[Senate Executive Report 110-17]
[From the U.S. Government Publishing Office]
110th Congress Exec. Rept.
SENATE
2d Session 110-17
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TAX CONVENTION WITH ICELAND
_______
September 11, 2008.--Ordered to be printed
_______
Mr. Dodd, from the Committee on Foreign Relations,
submitted the following
REPORT
[To accompany Treaty Doc. 110-17]
The Committee on Foreign Relations, to which was referred
the Convention between the Government of the United States of
America and the Government of Iceland for the Avoidance of
Double Taxation and the Prevention of Fiscal Evasion with
Respect to Taxes on Income, and accompanying Protocol, signed
at Washington on October 23, 2007 (the ``Treaty'') (Treaty Doc.
110-17), having considered the same, reports favorably thereon
with one declaration, as indicated in the resolution of advice
and consent, and recommends that the Senate give its advice and
consent to ratification thereof, as set forth in this report
and the accompanying resolution of advice and consent.
CONTENTS
Page
I. Purpose..........................................................1
II. Background.......................................................2
III. Major Provisions.................................................2
IV. Entry Into Force.................................................5
V. Implementing Legislation.........................................6
VI. Committee Action.................................................6
VII. Committee Recommendation and Comments............................6
VIII.Resolution of Advice and Consent to Ratification.................7
IX. Annex.--Technical Explanation....................................7
I. Purpose
The Treaty is intended to promote and facilitate trade and
investment between the United States and Iceland, principally
through the elimination or reduction in withholding taxes on
certain cross-border payments of dividends, interest, and
royalties. In addition, the Treaty contains an anti-treaty-
shopping provision intended to limit abuse of the Treaty by
third-country residents, which has been a problem associated
with the current tax treaty with Iceland.
II. Background
The Treaty replaces an existing income tax treaty with
Iceland, which was concluded in 1975. The main impetus for
negotiating a new treaty with Iceland was to obtain an anti-
treaty-shopping provision that would limit abuse of the
existing treaty with Iceland by third-country residents,
otherwise known as a ``Limitation on Benefits'' or ``LOB''
provision. As noted in the President's Letter of Transmittal
for the Treaty, there has been ``substantial abuse of the
existing Treaty's provisions by third country investors.'' In
response to questions from the committee the Treasury
Department described the evidence on which they based this
assertion as follows:
A Treasury Department report to Congress, ``Earning
Stripping, Transfer Pricing and U.S. Income Tax Treaties,''
released in November 2007 (2007 Treasury Report), describes
abuses of the U.S. tax treaty network by third-country
investors, particularly through inappropriate reductions in
withholding tax. The 2007 Treasury Report presented data,
gathered from U.S. tax returns, on deductible payments such as
interest made by U.S. companies to related foreign companies
located in treaty jurisdictions. The data suggested that tax
treaties that have no LOB provision and a zero rate of
withholding tax on deductible payments, such as our treaties
with Iceland and Hungary, had begun to be abused by third-
country investors. In particular, the 2007 Treasury Report
notes that while in 1996 almost no U.S.-source interest was
paid by foreign-controlled U.S. companies to related parties in
Iceland and Hungary, payments of such interest had increased by
2004 to over $2 billion. In addition, publicly available
information indicates that many of those related parties were
ultimately owned by corporations from third countries. This
evidence strongly suggests the existence of treaty abuse by
third-country residents.
Modern tax treaties negotiated by the Department of
Treasury generally contain a Limitation on Benefits provision;
however, the existing treaty with Iceland contains no such
provision and thus is easily abused by third-country investors.
The new Treaty contains a comprehensive Limitation on Benefits
provision, which is described in greater detail below.
Presumably, if the Treaty is ratified, as a result of the new
Limitation on Benefits provision, the amount of tax revenue
that the United States is currently losing through the abuse of
the existing treaty will be reduced.
III. Major Provisions
Although the need for a Limitation on Benefits provision
was the main reason for negotiating a new tax treaty with
Iceland, a number of other changes were made in the new Treaty.
A detailed article-by-article analysis of the Treaty may be
found in the Technical Explanation published by the Department
of the Treasury on July 10, 2008, which is reprinted in the
Annex. In addition, the staff of the Joint Committee on
Taxation prepared an analysis of the Treaty, Document JCX-58-08
(July 8, 2008), which was of great assistance to the committee
in reviewing the Treaty. What follows is a discussion of
certain key provisions.
1. Dividends, Interest, and Royalties
Like the existing treaty, the new Treaty provides for
reduced source-country taxation of cross-border dividends and
would eliminate withholding taxes on all cross-border interest
payments with minor exceptions. See Articles 10 and 11. Yet,
while the existing treaty eliminates withholding taxes on all
cross-border payments of royalties, the new Treaty would allow
a withholding tax of up to five percent on certain royalties
with respect to trademarks and certain trademark-related
industrial, commercial, or scientific experience, motion
picture films, or works for use in connection with television.
See Article 12(2).
2. Permanent Establishment and Services
In general, U.S. bilateral tax treaties attempt to ensure
that a person or entity is not subject to undue and overly
burdensome taxation in instances in which the taxpayer has
minimal contacts with the taxing jurisdiction. This is
accomplished in the Treaty through provisions under which each
country generally agrees not to tax business income derived
from sources within that country by residents of the other
country unless the business activities in the taxing country
are substantial enough to constitute a permanent establishment.
See Article 7(1). A permanent establishment is generally
defined as ``a fixed place of business through which the
business of an enterprise is wholly or partly carried on.'' See
Article 5(1). Examples include a place of management, offices,
branches, and factories. See Article 5(2). The Treaty contains
certain exemptions under which residents of one country
performing services in the other country will not be required
to pay tax in the other country unless their contacts with the
other country exceed specified minimums. See Articles 14 and
16. These provisions are in line with the 2006 U.S. Model Tax
Treaty.
3. Limiting Treaty Abuse
As noted above in Section II, the main reason for updating
the U.S. bilateral tax treaty with Iceland was to obtain a
Limitation on Benefits provision, which is designed to avoid
treaty-shopping by limiting use of the treaty's benefits to
persons who are intended to receive the advantage of those
benefits. The new Treaty's LOB provision is in line with the
2006 U.S. Model Tax Treaty. The provision generally limits
treaty benefits to treaty country residents such that only
those residents with a sufficient nexus to the United States or
Iceland will receive benefits. For example, the LOB provision
provides that a treaty country company whose shares are
regularly traded on a recognized stock exchange may qualify for
treaty benefits if the company satisfies one of two tests:
either the company must be primarily traded on a recognized
stock exchange in its country of residence or the company's
primary place of management and control must be in its country
of residence. See Article 21(2). This requirement ensures that
there is an adequate connection to the company's claimed
country of residence.
The Treaty also includes special anti-abuse rules intended
to deny benefits in certain circumstances in which an
Icelandic-resident company earns U.S.-source income
attributable to a third-country permanent establishment and is
subject to little or no tax in the third jurisdiction and
Iceland. Similar anti-abuse rules are included in other recent
treaties, including the Convention with Bulgaria. The 2006 U.S.
