local level. The Technical Explanation notes that, under the second provision of Paragraph 3 of the proposed protocol, if the nondiscrimination provisions of the treaty apply to a taxation measure, 

8

then no national treatment or most-favored-nation (‘‘MFN’’) obligations in another agreement of the Contracting States applies to 

that taxation measure. The Technical Explanation concludes that 

this provision, though it differs from the equivalent provision in the 

U.S. model treaty, has a similar effect. The provision does not explicitly provide that the General Agreement on Tariffs and Trade 

(‘‘GATT’’) also is applicable to taxation measures that are within 

the scope of Article 25 of the treaty, but that article generally does 

not relate to the treatment of trade in goods. Thus, if the competent authorities agree that a taxation measure is not within the 

scope of Article 25, the provisions of GATT would apply to the 

measure, which is the same result as under the U.S. model. 

Under paragraph 6 of the proposed protocol, the United States 

and Mexico reserve for a period of 10 years their right to tax 

former citizens and former long-term residents whose loss of citizenship or long-term resident status had, as one of its principal 

purposes, the avoidance of tax. Consequently, the saving clause of 

paragraph 4 applies to such individuals for a period of 10 years. 

This provision expands on the comparable provision of the current 

treaty, which applies only to former citizens, and not to former 

long-term residents. The term ‘‘long-term resident’’ is defined to include an individual (other than a citizen of either country) who is 

a lawful permanent resident of the country in 8 or more taxable 

years of the proceeding 15 taxable years. Paragraphs 7 and 8 of the 

proposed protocol set forth factors similar to those set forth in section 877 of the Code for use in determining whether one of the 

principal purposes of a change in status of a former citizen or longterm resident was the avoidance of tax. 

Article 2. Dividends 

Internal taxation rules 

United States 

The United States generally imposes a 30–percent tax on the 

gross amount of U.S.-source dividends paid to nonresident alien individuals and foreign corporations. The 30–percent tax does not 

apply if the foreign recipient is engaged in a trade or business in 

the United States and the dividends are effectively connected with 

that trade or business. In such a case, the foreign recipient is subject to U.S. tax on such dividends on a net basis at graduated rates 

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

Under U.S. law, the term dividend generally means any distribution of property made by a corporation to its shareholders, either 

from accumulated earnings and profits or current earnings and 

profits. However, liquidating distributions generally are treated as 

payments in exchange for stock and, thus, are not subject to the 

30–percent withholding tax described above (see discussion of capital gains in connection with Article 13 below). 

Dividends paid by a U.S. corporation generally are U.S.-source 

income. Also treated as U.S.-source dividends for this purpose are 

portions of certain dividends paid by a foreign corporation that conducts a U.S. trade or business. The U.S. 30–percent withholding 

tax imposed on the U.S.-source portion of the dividends paid by a 

foreign corporation is referred to as the ‘‘second-level’’ withholding 

9

2Mexico adopted a dividend withholding tax in 1999, but then repealed it in 2001 (effective 

for dividends paid after 2001). 

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

prevents application of the statutory branch profits tax. 

In general, corporations are not entitled under U.S. law to a deduction for dividends paid. Thus, the withholding tax on dividends 

theoretically represents imposition of a second level of tax on corporate taxable income. Treaty reductions of this tax reflect the view 

that where the United States already imposes corporate-level tax 

on the earnings of a U.S. corporation, a 30–percent withholding 

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

Moreover, the reduced rate of tax often applied by treaty to dividends paid to direct investors reflects the view that the sourcecountry tax on payments of profits to a substantial foreign corporate shareholder may properly be reduced further to avoid double 

corporate-level taxation and to facilitate international investment. 

A real estate investment trust (‘‘REIT’’) is a corporation, trust, or 

association that is subject to the regular corporate income tax, but 

that receives a deduction for dividends paid to its shareholders if 

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

dividends paid, a REIT must distribute most of its income. Thus, 

a REIT is treated, in essence, as a conduit for federal income tax 

purposes. Because a REIT is taxable as a U.S. corporation, a distribution of its earnings is treated as a dividend rather than income of the same type as the underlying earnings. Such distributions are subject to the U.S. 30–percent withholding tax when paid 

to foreign owners. 

A REIT is organized to allow persons to diversify ownership in 

primarily passive real estate investments. As such, the principal 

income of a REIT often is rentals from real estate holdings. Like 

dividends, U.S.-source rental income of foreign persons generally is 

subject to the 30–percent withholding tax (unless the recipient 

makes an election to have such rental income taxed in the United 

States on a net basis at the regular graduated rates). Unlike the 

withholding tax on dividends, however, the withholding tax on 

rental income generally is not reduced in U.S. income tax treaties. 

