Current income tax treaty developments.

• Author: Dichter, Arthur J.

EXECUTIVE SUMMARY

* Despite requests from large U.S. multinationals, Treasury has indicated that it will not yet renegotiate the U.S.-Japan treaty.

* The treaties with Estonia, Latvia and Lithuania have not yet been ratified by the Senate.

* The U.S. has agreed to allow a partial FTC for taxes paid to Italy under the IRAP.

Relatively speaking, 1998 was a rather slow year in the income tax treaty area; only three new treaties and one new protocol were signed. This article provides highlights of recent income tax treaty activity and focuses on the salient aspects of the new treaties with Estonia, Latvia and Lithuania.

Compared to the hst five years, 1998 was a relatively slow year for U.S. income tax treaty developments. The U.S. signed three essentially identical treaties with the Baltic Republics (Estonia, Latvia and Lithuania) on Jan. 15, 1998; those were the only U.S. income tax treaties signed during the year. A protocol to the U.S.-Germany estate tax treaty was signed on Dec. 14, 1998.

In comparison, 1999 promises to be a much more eventful year, beginning with the signing of a new treaty with Venezuela on Jan. 25, 1999. A new treaty was initialed with Italy in November 1998 that is expected to be signed shortly. Treaty negotiations were also reported during 1998 with Canada, Denmark, Korea, Slovenia and the U.K. However, despite requests from some of the largest U.S. corporations (includingAmway, Baxter International, Coca-Cola, DuPont, Eli Lilly, Microsoft and Xerox), Treasury has indicated that it will not yet renegotiate the U.S.-Japan treaty.(1) This article reviews the past year's activity in this area.

Treaties and Protocols Taking Effect in 1998

* Austria

The treaty signed May 31, 1996 replaced a 1956 agreement and entered into force Feb. 1, 1998. Reduced withholding rates apply for payments on or after April 1, 1998; otherwise, the treaty is generally effective for fiscal periods beginning after 1998. Taxpayers may elect to apply the existing Austrian treaty for the first year the new treaty is in effect.

* Ireland

The treaty signedJuly 28, 1997 replaced a 1949 agreement and entered into force Dec. 17, 1997. The treaty is generally effective for payments and tax periods beginning after 1997.

Taxpayers may elect to apply the existing Irish treaty for the first year the new treaty is in effect.

Certain provisions in the limitation on benefits article may be deferred for the first three years the new treaty is in effect.

* South Africa

The treaty signed Feb. 17, 1997 replaced a 1946 treaty (which was terminated in accordance with the Anti-Apartheid Act, effective July 1, 1987) and entered into force Dec. 28, 1997; it is generally effective for payments and tax periods beginning after 1997.

* Switzerland

The treaty signed Oct. 2, 1996 replaced a 1951 agreement and entered into force Dec. 19, 1997. Reduced withholding rates are effective for payments on or after Feb. 1, 1998; otherwise, the treaty is generally effective for tax periods beginning after 1997. Taxpayers may elect to apply the existing Swiss treaty for the first 12 months the new treaty is in effect.

* Thailand

The treaty signed Nov. 26, 1996 replaced an unratified 1965 agreement and entered into force Dec. 15, 1997. Reduced withholding rates are effective for payments on or after June 1, 1998; otherwise, the treaty is generally effective for tax periods beginning afier 1997.

* Turkey

The first-ever income tax treaty with the U.S. was signed March 28, 1996 and entered into force Dec. 19, 1997. The treaty is generally effective for payments and tax periods beginning after 1997.

Treaties Approved in 1997, But Not Yet In Force

* Luxembourg

A treaty replacing a 1962 agreement was signed April 3, 1996 and approved by the Senate Oct. 31, 1997. While the Luxembourg Parliament approved the new treaty in January 1999, it has not yet entered into force. The U.S. Senate attached a declaration to its Resolution of Advice and Consent prohibiting the new treaty from entering into force until the treaty on Mutual Legal Assistance in Criminal Matters(2) (MLAT) between the U.S. and Luxembourg enters into force.

The U.S. Senate ratified the MLAT on Oct. 21, 1998. According to a Luxembourg embassy official, although the Luxembourg Parliament has no particular objections to the MLAT, it has not yet approved it. Until Luxembourg approves the MLAT and instruments of ratification are exchanged, the income tax treaty remains in limbo.

Once in force, the income tax treaty will generally be effective for payments and tax periodsbeginning on or after January 1 of the year following entry into force (Jan. 1, 2000, if the treaty enters into force in 1999). Taxpayers will be permitted to elect to apply the existing Luxembourg treaty for the first year the new treaty is in effect.

Treaties Signed in 1998, Awaiting Senate Ratification

* Estonia, Latvia, Lithuania

On Jan. 15, 1998, Treasury announced the signing of treaties with Estonia, Latvia and Lithuania, all of which had been initialed in May 1997. These agreements are the first income tax treaties between the U.S. and these countries. The treaties were reportedly sent to the Senate for approval on June 16, 1998.(3) However, the Senate Foreign Relations Committee (which is responsible for reviewing and recommending treaties) did not hold a hearing on these agreements during 1998.

Treaties Initialed in 1998

* Italy

On Nov. 25, 1998, the U.S. and Italy initialed a new income tax treaty. Once signed, ratified and in force, the new treaty will replace a 1984 agreement. The new treaty may reduce withholding rates and should reflect significant changes in Italian income tax law, including the replacement of one tax with another (discussed below).

* Venezuela

On Aug. 18, 1998, the U.S. and Venezuela initialed the frost income tax treaty between the two countries; it was signed on Jan. 25, 1999. Once in force, it will be the first income tax treaty between the U.S. and a South American country.

Other Agreements

* Germany

A protocol(4) was signed on Dec. 14, 1998; once in force, it will amend the 1980 estate and gift tax treaty. The protocol is intended to address two significant changes made to the U.S. estate and gift tax laws. The Technical and Miscellaneous Revenue Act of 1988 significantly limited the unified credit for estates of nonresident non-U.S, citizen decedents and eliminated the marital deduction for gifts and bequests to non-U.S, citizen surviving spouses.

For 1999, under Sec. 2010, U.S. residents and citizens are generally allowed a $211,300 unified credit, which shelters the first $650,000 of property from U.S. estate tax. On the other hand, a nonresident noncitizen of the U.S. is generally allowed only a $13,000 unified credit, under Sec. 2102(c). This amount shelters only the first $60,000 of U.S.-situs property from U.S. estate taxation.

The protocol will allow the estate of a non-U.S, citizen resident in Germany a unified credit equal to the greater of (1) the U.S. citizen or resident credit ($211,300 for 1999), pro rated based on the ratio of U.S.-situs property to worldwide property or (2) the credit ($13,000) allowed nonresident non-U.S. citizens. The protocol also partially restores the marital deduction if (1) at the time of death, the decedent was domicfied in Germany or the U.S.; (2) at the decedent's death, the surviving spouse was domiciled in Germany or the U.S.; (3) both the decedent and the surviving spouse were domiciled in the U.S. at the time of the decedent's death, one or both was a citizen of Germany; and (4) the executor makes an irrevocable election and...