Model Tax Treaty, however, does not include rules addressing
so-called ``triangular arrangements.'' The Department of
Treasury indicated that the ``Department's current policy is to
incorporate the so-called `triangular rule' into tax treaties
in which the treaty partner exempts from tax certain foreign
source income such that a tax treaty may be used
inappropriately in conjunction with certain branch structures
to exempt fully from tax certain U.S.-source payments.'' The
Department of Treasury additionally noted that it is
considering whether to include such a rule in the next update
of the 2006 U.S. Model Tax Treaty.
The Treaty includes a transition period during which
taxpayers impacted by the new LOB provisions will have an
opportunity to restructure their transactions. The Treaty
allows a person to claim benefits under the existing treaty
even after the new Treaty has entered into force, by electing
to have the existing treaty apply to them for up to one year.
This ``election'' is available to any person ``entitled to
greater benefits'' under the existing treaty than that person
is entitled to under the new Treaty. See Article 27(3). The
Department of Treasury has explained that this transition
period was needed in order to reach agreement in 2007 with
Iceland on the inclusion of the Limitation on Benefits
provision.
4. Fiscally Transparent Entities
The 2006 U.S. Model Tax Treaty allows recipients of
``income, gains, or profits'' through an entity that is
fiscally transparent under the tax laws of the recipient's
residence to enjoy the same treaty benefits on that income as
they would have if the ``income, gains, or profits'' had been
received by them directly. Fiscally-transparent entities (a
subset of which are called ``disregarded entities'') are
entities that act as a conduit, apportioning all income
received to those holding an interest in the entity.
The provision in the Iceland Treaty for fiscally
transparent entities closely parallels the provision in the
2006 U.S. Model Tax Treaty. But, rather than referring to ``an
entity that is fiscally transparent,'' the Iceland Treaty
specifies that the entity be ``a partnership, trust, or
estate.'' See Article 1(6). Treasury's Technical Explanation
makes clear that this is intended to include U.S. limited
liability companies (``LLCs'') that are treated as partnerships
or as disregarded entities for U.S. tax purposes, including
LLCs with only one member. In response to Committee questions,
the Department of Treasury explained why the phrase ``fiscally
transparent'' was not used, even though the intended meaning of
the provision appears to be the same, as follows:
Paragraph 6 of Article 1 of the proposed treaty with Iceland
does not use the U.S. Model's phrase ``fiscally transparent''
because that term does not have meaning under the domestic law
of Iceland. During the course of the negotiations, the Treasury
Department obtained agreement in principle with Iceland over
the intent and application of paragraph 6 of Article 1.
Accordingly, the Treasury Department believes that the rule
will be interpreted and applied by Iceland consistent with the
language in the U.S. Model Tax Treaty.
5. Students, Business Trainees, and Researchers
The Treaty generally provides that students, business
trainees, and researchers visiting the other treaty country are
exempt from host country taxation on certain types of payments
received. See Articles 16 and 19.
6. Exchange of Information
The Treaty provides for the exchange of information between
the tax authorities of each country that is relevant to
carrying out the provisions of the agreement or the domestic
tax laws of either country. See Article 25.
7. Pensions, Alimony, and Child Support
The Treaty differs from the 2006 U.S. Model Tax Treaty in
some key ways with respect to pensions, alimony, and child
support.
Like the 2006 U.S. Model Tax Treaty, the Iceland Treaty
provides that pension distributions owned by a resident of a
treaty country are only taxable in the recipient's country of
residence. The 2006 U.S. Model Tax Treaty, however, contains an
exception to this provision under which a pension beneficiary's
country of residence must exempt from tax a pension amount or
other similar remuneration that would be exempt from tax in the
other contracting country where the pension fund is
established, as if the beneficiary had been a resident of that
other country. The Treaty does not contain this exception.
Another difference from the 2006 U.S. Model Tax Treaty is
that the Treaty makes no mention of the tax treatment of child
support amounts that are paid to a resident of either country.
Under the 2006 U.S. Model Tax Treaty, child support payments
paid to a resident of a contracting country are exempt from tax
in either country. Because the Treaty makes no mention of the
tax treatment of child support payments, it would be governed
by Article 20 (Other Income), which assigns the exclusive right
to tax to the country of residence of the recipient. In
response to Committee questions, the Treasury Department
explained that although this was a departure from the Model,
the result achieved was similar because in most cases child
support payments are exempt from tax under the domestic law of
both the United States and Iceland.
In addition, the Treaty does not contain provisions that
deal with the tax treatment of cross-border pension
contributions. These provisions cover, among other things, the
tax treatment of pension contributions (paid by an individual
or an individual's employer) when an individual is a
participant or beneficiary of a pension fund resident in one
country, but is employed in the other country. In response to
Committee questions regarding this omission, the Treasury
Department offered the following explanation:
The proposed treaty with Iceland does not address the tax
treatment of cross-border pension contributions primarily for
two reasons. First, the U.S. Model pension funds provision
provides for deductibility in one State of contributions to a
pension fund of the other State only where the pension fund
``generally corresponds'' to a pension fund in the first state.
The provision is, therefore, only appropriate if the two
countries have pension systems that are similar. During the
course of negotiations, it became clear that Iceland and the
United States have very different pension systems. As a result,
the provision was not appropriate to include in the proposed
treaty. Second, Iceland had limited flexibility in changing by
tax treaty its rules for taxing pensions, because those rules
are technically under Iceland's pension law, not its tax law.
IV. Entry Into Force
The United States and Iceland shall notify each other in
writing through diplomatic channels when their respective
applicable procedures for the entry into force of this Treaty
have been satisfied. This Treaty shall enter into force on the
date of receipt of the later of these notifications. The
various provisions of this Treaty will have effect as described
in paragraphs 2 and 3 of Article 27.
V. Implementing Legislation
As is the case generally with income tax treaties, the
Treaty is self-executing and does not require implementing
legislation for the United States.
VI. Committee Action
The committee held a public hearing on the Treaty on July
10, 2008. Testimony was received from Mr. Michael Mundaca,
Deputy Assistant Secretary (International), Office of Tax
Policy, U.S. Department of the Treasury and Ms. Emily S.
McMahon, Deputy Chief of Staff to the Joint Committee on
Taxation. A transcript of this hearing can be found in the
Annex to Executive Report 110-15.
On July 29, 2008, the committee considered the Treaty and
ordered it favorably reported by voice vote, with a quorum
present and without objection.
VII. Committee Recommendation and Comments
The Committee on Foreign Relations believes that the Treaty
is a significant improvement over the existing treaty with
Iceland, in particular because of the inclusion of the
Limitation on Benefits provision that prevents treaty shopping.
The committee therefore urges the Senate to act promptly to
give advice and consent to ratification of the Treaty, as set
forth in this report and the accompanying resolution of advice
and consent.