U.S. internal law also generally treats a regulated investment 

company (‘‘RIC’’) as both a corporation and a conduit for income tax 

purposes. The purpose of a RIC is to allow investors to hold a diversified portfolio of securities. Thus, the holder of stock in a RIC 

may be characterized as a portfolio investor in the stock held by 

the RIC, regardless of the proportion of the RIC’s stock owned by 

the dividend recipient. 

Mexico 

Mexico currently does not impose a withholding tax on dividend 

payments to nonresidents.2

Proposed protocol limits on internal law 

10–percent and 5–percent withholding rates 

The proposed protocol generally limits dividend withholding tax 

in the country of source to 10 percent of the gross amount of the 

dividend. If the beneficial owner of the dividend is a company resiVerDate Jan 31 2003 19:59 Feb 28, 2003 Jkt 085197 PO 00000 Frm 00013 Fmt 6604 Sfmt 6604 E:\HR\OC\A197.XXX A197
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3The Technical Explanation states that these limitations are confirmed by paragraph 12 of 

the OECD Commentaries to Article 10. The Technical Explanation also refers to paragraph 24 

of the Commentary to Article 1 of the OECD model. 

dent in the other State and directly owns shares representing at 

least 10 percent of the voting power of the company paying the dividend, then the withholding tax in the State of source is limited to 

5 percent of the gross amount of the dividend. The Technical Explanation states that 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 Technical Explanation states that the 5 and 

10 percent rate benefits may be granted at the time of payment by 

means of reduced withholding at the source; and that it is also consistent with the protocol for tax to be withheld at the time 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 Technical Explanation notes that the term ‘‘beneficial owner’’ 

is not defined in the treaty, and is, therefore, defined as under the 

internal law of the country imposing tax (i.e., the source country). 

According to the Technical Explanation, 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, the Technical Explanation states that if a dividend is paid by a corporation that is a resident of one of the States 

(as determined under Article 4 (Residence)) is received by a nominee or agent that is a resident of the other State on behalf of a person that 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.3

The Technical Explanation states that companies holding shares 

through fiscally transparent entities such as partnerships are considered for purposes of this paragraph to hold their proportionate 

interest in the shares. As a result, companies holding shares 

through such entities may be able to claim the benefits of the proposed protocol 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. The Technical 

Explanation notes that whether this ownership threshold is satisfied may be difficult to determine and often will require an analysis 

of the partnership or trust agreement. 

Zero rate of withholding on certain dividends 

The proposed protocol provides a zero rate of withholding with 

respect to certain intercompany dividends where there is a sufficiently high (80 percent of voting power) level of ownership (often 

referred to as ‘‘direct dividends’’). The proposed protocol also provides a zero rate of withholding with respect to dividends received 

by tax-exempt pension funds. 

Direct dividends 

The proposed protocol reduces the withholding tax rate to zero on 

certain dividends beneficially owned by a company that has owned 

11

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

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

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

is contained in the proposed income tax treaty with the United Kingdom. 

directly 80 percent or more of the voting stock of the company paying the dividend for the 12–month period ending on the date the 

dividend is declared. 

In the case of a dividend-receiving company that satisfies the 

Limitation on Benefits provision of the treaty only under paragraphs 1(c), 1(d)(iii), or 1(f) of Article 17, the proposed protocol imposes an additional requirement for qualification for the zero rate, 

that the dividend be received from a company with respect to 

which the dividend-receiving company owned, directly or indirectly, 

80 percent of the voting stock prior to October 1, 1998.4 The October 1, 1998, date is intended to prevent restructurings of corporate 

ownership in order to take advantage of the zero-rate provision in 

circumstances where the Limitation on Benefits provision does not 

provide sufficient protection against treaty shopping. 

The proposed protocol also provides that, if the United States 

agrees in another tax treaty to a zero-rate dividends provision 

under conditions more beneficial than those of the proposed protocol, the United States and Mexico shall, at Mexico’s request, consult with a view to incorporating a similar provision into the U.S.-

Mexico treaty. 

Tax exempt pension plans 

The proposed protocol also allows the zero withholding rate for 

dividends beneficially owned by a trust, company, or other organization constituted and operated exclusively to provide benefits 

under a pension, retirement, or other employee benefit plan. In 

order to qualify for the zero rate, the trust, company, or other organization must be generally exempt from tax in the Contracting 

State of which it is a resident, and the dividends must not be derived from the carrying on of a business, directly or indirectly, by 

such trust, company, or organization. The Technical Explanation 

states that the exemption is parallel to an existing exemption from 

the withholding tax on interest available to pension funds under 

Article 11(4)(c). 

Dividends paid by RICs and REITs 

The proposed protocol generally denies the 5 percent and zero 

rates of withholding to dividends paid by a RIC or REIT. 

In the case of a RIC, any such dividends are eligible for the zero 

rate paid to tax exempt pension, retirement, or other employee benefit plans. The 10 percent rate of withholding is allowed for any 

dividends paid by a RIC. 

