Current income tax treaty developments.

• Author: Dichter, Arthur J.
• Position: Part 2

Six new treaties await Senate ratification--with Austria, Luxembourg, South Africa, Switzerland, Thailand and Turkey. The Senate Foreign Relations Committee has indicated that a hearing on these agreements will not be held until late this summer or early fall. All these agreements generally follow the OECD and U.S. models (with some modifications). This article addresses these treaties and highlights important deviations from the models.

Treaties Awaiting Ratification--Highlights

* Austria Withholding rates

[] Dividends: Under the existing treaty, the rate on portfolio dividends is one-half of the statutory rate (15% in the case of the U.S.; 12.5% in the case of Austria); the rate for direct investment dividends is 5%.(39) The 5% rate is available only if: (1) 95% of the payer's voting stock is owned (directly or indirectly) by a corporation; (2) not more than 25% of the payer's gross income was derived from interest and dividends from a nonsubsidiary; and (3) the relationship between the two companies was not arranged or maintained primarily with the intention of securing the reduced rate.

Under the new treaty, the rate on portfolio dividends cannot exceed 15%; this would allow Austria to increase its withholding tax on dividends paid to the U.S. from 12.5% to 15%. The 5% rate for direct investment dividends is retained and applies if the beneficial owner is a company (other than a partnership) that directly holds at least 10% of the payer's voting stock.(40)

In general, under the new treaty, the 15% rate applies when the payer is a U.S. regulated investment company (RIC) or real estate investment trust (REIT). However, the U.S. statutory rate (30%) applies to a U.S.-source dividend paid by a REIT, unless the dividend is beneficially owned by an Austrian individual with a less-than-10% interest in the trust.

The U.S. can apply a maximum 5% branch profits tax to Austrian branches in the U.S.

[] Interest: The exemption for interest is retained. Under the new treaty, interest on debts secured by mortgages are exempt, under the interest article (Art. 11). The existing treaty deals with such income under the article addressing income from immovable property (Art. IX). The exemption does not apply to (1) contingent interest of a type that is not portfolio interest or (2) an excess inclusion with respect to a real estate mortgage investment conduit (REMIC); these are subject to the U.S. statutory rate (30%).(41)

[] Royalties: The exemption for royalties (other than motion picture and broadcasting royalties) is maintained. The rate will be 10% for royalties for the use of (or the right to use) cinematograph films or films, tapes or other means of reproduction used for radio or television broadcasting. For this purpose, royalties include gains from the alienation of intangible property rights contingent on the productivity, use or disposition of such property.(42)

Other provisions

[] Business profits: The new treaty applies to the business profits derived by a "sleeping partner" in a "sleeping partnership" (Stifle Gesellschaft) under Austrian law.(43) A "sleeping partnership" is a contractual arrangement under which an investor (the sleeping partner, with limited liability) contributes money or property to the contracting partner's business in exchange for a share in the business's profits and under the entitlement to obtain specified information about the business's development.(44)

[] Gains: If an enterprise of one contracting state (CS) has a permanent establishment (PE) or fixed base in the other CS, the latter can tax gains from the alienation of personal property forming part of the business property of such PE or fixed base.(45) The first CS may also tax the gain, after the PE or fixed based no longer exists, but must allow a deduction for the gain taxed by the other CS.

[] Limitation on benefits: Similar to provisions in the new treaties with Luxembourg and Switzerland, as well as the existing treaties with France and the Netherlands, treaty benefits will only be allowed to a person that is(46):

1. An individual;

2. A CS, political subdivision or local authority thereof;

3. Engaged in the active conduct of a substantial trade or business in the CS of residence (other than the business of making or managing investments, unless by a bank or insurance company), and deriving income from the other CS in connection with (or incidental to) that business(47);

4. A person who satisfies a 50% ownership and 50% base erosion test(48);

5. A company whose principal class of shares is substantially and regularly traded on a recognized stock exchange, or a company, at least 90% of which is owned (directly or indirectly) by not more than five such publicly traded companies (provided each company in the chain of ownership is a resident of a CS and the owner of any remaining portion of the company is an individual resident in a CS);

6. A tax-exempt, nonprofit organization (including pension funds and private foundations) deemed a resident of a CS, provided that more than half of the beneficiaries, members or participants are entitled to treaty benefits;

7. A recognized headquarters company for a multinational corporate group (a company that meets the same criteria listed below under the Switzerland treaty).