A. TREATY SHOPPING
As discussed, one of the most important features of this
Treaty is the addition of a strong Limitation on Benefits
provision, which is intended to limit abuse of the Treaty with
Iceland by third-country residents. With the entry into force
of the provision, however, it is reasonable to expect that the
treaty-shopping now occurring through the Iceland Treaty will
shift to other countries with favorable tax regimes and with
which the United States has a tax treaty with similar
advantages, including an exemption from withholding taxes on
cross-border interest payments but no Limitation on Benefits
provision to prevent abuse. There are two countries that fit
this description for which there are tax treaties that are
currently in force: Hungary and Poland.\1\ Consequently, these
two countries will likely attract those currently abusing the
Iceland tax treaty. In addition, as noted by the Treasury
Department in response to Committee questions on this subject,
there is already evidence that the treaty with Hungary is being
substantially abused by third-country investors.
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\1\The present treaty between the United States and Iceland is one
of only eight U.S. income tax treaties that do not include a Limitation
on Benefits provision of any type. The Iceland Treaty, along with
treaties with Hungary and Poland are the only three of the eight that
provide for complete exemption from withholding on interest payments
from one treaty country to the other treaty country.
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The Treasury Department has indicated that ``[u]pdating the
agreements with Hungary and Poland is a key part of the
Treasury Department's effort to protect the U.S. tax treaty
network from abuse.'' Moreover, the Department stated that
negotiations are ongoing with Hungary and in a preliminary
stage with Poland. The committee urges the Treasury Department
in such negotiations not to settle for anything less than a
robust Limitation on Benefits provision that can be readily
enforced by the United States, particularly in the case of
Hungary. The committee is encouraged by the fact that the
Treasury Department has made this a priority. In the
committee's view, the Treasury Department should strengthen
anti-treaty-shopping provisions in tax treaties whenever
possible, with a particular focus on closing the loophole
created by those U.S. tax treaties currently in force that do
not have an anti-treaty-shopping provision.
B. RESOLUTION
The proposed resolution of advice and consent for the
Treaty includes a declaration.
Declaration
The committee has included a proposed declaration, which
states that the Treaty is self-executing, as is the case
generally with income tax treaties. The committee has in the
past included such a statement in the committee's report but,
in light of the recent Supreme Court decision, Medellin v.
Texas, 128 S. Ct. 1346 (2008), the committee has determined
that a clear statement in the Resolution is warranted. A
further discussion of the committee's views on this matter can
be found in Section VIII of Executive Report 110-12.
VIII. Resolution of Advice and Consent to Ratification
Resolved (two-thirds of the Senators present concurring
therein),
SECTION 1. SENATE ADVICE AND CONSENT SUBJECT TO A DECLARATION
The Senate advises and consents to the ratification of the
Convention between the Government of the United States of
America and the Government of Iceland for the Avoidance of
Double Taxation and the Prevention of Fiscal Evasion with
Respect to Taxes on Income, and accompanying Protocol, signed
at Washington on October 23, 2007 (Treaty Doc. 110-17), subject
to the declaration of section 2.
SECTION 2. DECLARATION
The advice and consent of the Senate under section 1 is
subject to the following declaration:
This Convention is self-executing.
IX. Annex.--Technical Explanation
DEPARTMENT OF THE TREASURY TECHNICAL EXPLANATION OF THE CONVENTION
BETWEEN THE GOVERNMENT OF THE UNITED STATES OF AMERICA AND THE
GOVERNMENT OF ICELAND FOR THE AVOIDANCE OF DOUBLE TAXATION AND THE
PREVENTION OF FISCAL EVASION WITH RESPECT TO TAXES ON INCOME.
This is a technical explanation of the Convention between
the Government of the United States and the Government of
Iceland For the Avoidance Of Double Taxation and the Prevention
of Fiscal Evasion with Respect to Taxes on Income, signed on
October 23, 2007 (the ``Convention'').
Negotiations took into account the U.S. Treasury
Department's current tax treaty policy, and the Treasury
Department's Model Income Tax Convention. Negotiations also
took into account the Model Tax Convention on Income and on
Capital, published by the Organisation for Economic Cooperation
and Development (the ``OECD Model''), and recent tax treaties
concluded by both countries.
The Technical Explanation is an official guide to the
Convention and an accompanying Protocol. It reflects the
policies behind particular Convention and Protocol provisions,
as well as understandings reached during the negotiations with
respect to the application and interpretation of the Convention
and Protocol. References in the Technical Explanation to ``he''
or ``his'' should be read to mean ``he or she'' or ``his and
her.''
ARTICLE 1 (GENERAL SCOPE)
Paragraph 1
Paragraph 1 of Article 1 provides that the Convention
applies only to residents of the United States or Iceland
except where the terms of the Convention provide otherwise.
Under Article 4 (Resident) a person is generally treated as a
resident of a Contracting State if that person is, under the
laws of that State, liable to tax therein by reason of his
domicile, citizenship, residence, or other similar criteria.
However, if a person is considered a resident of both
Contracting States, Article 4 provides rules for determining a
State of residence (or no State of residence). This
determination governs for all purposes of the Convention.
Certain provisions are applicable to persons who may not be
residents of either Contracting State. For example, paragraph 1
of Article 23 (Non-Discrimination) applies to nationals of the
Contracting States. Under Article 25 (Exchange of Information
and Administrative Assistance), information may be exchanged
with respect to residents of third states.
Paragraph 2
Paragraph 2 states the generally accepted relationship both
between the Convention and domestic law and between the
Convention and other agreements between the Contracting States.
That is, no provision in the Convention may restrict any
exclusion, exemption, deduction, credit or other benefit
accorded by the tax laws of the Contracting States, or by any
other agreement between the Contracting States. The
relationship between the non-discrimination provisions of the
Convention and other agreements is addressed not in paragraph 2
but in paragraph 3.
Under paragraph 2, for example, if a deduction would be
allowed under the U.S. Internal Revenue Code (the ``Code'') in
computing the U.S. taxable income of a resident of Iceland, the
deduction also is allowed to that person in computing taxable
income under the Convention. Paragraph 2 also means that the
Convention may not increase the tax burden on a resident of a
Contracting States beyond the burden determined under domestic
law. Thus, a right to tax given by the Convention cannot be
exercised unless that right also exists under internal law.
It follows that, under the principle of paragraph 2, a
taxpayer's U.S. tax liability need not be determined under the
Convention if the Code would produce a more favorable result. A
taxpayer may not, however, choose among the provisions of the
Code and the Convention in an inconsistent manner in order to
minimize tax. Thus, a taxpayer may use the Convention to reduce
its taxable income, but may not use both treaty and Code rules
where doing so would thwart the intent of either set of rules.
For example, assume that a resident of Iceland has three
separate businesses in the United States. One is a profitable
permanent establishment and the other two are trades or
businesses that would earn taxable income under the Code but
that do not meet the permanent establishment threshold tests of
the Convention. One is profitable and the other incurs a loss.