In the case of a REIT, the 10 percent rate of withholding or zero 

rate of withholding with respect to dividends paid to tax exempt 

pension, retirement, or other employee benefit plans is allowed for 

dividends paid by a REIT only if one of three additional conditions 

is met. First, the person beneficially entitled to the dividend is an 

individual 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 person beneficially entitled to the 

12

dividend is a person holding an interest of not more than 5 percent 

of any class of the REIT’s stock. Third the person beneficially entitled to the dividend holds an interest in the REIT of not more than 

10 percent and the REIT is ‘‘diversified’’ (i.e., 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). 

For purposes of this diversification test, the Technical Explanation 

indicates that 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. 

The Technical Explanation indicates that these restrictions in 

availability of the different rates are intended to prevent the use 

of RICs and REITs to gain unjustifiable source-country benefits for 

certain shareholders resident in Mexico. For example, a company 

resident in Mexico could directly own a diversified portfolio of U.S. 

corporate shares and pay a U.S. withholding tax of 10 percent on 

dividends on those shares. There is a concern that such a company 

could purchase 10 percent or more of the interests in a RIC, which 

could even be established as a mere conduit, and thus obtain a 

lower withholding rate on a similar portfolio held by the RIC if the 

5 percent rate were allowed to RIC dividends, or if the zero rate 

were allowed for RIC dividends other than for dividends paid to 

pension plans. 

Similarly, the Technical Explanation gives an example of a resident of Mexico directly holding real property and required to pay 

U.S. tax either at a 30–percent rate on gross income or at graduated rates on the net income. By placing the property in a REIT, 

the investor could transform real estate income into dividend income, taxable at the rates provided in the proposed protocol. The 

limitations on REIT dividend benefits are intended to protect 

against this result. 

Dividends with respect to permanent establishment or fixed 

base 

The proposed protocol provides that dividends paid with respect 

to holdings that form part of the business property of a permanent 

establishment or fixed base situated in the source country are 

taxed on a net basis, using the rules of taxation generally applicable to residents of the State in which the permanent establishment 

is located, as modified by the treaty. The Technical Explanation 

gives as an example dividends derived by a dealer in stock or securities from stock or securities that the dealer held for sale to customers. 

Definition of ‘‘dividends’’ 

Dividends are defined under the proposed protocol as covering income from shares or other rights, not being debt-claims, participating in profits, as well as income from other corporate rights that 

is subjected to the same taxation treatment as income from shares 

by the laws of the State of which the company making the distribution is a resident. 

The Technical Explanation states that this definition is intended 

to cover all arrangements that yield a return on an equity investVerDate Jan 31 2003 19:59 Feb 28, 2003 Jkt 085197 PO 00000 Frm 00016 Fmt 6604 Sfmt 6604 E:\HR\OC\A197.XXX A197
13

ment 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 Technical Explanation gives as examples of covered situations a constructive dividend that results from a non-arm’s 

length transaction between a corporation and a related party; 

amounts treated as dividends under U.S. law upon a sale or redemption of shares; distributions from publicly traded limited partnerships that are treated as corporations under U.S. law (but not 

from limited liability companies, under U.S. law); and payments 

denominated as interest but made by a thinly capitalized corporation such that the debt is recharacterized as equity under the laws 

of the source State. 

The Technical Explanation states that under the existing treaty 

and protocol, each Contracting State may apply its statutory rules 

for distinguishing debt from equity or for preventing thin capitalization in defining dividends for purposes of this article. As under 

the existing Treaty, the Technical Explanation gives an example of 

the U.S. rules of Code section 163(f), denying a deduction for interest on certain obligations not in registered form. 

Company resident of one State deriving profits or income 

from the other State

Under the proposed protocol, if a company that is a resident of 

one Contracting State derives profits or income from the other Contracting State, that other State may not impose any tax on the 

dividends paid by a company which is not a resident of that State, 

except insofar as such dividends are paid to a resident of that other 

State or are attributable to a permanent establishment or fixed 

base situated in that State. The Technical Explanation states that 

in the case of the United States, this provision overrides the ability 

to impose taxes under section 871 and 882(a) on dividends paid by 

foreign corporations that have a U.S. source under section 

861(a)(2)(B). 

Relation to other Articles 

The Technical Explanation notes that the saving clause of paragraph 4 of Article 1 (General Scope) permits the United States to 

tax dividends received by its residents and citizens, subject to the 

special foreign tax credit rules of paragraph 6 of Article 24 (Relief 

from Double Taxation), as if the Treaty had not come into effect. 

The benefits of the dividends article are also subject to the provisions of Article 17 (Limitation on Benefits). Thus, if a resident of 

Mexico is the beneficial owner of dividends paid by a U.S. company, 

the shareholder must qualify for treaty benefits under at least one 

of the tests of Article 17 in order to receive the benefits of the Article 10 (Dividends). 