   A resident of a CS who does not otherwise qualify for treaty benefits may request that the competent authority of the other CS grant it treaty benefits.

   Triangular rule: This rule denies treaty benefits when an Austrian enterprise derives interest or royalties from the U.S., the income is attributable to a PE in a third jurisdiction, and the profits of that PE are subject to an aggregate effective tax rate in Austria and the third jurisdiction that is less than 60% of the general rate of company tax applicable in Austria (i.e., for treaty benefits to apply, the aggregate tax rate must be at least 20.4%, 60% of the Austrian corporate tax rate of 34%).(49) This rule does not apply to: (1) interest derived in connection with (or incidental to) the active conduct of a trade or business carried on by the PE in the third jurisdiction; (2) royalties received as compensation for the use of (or the right to use) intangible property produced or developed by the PE; or (3) income derived by an Austrian enterprise if the U.S. taxes the enterprise's profits under subpart F.

   Unlike similar provisions in the treaties with France, the Netherlands and Switzerland, withholding is imposed at the statutory rate on interest and royalties received by an Austrian enterprise failing the 60% test.

   [] Pensions: Individuals who render dependent personal services in one CS and contribute to a recognized pension scheme in the other CS can deduct the contributions in determining their taxable income in the first CS; the contributions are treated in the first CS in the same way and subject to the same conditions and limits that ordinarily apply to contributions to the first CS's pension scheme. This rule applies only if (1) the individual was not a resident of the first CS and was contributing to the pension scheme immediately before beginning to work there; and (2) the pension scheme is accepted by the competent authority of that CS as generally corresponding to a pension scheme recognized as such by that CS for tax purposes.(50)

   [] Relief from double taxation: With respect to income derived by U.S. citizens, Austria allows a credit for income derived by U.S. citizens only to the extent the U.S. can tax the income under the treaty(51); thus, a U.S. citizen resident in Austria can take a credit against Austrian tax of 15% of the portfolio dividend from U.S. sources, even though the individual is subject to U.S. net income tax because of his citizenship.(52) With respect to interest, however, no Austrian credit is available for the U.S. net income tax, because the rate of tax allowed under the treaty is zero. To the extent necessary to avoid double taxation, the income referred to above that does not qualify for a credit in Austria is Austrian-source income for which the U.S. will allow a credit for Austrian taxes paid.

   [] Entry into force: The treaty will enter into force on the first day of the second month following the exchange of instruments of ratification. For withholding taxes, the treaty is effective for payments made on or after the first day of the second month following entry into force. For taxes on other income, the treaty is effective for fiscal periods beginning on or after the January first of the year following entry into force.(53)

   Therefore, if instruments of ratification are exchanged in September 1997, the treaty would enter into force on Nov. 1, 1997. For withholding tax purposes, it would be effective for payments made on or after Jan. 1, 1998; for other taxes, it would be effective for fiscal periods beginning on or after Jan 1, 1998. Taxpayers can elect to apply the existing treaty for the first tax year after the new treaty enters into force.

   * Luxembourg Withholding rates

   [] Dividends: The rate is 15% on portfolio dividends and 5% for direct investment dividends.(54) Under the new treaty, the 5% rate applies only if the beneficial owner of the dividend is a company that owns directly at least 10% of the payer's voting stock.

   Under the existing treaty, the rate on portfolio dividends is 50% of the statutory rate (15% in the case of the U.S.; 7.5% in the case of Luxembourg).(55) The 5% rate is available only if: (1) during part of the payer's tax year that preceded the dividend and the whole prior tax year, the payee owned at least 50% of the payer's voting shares, either alone or in association with no more than three other companies of the same CS, provided that each owned at least 10% and (2) no more than 25% of the payer's gross income, other than a company in the principal business of making loans, is derived from interest and dividends from nonsubsidiaries.(56)

   Generally, under the new treaty, the 15% rate applies...