Under the Convention, the income of the permanent establishment
is taxable in the United States, and both the profit and loss
of the other two businesses are ignored. Under the Code, all
three would be subject to tax, but the loss would offset the
profits of the two profitable ventures. The taxpayer may not
invoke the Convention to exclude the profits of the profitable
trade or business and invoke the Code to claim the loss of the
loss trade or business against the profit of the permanent
establishment. (See Rev. Rul. 84-17, 1984-1 C.B. 308.) If,
however, the taxpayer invokes the Code for the taxation of all
three ventures, he would not be precluded from invoking the
Convention with respect, for example, to any dividend income he
may receive from the United States that is not effectively
connected with any of his business activities in the United
States.
Similarly, nothing in the Convention can be used to deny
any benefit granted by any other agreement between the United
States and Iceland. For example, if certain benefits are
provided for military personnel or military contractors under a
Status of Forces Agreement between the United States and
Iceland, those benefits or protections will be available to
residents of the Contracting States regardless of any
provisions to the contrary (or silence) in the Convention.
Paragraph 3
Paragraph 3 specifically relates to non-discrimination
obligations of the Contracting States under other agreements.
The provisions of paragraph 3 are an exception to the rule
provided in paragraph 2 of this Article under which the
Convention shall not restrict in any manner any benefit now or
hereafter accorded by any other agreement between the
Contracting States.
Subparagraph 3(a) provides that, notwithstanding any other
agreement to which the Contracting States may be parties, a
dispute concerning whether a measure is within the scope of
this Convention shall be considered only by the competent
authorities of the Contracting States, and the procedures under
this Convention exclusively shall apply to that dispute. Thus,
procedures for dealing with disputes that may be incorporated
into trade, investment, or other agreements between the
Contracting States shall not apply for the purposes of
determining the scope of the Convention.
Subparagraph 3(b) provides that, unless the competent
authorities determine that a taxation measure is not within the
scope of this Convention, the non-discrimination obligations of
this Convention exclusively shall apply with respect to that
measure, except for such national treatment or most-favored-
nation (``MFN'') obligations as may apply to trade in goods
under the General Agreement on Tariffs and Trade (``GATT''). No
national treatment or MFN obligation under any other agreement
shall apply with respect to that measure. Thus, unless the
competent authorities agree otherwise, any national treatment
and MFN obligations undertaken by the Contracting States under
agreements other than the Convention shall not apply to a
taxation measure, with the exception of GATT as applicable to
trade in goods.
Paragraph 4
Paragraph 4 contains the traditional saving clause found in
all U.S. treaties. The Contracting States reserve their rights,
except as provided in paragraph 5, to tax their residents and
citizens as provided in their internal laws, notwithstanding
any provisions of the Convention to the contrary. For example,
if a resident of Iceland performs professional services in the
United States and the income from the services is not
attributable to a permanent establishment in the United States,
Article 7 (Business Profits) would by its terms prevent the
United States from taxing the income. If, however, the resident
of Iceland is also a citizen of the United States, the saving
clause permits the United States to include the remuneration in
the worldwide income of the citizen and subject it to tax under
the normal Code rules (i.e., without regard to Code section 8
94(a)). However, subparagraph 5(a) of Article 1 preserves the
benefits of special foreign tax credit rules applicable to the
U.S. taxation of certain U.S. income of its citizens resident
in Iceland. See paragraph 4 of Article 22 (Relief from Double
Taxation).
For purposes of the saving clause, ``residence'' is
determined under Article 4. Thus, an individual who is a
resident of the United States under the Code (but not a U.S.
citizen) but who is determined to be a resident of Iceland
under the tie-breaker rules of Article 4 would be subject to
U.S. tax only to the extent permitted by the Convention. The
United States would not be permitted to apply its statutory
rules to that person to the extent the rules are inconsistent
with the Convention.
However, the person would be treated as a U.S. resident for
U.S. tax purposes other than determining the individual's U.S.
tax liability. For example, in determining under Code section
957 whether a foreign corporation is a controlled foreign
corporation, shares in that corporation held by the individual
would be considered to be held by a U.S. resident. As a result,
other U.S. citizens or residents might be deemed to be United
States shareholders of a controlled foreign corporation subject
to current inclusion of Subpart F income recognized by the
corporation. See, Treas. Reg. section 301.7701 (b)-7(a)(3).
Under paragraph 4, the United States also reserves its
right to tax former citizens and former long-term residents for
a period of ten years following the loss of such status. Thus,
paragraph 4 allows the United States to tax former U.S.
citizens and former U.S. long-term residents in accordance with
Section 877 of the Code. Section 877 generally applies to a
former citizen or long-term resident of the United States who
relinquishes citizenship or terminates long-term residency
before June 17, 2008 if either of the following criteria exceed
established thresholds: (a) the average annual net income tax
of such individual for the period of 5 taxable years ending
before the date of the loss of status, or (b) the net worth of
such individual as of the date of the loss of status.
The United States defines ``long-term resident'' as an
individual (other than a U.S. citizen) who is a lawful
permanent resident of the United States in at least 8 of the
prior 15 taxable years. An individual is not treated as a
lawful permanent resident for any taxable year in which the
individual is treated as a resident of Iceland under this
Convention, or as a resident of any country other than the
United States under the provisions of any other tax treaty of
the United States, and in either case the individual does not
waive the benefits of the relevant convention.
Paragraph 5
Paragraph 5 sets forth certain exceptions to the saving
clause. The referenced provisions are intended to provide
benefits to citizens and residents even if such benefits do not
exist under internal law. Paragraph 5 thus preserves these
benefits for citizens and residents of the Contracting States.
Subparagraph 5(a) lists certain provisions of the
Convention that are applicable to all citizens and residents of
a Contracting State, despite the general saving clause rule of
paragraph 4:(1) Paragraph 2 of Article 9 (Associated
Enterprises) grants the right to a correlative adjustment with
respect to income tax due on profits reallocated under Article
9.
(2) Paragraphs 2 and 4 of Article 17 (Pensions, Social
Security, and Annuities) provide exemptions from source or
residence State taxation for certain pension distributions and
social security payments.
(3) Article 22 (Relief from Double Taxation) confirms to
citizens and residents of one Contracting State the benefit of
a credit for income taxes paid to the other or an exemption for
income earned in the other State.
(4) Article 23 (Non-Discrimination) protects residents and
nationals of one Contracting State against the adoption of
certain discriminatory practices in the other Contracting
State.
(5) Article 24 (Mutual Agreement Procedure) confers certain
benefits on citizens and residents of the Contracting States in
order to reach and implement solutions to disputes between the
two Contracting States. For example, the competent authorities
are permitted to use a definition of a term that differs from
an internal law definition. The statute of limitations may be
waived for refunds, so that the benefits of an agreement may be
implemented.