Paragraph (b) of Article 2 of the protocol replaces paragraph 8 

of the treaty’s existing protocol. The new paragraph provides that 

if the United States agrees in a tax treaty to a dividend exemption 

under conditions more beneficial than those in paragraph 3 (which 

grants a zero rate of withholding tax in certain circumstances), the 

Contracting States shall, at Mexico’s request, consult each other 

with a view to concluding another protocol to incorporate a similar 

provision into paragraph 3 of Article 10 (Dividends). 

14

Paragraph (c) of Article 2 of the proposed protocol is a technical 

correction to ensure that the provision of the treaty’s existing protocol paragraph 9 will continue to refer to the definition of ‘‘dividends’’ which in the new Article 10 is found in paragraph 6. 

Article 3. Branch Tax 

Internal taxation rules 

United States 

U.S. persons are subject to U.S. tax on their worldwide income. 

Foreign taxes may be credited against U.S. tax on foreign-source 

income of the taxpayer. For purposes of computing the foreign tax 

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

must be determined. 

Nonresident individuals who are not U.S. citizens and foreign 

corporations (collectively, foreign persons) are subject to U.S. tax on 

income that is effectively connected with the conduct of a U.S. 

trade or business; the U.S. tax on such income is calculated in the 

same manner and at the same graduated rates as the tax on U.S. 

persons (secs. 871(b) and 882). Foreign persons also are subject to 

a 30–percent gross basis tax, collected by withholding, on certain 

U.S.-source passive income (e.g., interest and dividends) that is not 

effectively connected with a U.S. trade or business. This 30–percent 

withholding tax may be reduced or eliminated pursuant to an applicable tax treaty. Foreign persons generally are not subject to 

U.S. tax on foreign-source income that is not effectively connected 

with a U.S. trade or business. 

In general, dividends paid by a domestic corporation are treated 

as being from U.S. sources and dividends paid by a foreign corporation are treated as being from foreign sources. Thus, dividends paid 

by foreign corporations to foreign persons generally are not subject 

to withholding tax because such income generally is treated as foreign-source income. 

An exception from this general sourcing rule applies in the case 

of dividends paid by certain foreign corporations. If a foreign corporation derives 25 percent or more of its gross income as income 

effectively connected with a U.S. trade or business for the threeyear period ending with the close of the taxable year preceding the 

declaration of a dividend, then a portion of any dividend paid by 

the foreign corporation to its shareholders will be treated as U.S.-

source income and, in the case of dividends paid to foreign shareholders, will be subject to the 30–percent withholding tax (sec. 

861(a)(2)(B)). This rule is sometimes referred to as the ‘‘secondary 

withholding tax.’’ The portion of the dividend treated as U.S.-

source income is equal to the ratio of the gross income of the foreign corporation that was effectively connected with its U.S. trade 

or business over the total gross income of the foreign corporation 

during the three-year period ending with the close of the preceding 

taxable year. The U.S.-source portion of the dividend paid by the 

foreign corporation to its foreign shareholders is subject to the 30-

percent withholding tax. 

Under the branch profits tax provisions, the United States taxes 

foreign corporations engaged in a U.S. trade or business on 

amounts of U.S. earnings and profits that are shifted out of the 

15

5This provision is similar to the provision relating to branch profits tax in the proposed U.S.-

U.K. treaty. The October 1, 1998, date in the proposed protocol follows the date set forth in the 

proposed U.S.-U.K. treaty. 

U.S. branch of the foreign corporation. The branch profits tax is 

comparable to the second-level taxes imposed on dividends paid by 

a domestic corporation to its foreign shareholders. The branch profits tax is 30 percent of the foreign corporation’s ‘‘dividend equivalent amount,’’ which generally is the earnings and profits of a U.S. 

branch of a foreign corporation attributable to its income effectively 

connected with a U.S. trade or business (secs. 884(a) and (b)). In 

arriving at the dividend equivalent amount, a branch’s effectively 

connected earnings and profits are adjusted to reflect changes in a 

branch’s U.S. net equity (i.e., the excess of the branch’s assets over 

its liabilities, taking into account only amounts treated as connected with its U.S. trade or business) (sec. 884(b)). The first adjustment reduces the dividend equivalent amount to the extent the 

branch’s earnings are reinvested in trade or business assets in the 

United States (or reduce U.S. trade or business liabilities). The second adjustment increases the dividend equivalent amount to the 

extent prior reinvested earnings are considered remitted to the 

home office of the foreign corporation. 

If a foreign corporation is subject to the branch profits tax, then 

no secondary withholding tax is imposed on dividends paid by the 

foreign corporation to its shareholders (sec. 884(e)(3)(A)). If a foreign corporation is a qualified resident of a tax treaty country and 

claims an exemption from the branch profits tax pursuant to the 

treaty, the secondary withholding tax could apply with respect to 

dividends it pays to its shareholders. Several tax treaties (including 

treaties that prevent imposition of the branch profits tax), however, 

exempt dividends paid by the foreign corporation from the secondary withholding tax.

