U.S. Model Income Tax Treaty.

On December 8, 1992, Tax Executives Institute filed the following comments with the U.S. Departmen the proposed revision of the U.S. Model Income Tax Treaty. The comments follow-up on a November 20 m and Treasury Department representatives to discuss the Institute's preliminary comments on the propo Institute's comments were prepared under the aegis of its International Tax Committee whose chair is

On July 17, 1992, the U. S. Department of the Treasury announced a project to review the U.S. Model Income Tax Treaty. At the same time, the Treasury Department announced the withdrawal of both the proposed Model Treaty of June 6, 1981, and the Model Treaty of May 17, 1977. In response to the Treasury Department's request for comments, representatives of Tax Executives met with Treasury Department representatives on November 20, 1992 to discuss the Institute's preliminary comments. TEI's more detailed comments and recommendations are set forth below.(1)

Background

Tax Executives Institute is the principal association of corporate tax executives in North America. Our 4,700 members represent more than 2,000 of the leading corporations in the United States and Canada. TEI represents a cross-section of the business community, and is dedicated to the development and effective implementation of 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.

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 an important, balanced, and practical perspective to the proposed revision of the U.S. Model Income Tax Treaty.

Overview

TEI commends the Treasury Department for undertaking to revise the U.S. Model Treaty. Given the dramatic increase in international commerce since the publication of the 1981 Draft, TEI believes it is critical for the United States to safeguard multinational businesses more effectively against the threat of double taxation. The Institute has long been concerned that arbitrary tax rules restrict the ability of U.S. multinationals to compete effectively abroad. In a perfect world, tax rules would not affect business decisions. The world is far from perfect, however, and tax rules can -- and do -- affect the decisions of multinational corporations.

TEI believes that the overriding goal in treaty negotiations should be to create as level a "playing field" as possible. Tax barriers should not impede the flow of goods across borders.(2) To this end, we recommend stronger coordination of treaty partners' rules, especially with respect to sourcing and tax-free reorganizations. Treaties should also seek to provide relief from the double taxation that may occur when both source and residence countries tax the same income. We thus recommend that binding arbitration procedures be included in the Competent Authority provisions. We also recommend that the limitation-on-benefits provision not be applied mechanically to deny treaty benefits in respect of income derived for a valid business purpose in or through a treaty country.

Finally, we submit that safeguards against treaty overrides are central to preserving the integrity of U.S. tax treaty network and to the ongoing process of treaty negotiations. TEI urges the Treasury Department to take steps ensuring that legislation does not abrogate extant agreements between sovereign states.

TEI's specific comments, set forth below, are directed toward not only eliminating tax barriers such as withholding taxes, but also reducing the potential for inconsistent tax treatment by treaty partners.

Specific Comments

Relief from Double Taxation

The 1981 Draft adopts the credit mechanism for avoiding double taxation of income. Article 23 provides that the United States shall allow a resident or citizen of the United States as a credit against the U.S. tax on income --

* The income tax paid to the Contracting

State by or on behalf of

such citizen or resident; and

* In the case of a U.S. company

owning at least 10 percent of

the voting stock of a company

resident in the Contracting

State and from which the U.S.

company receives dividends,

the income tax paid to the Contracting

State by or on behalf of

the distributing company with

respect to the profits out of

which the dividends are paid.

Paragraph 3 of article 23 generally provides that source rules for income follow the allocation of taxing jurisdiction. The 1981 Draft fails, however, to source items of expense.

The function of the source rules in the 1981 Draft is to ensure that allocation of primary taxing jurisdiction to the source country is respected by the residence country in giving double tax relief. ALI Proposals at 233. Double taxation may result, however, when domestic rules for calculating and allocating expenses are not consistent between treaty partners. Although it may not be feasible to require that a country of residence always defer to the source country's tax rules, we strongly recommend that the United States attempt to reduce double taxation by coordinating the rules for the sourcing of income and expenses. Accordingly, the U.S. Model Treaty should provide that, for purposes of providing relief from double taxation, the residence country should treat income items as sourced within the other Contracting State to the extent that the source country is afforded primary taxing jurisdiction over such items under the treaty.

In addition, TEI recommends that the residence country be required to calculate items of income -- and expenses allocable to such items -- in accordance with the rules of the country with primary taxing authority over such items. The residence country should be permitted, however, to apply its own rules to apportion expenses not directly allocable to any item of income (i.e., in accordance with section 861 of the Internal Revenue Code).

With respect to items of net income that are re-sourced under the U.S. Model Treaty, TEI recommends that no separate foreign tax credit limitation apply. Such a limitation adds still another layer of administrative complexity to the labyrinthine U.S. foreign tax...