Subparagraph 5(b) provides a different set of exceptions to
the saving clause. The benefits referred to are all intended to
be granted to temporary residents of a Contracting State (for
example, in the case of the United States, holders of non-
immigrant visas), but not to citizens or to persons who have
acquired permanent residence in that State. If beneficiaries of
these provisions travel from one of the Contracting States to
the other, and remain in the other long enough to become
residents under its internal law, but do not acquire permanent
residence status (i.e., in the U.S. context, they do not become
``green card'' holders) and are not citizens of that State, the
host State will continue to grant these benefits even if they
conflict with the statutory rules. The benefits preserved by
this paragraph are: (1) the host country exemptions for
government service salaries and pensions under Article 18
(Government Service), certain income of visiting students and
trainees under Article 19 (Students and Trainees), and the
income of diplomatic agents and consular officers under Article
26 (Members of Diplomatic Missions and Consular Posts).
Paragraph 6
Paragraph 6 provides that an item of income derived by a
fiscally transparent entity is considered to be derived by a
resident of a Contracting State to the extent that the resident
is treated under the taxation laws of the State where he is
resident as deriving the item of income. This paragraph applies
to any resident of a Contracting State who is entitled to
income derived through an entity that is treated as fiscally
transparent under the laws of either Contracting State. For
example, if a corporation resident in Iceland distributes a
dividend to an entity that is treated as fiscally transparent
for U.S. tax purposes, the dividend will be considered derived
by a resident of the United States only to the extent that the
taxation laws of the United States treat one or more U.S.
residents (whose status as U.S. residents is determined, for
this purpose, under U.S. tax laws) as deriving the dividend
income for U.S. tax purposes. In the case of a partnership, the
persons who are, under U.S. tax laws, treated as partners of
the entity would normally be the persons whom the U.S. tax laws
would treat as deriving the dividend income through the
partnership. Thus, it also follows that persons whom the United
States treats as partners but who are not U.S. residents for
U.S. tax purposes may not claim a benefit under the Convention
for the dividend paid to the entity. Although these partners
are treated as deriving the income for U.S. tax purposes, they
are not residents of the United States for purposes of the
treaty. If, however, they are treated as residents of a third
country under the provisions of an income tax convention which
that country has with Iceland, they may be entitled to claim a
benefit under that convention. In contrast, if an entity is
organized under U.S. laws and is classified as a corporation
for U.S. tax purposes, dividends paid by a corporation resident
in Iceland to the U.S. entity will be considered derived by a
resident of the United States since the U.S. corporation is
treated under U.S. taxation laws as a resident of the United
States and as deriving the income.
Because the entity classification rules of the State of
residence govern, the results in the examples discussed above
would obtain even if the entity were viewed differently under
the tax laws of Iceland (e.g., as not fiscally transparent in
the first example above where the entity is treated as a
partnership for U.S. tax purposes or as fiscally transparent in
the second example where the entity is viewed as not fiscally
transparent for U.S. tax purposes). Moreover, these results
follow regardless of whether the entity is organized in the
United States, Iceland, or in a third country. For example,
income from sources in Iceland received by an entity organized
under the laws of Iceland, which is treated for U.S. tax
purposes as a corporation and is owned by a U.S. shareholder
who is a U.S. resident for U.S. tax purposes, is not considered
derived by the shareholder of that corporation even if, under
the tax laws of Iceland, the entity is treated as fiscally
transparent. These results also follow regardless of whether
the entity is disregarded as a separate entity under the laws
of one jurisdiction but not the other, such as a single owner
entity that is viewed as a branch for U.S. tax purposes and as
a corporation for tax purposes of in Iceland.
Where income is derived through an entity organized in a
third state that has owners resident in one of the Contracting
States, the characterization of the entity in that third state
is irrelevant for purposes of determining whether the resident
is entitled to treaty benefits with respect to income derived
by the entity.
In general, paragraph 6 relates to entities that are not
subject to tax at the entity level, as distinct from entities
that are subject to tax, but with respect to which tax may be
relieve under an integrated system. Entities falling under this
description in the United States include partnerships, common
investment trusts under section 584 and grantor trusts. This
paragraph also applies to U.S. limited liability companies
((``LLCs''), including an LLC with only one member), that are
treated as partnerships or as disregarded entities for U.S. tax
purposes. The taxation laws of a Contracting State may treat an
item of income as income of a resident of that State even if
the resident is not subject to tax on that particular item of
income. For example, if a Contracting State has a participation
exemption for certain foreign-source dividends and capital
gains, such income or gains would be regarded as income or gain
of a resident of that State who otherwise derived the income or
gain, despite the fact that the resident could be exempt from
tax in that State on the income or gain.
Paragraph 6 is not an exception to the saving clause of
paragraph 4. Accordingly, paragraph 6 does not prevent a
Contracting State from taxing an entity that is treated as a
resident of that State under its own tax law. For example, if a
U.S. LLC with members who are residents of Iceland elects to be
taxed as a corporation for U.S. tax purposes, the United States
will tax that LLC on its worldwide income on a net basis,
without regard to whether Iceland views the LLC as fiscally
transparent.
ARTICLE 2 (TAXES COVERED)
This Article specifies the U.S. taxes and the taxes of
Iceland to which the Convention applies. With two exceptions,
the taxes specified in Article 2 are the covered taxes for all
purposes of the Convention. A broader coverage applies for
purposes of Articles 23 (Non-Discrimination) and 25 (Exchange
of Information and Administrative Assistance). Article 23
applies with respect to all taxes, including those imposed by
state and local governments. Article 25 applies with respect to
all taxes imposed at the national level.
Paragraph 1
Paragraph 1 identifies the category of taxes to which the
Convention applies. Paragraph 1 is based on the U. S. and OECD
Models and defines the scope of application of the Convention.
The Convention applies to taxes on income, including gains,
imposed on behalf of a Contracting State, irrespective of the
manner in which they are levied. Except with respect to Article
23 state and local taxes are not covered by the Convention.
Paragraph 2
Paragraph 2 also is based on the U.S. and OECD Models and
provides a definition of taxes on income, on capital and on
capital gains. The Convention covers taxes on total income, on
total capital, or any part of income and includes tax on gains
derived from the alienation of property. The Convention does
not apply, however, to social security charges, or any other
charges where there is a direct connection between the levy and
individual benefits. Social security and unemployment taxes
(Code sections 1401, 3101, 3111 and 3301) are excluded from
coverage. The Convention also does not apply to property taxes,
except with respect to Article 23.
Paragraph 3
Paragraph 3 lists the taxes in force at the time of
signature of the Convention to which the Convention applies.
The existing covered taxes of Iceland are identified in
subparagraph 3(a). These taxes are i) the income taxes to the
state and ii) the income taxes to the municipalities.
Subparagraph 3(b) provides that the existing U.S. taxes
subject to the rules of the Convention are the Federal income
taxes imposed by the Code, together with the excise taxes
imposed with respect to private foundations (Code sections 4940
through 4948).
Paragraph 4
Under paragraph 4, the Convention will apply to any taxes
that are identical, or substantially similar, to those
enumerated in paragraph 3, and which are imposed in addition
to, or in place of, the existing taxes after October 23, 2007,
the date of signature of the Convention. The paragraph also
provides that the competent authorities of the Contracting
States will notify each other of any significant changes that
have been made in their laws, whether tax laws or non-tax laws,
that affect significantly their obligations under the
Convention. Non-tax laws that may affect a Contracting State's
obligations under the Convention may include, for example, laws
affecting bank secrecy.