Mexico 

Mexico does not impose a branch profits tax. 

Proposed treaty limitations on internal law 

Article 3 of the proposed protocol provides an exemption from the 

branch profits tax that parallels the provision of the proposed protocol providing a zero rate of withholding on dividends.5

The United States is allowed under the current treaty to impose 

the branch profits tax (at a rate of 5 percent) on the business profits of a Mexican corporation that are effectively connected (or treated as effectively connected) with the conduct of a trade or business 

in the United States, and are either attributable to a permanent 

establishment in the United States, or subject to tax on a net basis 

in the United States on income subject to Article 6 (Income From 

Immovable Property (Real Property)) or paragraphs 1 or 4 of Article 13 (Capital Gains). The tax is imposed on the ‘‘dividend equivalent amount,’’ as described above. 

Under the proposed protocol, the branch profits tax will not be 

imposed by the United States in cases in which a zero rate of withholding on dividends would apply if the U.S. branch business had 

been conducted by the Mexican company through a separate U.S. 

subsidiary. Thus, the branch profits tax will not be imposed in the 

16

case of a company that, before October 1, 1998, had a permanent 

establishment in the United States, or in the case of income or 

gains subject to tax on a net basis in the United States from real 

property or from the disposition of interests in real property. In addition, the branch profits tax will not apply to a Mexican company 

that is considered a qualified person by reason of being a publiclytraded company, or that is entitled to benefits with respect to the 

dividend equivalent amount under the derivative benefits or competent-authority discretion rules under Article 17 (Limitation on 

Benefits). 

Article 4. Capital Gains 

Article 4 of the proposed protocol relates to the sourcing rule for 

capital gains. The provision removes a sentence relating to 

resourcing of capital gains from Article 13, paragraph 4 of the treaty (Capital Gains) that is not necessary, given the modification of 

the treaty’s resourcing rule made by Article V of the proposed protocol (described below). 

Article 5. Relief from Double Taxation 

Internal taxation rules 

United States 

The United States taxes the worldwide income of its citizens and 

residents. It attempts unilaterally to mitigate double taxation generally by allowing taxpayers to credit the foreign income taxes that 

they pay against U.S. tax imposed on their foreign-source income. 

An indirect or ‘‘deemed-paid’’ credit is also provided. Under this 

rule, a U.S. corporation that owns 10 percent or more of the voting 

stock of a foreign corporation and that receives a dividend from the 

foreign corporation (or an inclusion of the foreign corporation’s income) is deemed to have paid a portion of the foreign income taxes 

paid (or deemed paid) by the foreign corporation on its earnings. 

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

total foreign taxes paid for the year the dividend is received. 

A fundamental premise of the foreign tax credit is that it may 

not offset the U.S. tax on U.S.-source income. Therefore, the foreign 

tax credit provisions contain a limitation that ensures that the foreign tax credit only offsets U.S. tax on foreign-source income. The 

foreign tax credit limitation generally is computed on a worldwide 

consolidated basis. Hence, all income taxes paid to all foreign countries are combined to offset U.S. taxes on all foreign income. The 

limitation is computed separately for certain classifications of income (e.g., passive income and financial services income) in order 

to prevent the crediting of foreign taxes on certain high-taxed foreign-source income against the U.S. tax on certain types of traditionally low-taxed foreign-source income. Other limitations may 

apply in determining the amount of foreign taxes that may be credited against the U.S. tax liability of a U.S. taxpayer. 

Mexico 

Mexican residents are allowed a credit against their Mexican income tax for foreign income taxes imposed on their foreign-source 

income. The credit is limited to the Mexican tax payable on the net 

17

foreign-source income. To the extent that foreign taxes are not 

credited in a particular tax year, a taxpayer may not deduct such 

foreign taxes. Excess foreign tax credits, however, may be carried 

forward for a period of 10 years. Foreign tax credits may not be 

carried back. 

Proposed treaty limitations on internal law 

Article 5 of the proposed protocol revises the rule in the current 

treaty for resourcing income taxed in accordance with the treaty to 

relieve double taxation (paragraph 3 of Article 24, Relief from Double Taxation). The resourcing rule currently in the treaty provides 

generally that income derived by a resident of the United States 

that may be taxed in Mexico is deemed to be Mexico-source income; 

however, such income generally is subject to the source rules of 

U.S. domestic law that apply for purposes of limiting the foreign 

tax credit (except with respect to capital gains). Certain gains derived by a U.S. resident from rights in the capital of a company or 

person that is a resident of Mexico are deemed to be Mexico-source 

income, to the extent necessary to avoid double taxation (paragraph 

4, Article 13 (Capital Gains)). Thus, in general, under the current 

resourcing rule of the treaty, income taxed in Mexico is subject to 

U.S. domestic foreign tax credit limitation sourcing rules (except 

for certain capital gains). 

