TEI's comments on U.S.-Canada Tax Protocol: on September 21, 2007, the United States and Canada signed the Fifth Protocol (the "Protocol") to the U.S.-Canada Income Tax Treaty. The new Protocol will become effective upon ratification by the U.S. Senate and Canadian Parliament. The Protocol is also accompanied by two sets of diplomatic notes exchanged between the two countries.

• Position: Tax Executives Institute

On behalf of Tax Executives Institute, I am pleased to submit recommendations for issues that should be addressed in Treasury's Technical Explanation to the Protocol. Because the Protocol substantially improves the operation of the income tax treaty between the United States and Canada, TEI urges that the Protocol and its accompanying explanation be referred to the U.S. Senate for approval as soon as possible.

Background

Tax Executives Institute is the preeminent association of business tax executives in North America. Our approximately 7,000 members represent 3,200 of the leading corporations in the United States, Canada, Europe, and Asia. TEI represents a cross-section of the business community, and is dedicated to developing and effectively implementing sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike.

As a professional association, TEI is firmly committed to maintaining a tax system that works--one that is administrable and with which taxpayers can comply in a cost-efficient manner. Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and professional training of our members enable us to bring a balanced and practical perspective to the Protocol.

Importance of the Protocol

The tax treaty network is an important part of a country's framework for international trade. Bilateral treaties play a critical role in bringing certainty to the global marketplace and safeguarding multinational businesses from the threat of double taxation. TEI has long been concerned that arbitrary tax rules restrict the ability of U.S.--and Canadian-based companies to compete effectively abroad and deter foreign investment in those countries. Because tax rules can--and do--affect the decisions of multinational corporations, the affected governments must respond accordingly.

A country's economic interests are best served when the international "playing field" is as level as possible. This goal can be advanced by removing tax barriers that impede the flow of goods across borders. Indeed, TEI believes that a principal function of income tax treaties is to facilitate international trade and investment by removing-or preventing the creation of--tax barriers to the free international exchange of goods and services and the unfettered international movement of capital and persons. Well-crafted tax treaties can foster a favorable investment climate in the United States and Canada for foreign businesses and investors, thereby creating substantial economic opportunities for all their citizens.

Trade with Canada--the United States' number one trading partner--is particularly important to U.S. businesses, and TEI's U.S. and Canadian members have first-hand knowledge of the need for the Protocol. TEI commends the Treasury Department for seeking to eliminate barriers to trade and investment between the United States and Canada. The Protocol and Diplomatic Notes have much to offer U.S- and Canadian-based businesses, in particular:

* Elimination of withholding tax on certain cross-border interest payments (over three years for related persons) and the clarification that guarantee fees are generally free from withholding;

* Reduction to five percent of the withholding tax on dividends paid to certain partnerships and LLCs;

* Extension of treaty benefits to members of limited liability companies (LLCs); and

* Introduction of mandatory and binding arbitration for issues such as transfer pricing.

The Protocol raises several issues, however, that should be addressed in the Technical Explanation. Our recommendations for resolving these issues follow. (1)

1. Article IV--Residence

   1. Paragraph 6. Article IV of the treaty provides definitions of who is considered a resident of a Contracting State. A new paragraph 6 is added to the article and provides that an amount of income, profit, or gain shall be considered to be derived by a person who is a resident of a Contracting State where:

      (a) the person is considered under the taxation law of that State to have derived the amount through an entity (other than an entity that is a resident of the other Contracting State); and

      (b) by reason of the entity being treated as fiscally transparent under the laws of the first-mentioned State, the treatment of the amount under the taxation law of that State is the same as its treatment would be if that amount had been derived directly by that person.

      The Technical Explanation should define the term "fiscally transparent" and state how common legal entity forms used in Canada and the United States will be classified under the definition. For example, it is not readily apparent how U.S. Subchapter "S" corporations or Canadian Mutual Fund Trusts subject to Canada's specified investment flow-through (SIFT) rules will be classified under paragraph 6. In this regard, the definition set forth in Treas. Reg. [section] 1.894-1(d)(3)(ii) could be referenced:

      [A]n entity is fiscally...