ARTICLE 3 (GENERAL DEFINITIONS)
Article 3 provides general definitions and rules of
interpretation applicable throughout the Convention. Certain
other terms are defined in other articles of the Convention.
For example, the term ``resident of a Contracting State'' is
defined in Article 4 (Resident). The term ``permanent
establishment'' is defined in Article 5 (Permanent
Establishment). These definitions are used consistently
throughout the Convention. Other terms, such as ``dividends,''
``interest'' and ``royalties'' are defined in specific articles
for purposes only of those articles.
Paragraph 1
Paragraph 1 defines a number of basic terms used in the
Convention. The introduction to paragraph 1 makes clear that
these definitions apply for all purposes of the Convention,
unless the context requires otherwise. This latter condition
allows flexibility in the interpretation of the treaty in order
to avoid results not intended by the treaty's negotiators.
The geographical scope of the Convention with respect
Iceland is set out in subparagraph 1(a). It encompasses the
territory of Iceland, including its territorial sea, and any
area beyond the territorial sea within which Iceland, in
accordance with international law, exercises jurisdiction or
sovereign rights with respect to the sea bed, its subsoil and
its adjacent waters, and their natural resources.
The geographical scope of the Convention with respect to
the United States is set out in subparagraph 1(b). It
encompasses the United States of America, including the states,
the District of Columbia and the territorial sea of the United
States. The term does not include Puerto Rico, the Virgin
Islands, Guam or any other U.S. possession or territory. For
certain purposes, the term ``United States'' includes the sea
bed and subsoil of undersea areas adjacent to the territorial
sea of the United States. This extension applies to the extent
that the United States exercises sovereignty in accordance with
international law for the purpose of natural resource
exploration and exploitation of such areas. This extension of
the definition applies, however, only if the person, property
or activity to which the Convention is being applied is
connected with such natural resource exploration or
exploitation. Thus, it would not include any activity involving
the sea floor of an area over which the United States exercised
sovereignty for natural resource purposes if that activity was
unrelated to the exploration and exploitation of natural
resources. This result is consistent with the result that would
be obtained under Section 638, which treats the continental
shelf as part of the United States for purposes of natural
resource exploration and exploitation.
Subparagraph 1(c) defines the term ``person'' to include an
individual, a trust, a partnership, a company and any other
body of persons. The definition is significant for a variety of
reasons. For example, under Article 4, only a ``person'' can be
a ``resident'' and therefore eligible for most benefits under
the treaty. Also, all ``persons'' are eligible to claim relief
under Article 24 (Mutual Agreement Procedure).
The term ``company'' is defined in subparagraph 1(d) as a
body corporate or an entity treated as a body corporate for tax
purposes in the state where it is organized. The definition
refers to the law of the state in which an entity is organized
in order to ensure that an entity that is treated as fiscally
transparent in its country of residence will not get
inappropriate benefits, such as the reduced withholding rate
provided by subparagraph 2(b) of Article 10 (Dividends). It
also ensures that the Limitation on Benefits provisions of
Article 21 will be applied at the appropriate level.
Subparagraph 1(e) defines the term ``enterprise'' as any
activity or set of activities that constitutes the carrying on
of a business. The term ``business'' is not defined, but
subparagraph (k) provides that it includes the performance of
professional services and other activities of an independent
character. Both subparagraphs are identical to definitions
recently added to the OECD Model in connection with the
deletion of Article 14 (Independent Personal Services) from the
OECD Model. The inclusion of the two definitions is intended to
clarify that income from the performance of professional
services or other activities of an independent character is
dealt with under Article 7 (Business Profits) and not Article
20 (Other Income).
The terms ``enterprise of a Contracting State'' and
``enterprise of the other Contracting State'' are defined in
subparagraph 1(f) as an enterprise carried on by a resident of
a Contracting State and an enterprise carried on by a resident
of the other Contracting State. An enterprise of a Contracting
State need not be carried on in that State. It may be carried
on in the other Contracting State or a third state (e.g., a
U.S. corporation doing all of its business in the other
Contracting State would still be a U.S. enterprise). Although
not explicitly stated in the Convention, these terms also
encompass an enterprise conducted through an entity (such as a
partnership) that is treated as fiscally transparent in the
Contracting State where the entity's owner is resident. In
accordance with Article 4 (Resident), entities that are
fiscally transparent in the Contracting State in which their
owners are resident are not considered to be residents of that
State (although income derived by such entities may be taxed as
the income of a resident, if taxed in the hands of resident
partners or other owners). An enterprise conducted by such an
entity will be treated as carried on by a resident of a
Contracting State to the extent its partners or other owners
are residents. This approach is consistent with the Code, which
under section 875 attributes a trade or business conducted by a
partnership to its partners and a trade or business conducted
by an estate or trust to its beneficiaries.
Subparagraph 1(g) provides that the terms ``a Contracting
State'' and ``the other Contracting State'' shall mean Iceland
or the United States, as the context requires.
Subparagraph 1(h) defines the term ``international
traffic.'' The term means any transport by a ship or aircraft
except when such transport is solely between places within a
Contracting State. This definition is applicable principally in
the context of Article 8 (Shipping and Air Transport). The
definition combines with paragraphs 2 and 3 of Article 8 to
exempt from tax by the source State income from the rental of
ships or aircraft that is earned both by lessors that are
operators of ships and aircraft and by those lessors that are
not (e.g., a bank or a container leasing company).
The exclusion from international traffic of transport
solely between places within a Contracting State means, for
example, that carriage of goods or passengers solely between
New York and Chicago would not be treated as international
traffic, whether carried by a U.S. or a foreign carrier. The
substantive taxing rules of the Convention relating to the
taxation of income from transport, principally Article 8
(Shipping and Air Transport), therefore, would not apply to
income from such carriage. Thus, if the carrier engaged in
internal U.S. traffic were a resident of Iceland (assuming that
were possible under U.S. law), the United States would not be
required to exempt the income from that transport under Article
8. The income would, however, be treated as business profits
under Article 7 (Business Profits), and therefore would be
taxable in the United States only if attributable to a U.S.
permanent establishment of the foreign carrier, and then only
on a net basis. The gross basis U.S. tax imposed by section 887
would never apply under the circumstances described. If,
however, goods or passengers are carried by a carrier resident
in Iceland from a non-U.S. port to, for example, New York, and
some of the goods or passengers continue on to Chicago, the
entire transport would be international traffic. This would be
true if the international carrier transferred the goods at the
U.S. port of entry from a ship to a land vehicle, from a ship
to a lighter, or even if the overland portion of the trip in
the United States was handled by an independent carrier under
contract with the original internation*al carrier, so long as
both parts of the trip were reflected in original bills of
lading. For this reason, the Convention, following the U.S.