The proposed protocol generally provides that the United States 

will allow a U.S. citizen or resident a foreign tax credit for the income taxes imposed by Mexico. The proposed protocol contains a 

resourcing rule for this purpose. This rule provides that an item of 

gross income (as defined under U.S. law) that is derived by a U.S. 

resident that is taxed by Mexico is deemed to be Mexico-source income. The proposed protocol eliminates the rule of the current treaty that such income is subject the source rules of U.S. domestic law 

that apply for purposes of limiting the foreign tax credit. The provision of the current treaty deeming certain capital gains as Mexicosource income is eliminated as unnecessary, as the general 

resourcing rule of the proposed protocol subsumes this provision. 

The Technical Explanation states that in the case in which the 

treaty allows Mexico to tax an item of gross income (as defined 

under U.S. law) derived by a U.S. resident, the United States will 

treat that item of income as Mexico-source income for purposes of 

the U.S. foreign tax credit. The Technical Explanation further 

states that in such a case, however, section 904(g)(10) may apply 

for purposes of determining the U.S. foreign tax credit. Section 

904(g)(10) generally provides that the foreign tax credit limitation 

applies separately to income resourced under a treaty. The Technical Explanation points out that, because the resourcing rule of 

the proposed protocol applies to gross income, not net income, U.S. 

expense allocation and apportionment rules continue to apply to income resourced under the rule of the proposed protocol. 

Article 6. Entry into Force 

The proposed protocol provides that the protocol is subject to 

ratification in accordance with the applicable constitutional and 

statutory requirements of each country. The proposed protocol requires each State to notify the other as soon as its requirements 

18

for ratification have been fulfilled; the proposed protocol will enter 

into force upon the date of the later of the two notifications. 

The proposed protocol provides explicit effective dates for each of 

the provisions of the proposed protocol. With respect to Article 2, 

the proposed protocol will be effective with respect to dividends 

paid or credited on or after the first day of the second month after 

the date on which the protocol enters into force. The Technical Explanation provides the following example to illustrate the operation 

of this rule: if the second notification of the fulfillment of the ratification requirements is received on April 25, then the provisions of 

Article 2 would take effect for dividends paid or credited on or after 

June 1. All other provisions of the proposed protocol will be effective for taxable periods beginning on or after the first day of January of the year following the year in which the proposed protocol 

enters into force. 

The purpose of this bifurcated effective date is to permit the benefits of the withholding reductions with respect to dividends to be 

put into effect as soon as is administratively feasible. A similar bifurcated effective date (permitting reductions in withholding to 

occur sooner than other provisions of the treaty) is included in the 

proposed income tax treaty with the United Kingdom. 

Article 7. Remaining in Force 

The proposed protocol will remain in force as long as the underlying convention to which this proposed protocol is an amendment 

remains in force. 

(19)

IV. ISSUES 

A. Zero Rate of Withholding Tax on Dividends from 80–

Percent-Owned Subsidiaries 

In general 

The proposed protocol would eliminate withholding tax on dividends paid by one corporation to another corporation that owns at 

least 80 percent of the stock of the dividend-paying corporation 

(often referred to as ‘‘direct dividends’’), provided that certain conditions are met (subparagraph 3(a) of Article 10 of the current treaty (Dividends)). The elimination of withholding tax under these circumstances is intended to reduce further the tax barriers to direct 

investment between the two countries. 

Currently, no U.S. treaty provides for a complete exemption from 

withholding tax under these circumstances, nor do the U.S. or 

OECD models. However, many bilateral tax treaties to which the 

United States is not a party eliminate withholding taxes under 

similar circumstances, and the same result has been achieved within the European Union under its ‘‘Parent-Subsidiary Directive.’’ In 

addition, the United States has signed a proposed treaty with the 

United Kingdom and a proposed protocol with Australia that include zero-rate provisions similar to the one in the proposed protocol. 

Description of provision 

Under the proposed protocol, the withholding tax rate is reduced 

to zero on certain dividends beneficially owned by a company that 

has owned at least 80 percent of the voting power of the company 

paying the dividend for the 12–month period ending on the date 

the dividend is declared (subparagraph 3(a) of Article 10 of the current treaty (Dividends)). Under the current U.S.-Mexico treaty, 

these dividends may be taxed at a 5–percent rate. 