Model, refers in the definition of ``international traffic,''
to ``such transport'' being solely between places in the other
Contracting State, while the OECD Model refers to the ship or
aircraft being operated solely between such places. The
formulation in the Convention is intended to make clear that,
as in the above example, even if the goods are carried on a
different aircraft for the internal portion of the
international voyage than is used for the overseas portion of
the trip, the definition applies to that internal portion as
well as the external portion.
Finally, a ``cruise to nowhere,'' i.e., a cruise beginning
and ending in a port in the same Contracting State with no
stops in a foreign port, would not constitute international
traffic.
Subparagraph 1(i) designates the ``competent authorities''
for Iceland and the United States. In the case of Iceland, the
competent authority is the Minister of Finance or his
authorized representative. The U.S. competent authority is the
Secretary of the Treasury or his delegate. The Secretary of the
Treasury has delegated the competent authority function to the
Commissioner of Internal Revenue, who in turn has delegated the
authority to the Deputy Commissioner (International) LMSB. With
respect to interpretative issues, the Deputy Commissioner
(International) LMSB acts with the concurrence of the Associate
Chief Counsel (International) of the Internal Revenue Service.
The term ``national,'' as it relates to the United States
and to Iceland, is defined in subparagraph 1(j). This term is
relevant for purposes of Articles 18 (Government Service) and
23 (Non-Discrimination). A national of one of the Contracting
States is (1) an individual who is a citizen or national of
that State, and (2) any legal person, partnership or
association deriving its status, as such, from the law in force
in the State where it is established.
Subparagraph 1(l) defines the term ``pension scheme'' to
include any plan, scheme, fund, trust or other arrangement
established in a Contracting State that is generally exempt
from income taxation in that State and that is operated
principally to administer or provide pension or retirement
benefits or to earn income for the benefit of one or more such
arrangements. Subparagraph 1(b) of the Protocol provides that
in the case of the United States, the term ``pension scheme''
includes the following: a trust providing pension or retirement
benefits under a Code section 401(a) qualified pension plan,
profit sharing or stock bonus plan, a Code section 403(a)
qualified annuity plan, a Code section 403(b) plan, a trust
that is an individual retirement account under Code section
408, a Roth individual retirement account under Code section
408A, or a simple retirement account under Code section 408(p),
a trust providing pension or retirement benefits under a
simplified employee pension plan under Code section 408(k), a
trust described in section 457(g) providing pension or
retirement benefits under a Code section 457(b) plan, and the
Thrift Savings Fund (section 7701(j)). Section 401(k) plans and
group trusts described in Revenue Ruling 8 1-100 and meeting
the conditions of Revenue Ruling 2004-67 qualify as pension
funds to the extent they are Code section 401(a) plans or other
pension schemes. In the case of Iceland, subparagraph 1(a) of
the Protocol provides that the term ``pension scheme'' includes
any pension fund or pension plan qualified under the Pension
Act or any identical or substantially similar schemes which are
created under any law enacted after October 23, 2007, the date
of signature of the Convention.
Paragraph 2
Terms that are not defined in the Convention are dealt with
in paragraph 2.
Paragraph 2 provides that in the application of the
Convention, any term used but not defined in the Convention
will have the meaning that it has under the law of the
Contracting State whose tax is being applied, unless the
context requires otherwise, or the competent authorities have
agreed on a different meaning pursuant to Article 24 (Mutual
Agreement Procedure). If the term is defined under both the tax
and non-tax laws of a Contracting State, the definition in the
tax law will take precedence over the definition in the non-tax
laws. Finally, there also may be cases where the tax laws of a
State contain multiple definitions of the same term. In such a
case, the definition used for purposes of the particular
provision at issue, if any, should be used.
If the meaning of a term cannot be readily determined under
the law of a Contracting State, or if there is a conflict in
meaning under the laws of the two States that creates
difficulties in the application of the Convention, the
competent authorities, as indicated in subparagraph 3(f) of
Article 24, may establish a common meaning in order to prevent
double taxation or to further any other purpose of the
Convention. This common meaning need not conform to the meaning
of the term under the laws of either Contracting State.
The reference in paragraph 2 to the internal law of a
Contracting State means the law in effect at the time the
treaty is being applied, not the law as in effect at the time
the treaty was signed. The use of ``ambulatory'' definitions,
however, may lead to results that are at variance with the
intentions of the negotiators and of the Contracting States
when the treaty was negotiated and ratified. The reference in
both paragraphs 1 and 2 to the ``context otherwise
requir[ing]'' a definition different from the treaty
definition, in paragraph 1, or from the internal law definition
of the Contracting State whose tax is being imposed, under
paragraph 2, refers to a circumstance where the result intended
by the Contracting States is different from the result that
would obtain under either the paragraph 1 definition or the
statutory definition. Thus, flexibility in defining terms is
necessary and permitted.
ARTICLE 4 (RESIDENT)
This Article sets forth rules for determining whether a
person is a resident of a Contracting State for purposes of the
Convention. As a general matter only residents of the
Contracting States may claim the benefits of the Convention.
The treaty definition of residence is to be used only for
purposes of the Convention. The fact that a person is
determined to be a resident of a Contracting State under
Article 4 does not necessarily entitle that person to the
benefits of the Convention. In addition to being a resident, a
person also must qualify for benefits under Article 21
(Limitation On Benefits) in order to receive benefits conferred
on residents of a Contracting State.
The determination of residence for treaty purposes looks
first to a person's liability to tax as a resident under the
respective taxation laws of the Contracting States. As a
general matter, a person who, under those laws, is a resident
of one Contracting State and not of the other need look no
further. For purposes of the Convention, that person is a
resident of the State in which he is resident under internal
law. If, however, a person is resident in both Contracting
States under their respective taxation laws, the Article
proceeds, where possible, to use tie-breaker rules to assign a
single State of residence to such a person for purposes of the
Convention.
Paragraph 1
The term ``resident of a Contracting State'' is defined in
paragraph 1. In general, this definition incorporates the
definitions of residence in U.S. law and that of Iceland by
referring to a resident as a person who, under the laws of a
Contracting State, is subject to tax there by reason of his
domicile, residence, citizenship, place of management, place of
incorporation or any other similar criterion. Thus, residents
of the United States include aliens who are considered U.S.
residents under Code section 7701(b). Paragraph 1 also
specifically includes the two Contracting States, and political
subdivisions and local authorities of the two States, as
residents for purposes of the Convention.
Certain entities that are nominally subject to tax but that
in practice are rarely required to pay tax also would generally
be treated as residents and therefore accorded treaty benefits.
For example, a U.S. Regulated Investment Company (RIC) and a
U.S. Real Estate Investment Trust (REIT) are residents of the
United States for purposes of the treaty. Although the income
earned by these entities normally is not subject to U.S. tax in
the hands of the entity, they are taxable to the extent that
they do not currently distribute their profits, and therefore
may be regarded as ``liable to tax.'' They also must satisfy a
number of requirements under the Code in order to be entitled
to special tax treatment.