Issues 

In general 

Given that the United States has never before agreed bilaterally 

to a zero rate of withholding tax on direct dividends, the Committee may wish to devote particular attention to the benefits and 

costs of taking this step. The Committee also may want to determine whether the inclusion of the zero-rate provision in the proposed protocol (as well as in the proposed treaty with the United 

Kingdom and the proposed protocol with Australia) signals a broader shift in U.S. treaty policy, and under what circumstances the 

United States may seek to include similar provisions in other treaties. Finally, the Committee may wish to be aware of the ‘‘most favored nation’’ provision relating to this subject in the current U.S.-

20

6See, e.g., Code sec. 904. 7 In contrast, including a similar provision in a treaty with a country that does impose withholding tax on some or all direct dividends under its internal law (e.g., Australia) would provide 

more immediate and direct benefits to the United States as both an importer and an exporter 

of capital. 

Mexico treaty, and the ramifications of this provision in light of the 

proposed treaty with the United Kingdom and proposed protocol 

with Australia. 

Benefits and costs of adopting a zero rate with Mexico 

Tax treaties mitigate double taxation by resolving the potentially 

conflicting claims of a residence country and a source country to 

tax the same item of income. In the case of dividends, standard 

international practice is for the source country to yield mostly or 

entirely to the residence country. Thus, the residence country preserves its right to tax the dividend income of its residents, and the 

source country agrees either to limit its withholding tax to a relatively low rate (e.g., 5 percent) or to forgo it entirely. 

Treaties that permit a positive rate of dividend withholding tax 

allow some degree of double taxation to persist. To the extent that 

the residence country allows a foreign tax credit for the withholding tax, this remaining double taxation may be mitigated or 

eliminated, but then the priority of the residence country’s claim to 

tax the dividend income of its residents is not fully respected. 

Moreover, if a residence country imposes limitations on its foreign 

tax credit,6 withholding taxes may not be fully creditable as a practical matter, thus leaving some double taxation in place. For these 

reasons, dividend withholding taxes are commonly viewed as barriers to cross-border investment. The principal argument in favor 

of eliminating withholding taxes on certain direct dividends in the 

proposed treaty is that it would remove one such barrier. 

Direct dividends arguably present a particularly appropriate case 

in which to remove the barrier of a withholding tax, in view of the 

close economic relationship between the payor and the payee. 

Whether in the United States or in Mexico, the dividend-paying 

corporation generally faces full net-basis income taxation in the 

source country, and the dividend-receiving corporation generally is 

taxed in the residence country on the receipt of the dividend (subject to allowable foreign tax credits). If the dividend-paying corporation is at least 80–percent owned by the dividend-receiving corporation, it is arguably appropriate to regard the dividend-receiving corporation as a direct investor (and taxpayer) in the source 

country in this respect, rather than regarding the dividend-receiving corporation as having a more remote investor-type interest 

warranting the imposition of a second-level source-country tax. 

Since Mexico does not currently impose a withholding tax on 

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

would principally benefit direct investment in the United States by 

Mexican companies, as opposed to direct investment in Mexico by 

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

is importing capital, as opposed to exporting it.7

However, it should be noted that, although Mexican internal law 

currently does not impose a withholding tax on dividends paid to 

21

8 Indeed, Mexican law has changed recently in this regard—Mexico adopted a dividend withholding tax in 1999, but then repealed it in 2001 (effective for dividends paid after 2001). 9More broadly, since the U.S. model has not been updated since 1996, the Committee may 

wish to ask whether the Treasury Department intends to update the model to reflect all relevant developments that have occurred in the intervening years. A thoroughly updated model 

would provide a more meaningful and useful guide to current U.S. tax treaty policy and would 

thereby increase transparency and facilitate Congressional oversight in this important area. See 

Joint Committee on Taxation, Study of the Overall State of the Federal Tax System and Recommendations for Simplification, Pursuant to Section 8022(3)(B) of the Internal Revenue Code 

Continued

foreign persons, there is no guarantee that this will always be the 

case.8 Thus, the inclusion of a zero-rate provision under the proposed protocol would give U.S.-based enterprises somewhat greater 

certainty as to the applicability of a zero rate in Mexico, which arguably would facilitate long-range business planning for U.S. companies in their capacities as capital exporters. Along the same 

lines, the provision would protect the U.S. fisc against increased 

foreign tax credit claims in the event that Mexico were to change 

its internal law in this regard. 

Although the United States has never agreed bilaterally to a zero 

rate of withholding tax on direct dividends, many other countries 

have done so in one or more of their bilateral tax treaties. These 

countries include OECD members Austria, Denmark, France, Finland, Germany, Iceland, Ireland, Japan, Luxembourg, Mexico, the 

Netherlands, Norway, Sweden, Switzerland, and the United Kingdom, as well as non-OECD-members Belarus, Brazil, Cyprus, 

Egypt, Estonia, Israel, Latvia, Lithuania, Mauritius, Namibia, 

Pakistan, Singapore, South Africa, Ukraine, and the United Arab 

Emirates. In addition, a zero rate on direct dividends has been 

achieved within the European Union under its ‘‘Parent-Subsidiary 

Directive.’’ Finally, many countries have eliminated withholding 

taxes on dividends as a matter of internal law (e.g., the United 

Kingdom and Mexico). Thus, although the zero-rate provision in 

the proposed protocol is unprecedented in U.S. treaty history, there 

is substantial precedent for it in the experience of other countries. 

It may be argued that this experience constitutes an international 

trend toward eliminating withholding taxes on direct dividends, 

and that the United States would benefit by joining many of its 

treaty partners in this trend and further reducing the tax barriers 

to cross-border direct investment. 

General direction of U.S. tax treaty policy 

Looking beyond the U.S.-Mexico treaty relationship, the Committee may wish to determine whether the inclusion of the zerorate provision in the proposed protocol (as well as in the proposed 

treaty with the United Kingdom and the proposed protocol with 

Australia) signals a broader shift in U.S. tax treaty policy. Specifically, the Committee may want to know whether the Treasury Department: (1) intends to pursue similar provisions in other proposed treaties in the future; (2) proposes any particular criteria for 

determining the circumstances under which a zero-rate provision 

may be appropriate or inappropriate; (3) expects to seek terms and 

conditions similar to those of the proposed treaty in connection 

with any zero-rate provisions that it may negotiate in the future; 

and (4) intends to amend the U.S. model to reflect these developments.9

22

of 1986 (JCS–3–01), April 2001, Vol. II, at 445–47 (recommending that the Treasury Department revise U.S. model tax treaties once per Congress). 10This formal understanding was a response to an objection raised by the Committee to the 

original language of the treaty protocol, under which the ‘‘most-favored nation’’ provision would 

have been self-executing—i.e., immediately upon U.S. agreement to a lower rate with another 

treaty partner, the United States and Mexico would have begun applying that lower rate in 

their treaty. 

‘‘Most favored nation’’ agreement 

Under the current U.S.-Mexico income tax treaty, dividends beneficially owned by a company that owns at least 10 percent of the 

voting stock of the dividend-paying company are subject to a maximum withholding rate of 5 percent (paragraph 2(a) of Article 10 

of the current treaty), which is the lowest rate of withholding tax 

on dividends currently available under U.S. treaties. Under Protocol 1 to that treaty, as modified by a formal understanding subject to which the treaty and protocol were ratified, the United 

States and Mexico have agreed, if the United States adopts a rate 

on dividends lower than 5 percent in a treaty with another country, 

‘‘to promptly amend [the U.S.-Mexico treaty] to incorporate that 

lower rate.’’ 10

The adoption of a zero-rate provision in the U.S.-Australia or the 

U.S.-U.K. treaty relationship would trigger this obligation to 

amend the current treaty with Mexico. The proposed protocol with 

Mexico would amend that treaty to incorporate a zero-rate provision substantially identical to that of the proposed treaty with the 

United Kingdom, and substantially similar to that of the proposed 

protocol with Australia, and thus would seem to fulfill the U.S. obligation under the ‘‘most favored nation’’ agreement. Thus, if the 

Senate were to ratify the proposed protocol with Mexico along with 

either the proposed treaty with the United Kingdom or the proposed protocol with Australia (or both of them), no issues of interaction between the two treaty relationships would need to be confronted. 

If, on the other hand, the Senate were to ratify either the proposed treaty with the United Kingdom or the proposed protocol 

with Australia, but not the proposed protocol with Mexico, then the 

possibility would arise that the United States eventually could be 

regarded as falling out of compliance with its obligations under the 

U.S.-Mexico treaty. This would raise difficult questions as to the 

exact nature of this obligation and whether and how the United 

States would come into compliance with it. 

B. Visiting Teachers and Professors 

The proposed protocol maintains the present treaty’s treatment 

of visiting teachers and professors, in which an individual visiting 

in the host country to engage in teaching or research at an educational institution is subject to income tax in the host country on 

any remuneration received for his or her teaching or research. The 

treatment of the present treaty conforms to the U.S. model. While 

this is the position of the U.S. model, an exemption for visiting 

teachers and professors has been included in many bilateral tax 

treaties. Of the more than 50 bilateral income tax treaties in force, 

30 include provisions exempting from host country taxation the income of a visiting individual engaged in teaching or research at an 

23

11The treaties with Italy, Slovenia, and Venezuela, each considered in 1999, contain provisions exempting the remuneration of visiting teachers and professors from host country income 

taxation. The treaties with Denmark, Estonia, Latvia, and Lithuania, also considered in 1999, 

did not contain such an exemption, but did contain a more limited exemption for visiting researchers.

educational institution, and an additional 10 treaties provide a 

more limited exemption from taxation in the host county for a visiting individual engaged in research. Although the proposed protocol with Australia would not include such a provision, the proposed treaty with the United Kingdom does include such a provision, and three of the most recently ratified income tax treaties did 

contain such a provision.11 The Committee may wish to satisfy 

itself that the inclusion of such an exemption is not appropriate. 

Æ