A person who is liable to tax in a Contracting State only
in respect of income from sources within that State or capital
situated therein or of profits attributable to a permanent
establishment in that State will not be treated as a resident
of that Contracting State for purposes of the Convention. Thus,
a consular official of Iceland who is posted in the United
States, who may be subject to U.S. tax on U.S. source
investment income but is not taxable in the United States on
non-U.S. source income (see Code section 7701(b)(5)(B)), would
not be considered a resident of the United States for purposes
of the Convention. Similarly, an enterprise of Iceland with a
permanent establishment in the United States is not, by virtue
of that permanent establishment, a resident of the United
States. The enterprise generally is subject to U.S. tax only
with respect to its income that is attributable to the U.S.
permanent establishment, not with respect to its worldwide
income, as it would be if it were a U.S. resident.
Paragraph 2
Paragraph 2 provides that certain tax-exempt entities such
as pension schemes and charitable organizations will be
regarded as residents of a Contracting State regardless of
whether they are generally liable to income tax in the State
where they are established. The inclusion of this provision is
intended to clarify the generally accepted practice of treating
an entity that would be liable for tax as a resident under the
internal law of a State but for a specific exemption from tax
(either complete or partial) as a resident of that State for
purposes of paragraph 1.
Subparagraph 2(a) applies to pension schemes, as defined in
subparagraph 1(l) of Article 3 (General Definitions).
Subparagraph 2(b) applies to any plan, scheme, fund, trust,
company or other arrangement established in a Contracting State
that is generally exempt from taxation in that State because it
is operated exclusively to administer or provide employee
benefits. The reference to a general exemption is intended to
reflect the fact that under U.S. law, certain organizations
that generally are considered to be tax-exempt entities may be
subject to certain excise taxes or to income tax on their
unrelated business income. Subparagraph 2(c) applies to an
organization that is established exclusively for religious,
charitable, scientific, artistic, cultural, or educational
purposes and that is a resident of a Contracting State. Thus, a
section 501(c) organization organized in the United States
(such as a U.S. charity) that is generally exempt from tax
under U.S. law is a resident of the United States for all
purposes of the Convention.
Paragraph 3
If, under the laws of the two Contracting States, and,
thus, under paragraph 1, an individual is deemed to be a
resident of both Contracting States, a series of tie-breaker
rules are provided in paragraph 3 to determine a single State
of residence for that individual. These tests are to be applied
in the order in which they are stated. The first test is based
on where the individual has a permanent home. If that test is
inconclusive because the individual has a permanent home
available to him in both States, he will be considered to be a
resident of the Contracting State where his personal and
economic relations are closest (i.e., the location of his
``center of vital interests''). If that test is also
inconclusive, or if he does not have a permanent home available
to him in either State, he will be treated as a resident of the
Contracting State where he maintains a habitual abode. If he
has a habitual abode in both States or in neither of them, he
will be treated as a resident of the Contracting State of which
he is a national. If he is a national of both States or of
neither, the matter will be considered by the competent
authorities, who will assign a single State of residence.
Paragraph 4
Paragraph 4 seeks to settle dual residence issues for
persons other than individuals (e.g., companies, trusts, or
estates). For example, a dual residence may arise in the case
of a company that is dually created in both the United States
and Iceland or that is incorporated in the United States, and
therefore treated as a resident of the United States, but that
is also considered a resident of Iceland because it is managed
and controlled in Iceland. In such a case, if such a person is,
under the rules of paragraph 1, resident in both Contracting
States, the competent authorities shall seek to determine a
single State of residence for that person for purposes of the
Convention. If the competent authorities do not reach an
agreement on a single State of residence, that company may not
claim any benefit accorded to residents of a Contracting State
by the Convention, except those provided in Article 23 (Non-
Discrimination) and Article 24 (Mutual Agreement Procedure).
Thus, for example, a State cannot impose discriminatory tax
measures on a dual resident company.
Dual resident companies may be treated as a resident of a
Contracting State for purposes other than that of obtaining
benefits under the Convention. For example, if a dual resident
company pays a dividend to a resident of Iceland, the U.S.
paying agent would withhold on that dividend at the appropriate
treaty rate because reduced withholding is a benefit enjoyed by
the resident of Iceland, not by the dual resident company. The
dual resident company that paid the dividend would, for this
purpose, be treated as a resident of the United States under
the Convention. In addition, information relating to dual
resident companies can be exchanged under the Convention
because, by its terms, Article 26 (Exchange of Information and
Administrative Assistance) is not limited to residents of the
Contracting States.
ARTICLE 5 (PERMANENT ESTABLISHMENT)
This Article defines the term ``permanent establishment,''
a term that is significant for several articles of the
Convention. The existence of a permanent establishment in a
Contracting State is necessary under Article 7 (Business
Profits) for the taxation by that State of the business profits
of a resident of the other Contracting State. Articles 10
(Dividends), 11 (Interest) and 12 (Royalties) provide for
reduced rates of tax at source on payments of these items of
income to a resident of the other State only when the income is
not attributable to a permanent establishment that the
recipient has in the source State. The concept is also relevant
in determining which Contracting State may tax certain gains
under Article 13 (Capital Gains) and certain ``other income''
under Article 20 (Other Income).
Paragraph 1
The basic definition of the term ``permanent
establishment'' is contained in paragraph 1. As used in the
Convention, the term means a fixed place of business through
which the business of an enterprise is wholly or partly carried
on. As indicated in the OECD Commentary to Article 5 (see
paragraphs 4 through 8), a general principle to be observed in
determining whether a permanent establishment exists is that
the place of business must be ``fixed'' in the sense that a
particular building or physical location is used by the
enterprise for the conduct of its business, and that it must be
foreseeable that the enterprise's use of this building or other
physical location will be more than temporary.
Paragraph 2
Paragraph 2 lists a number of types of fixed places of
business that constitute a permanent establishment. This list
is illustrative and non-exclusive. According to paragraph 2,
the term permanent establishment includes a place of
management, a branch, an office, a factory, a workshop, and a
mine, oil or gas well, quarry or other place of extraction of
natural resources.
Paragraph 3
This paragraph provides rules to determine whether a
building site or a construction, assembly or installation
project, or an installation or drilling rig or ship used for
the exploration of natural resources constitutes a permanent
establishment for the contractor, driller, etc. Such a site or
activity does not create a permanent establishment unless the
site, project, etc. lasts, or the exploration activity
continues, for more than twelve months. It is only necessary to
refer to ``exploration'' and not ``exploitation'' in this
context because exploitation activities are defined to
constitute a permanent establishment under subparagraph 2(f).
Thus, a drilling rig does not constitute a permanent
establishment if a well is drilled in only six months, but if
production begins in the following month the well becomes a
permanent establishment as of that date.
The twelve-month test applies separately to each site or
project. The twelve-month period begins when work (including
preparatory work carried on by the enterprise) physically
begins in a Contracting State. A series of contracts or
projects by a contractor that are interdependent both
commercially and geographically are to be treated as a single
project for purposes of applying the twelve-month threshold
test. For example, the construction of a housing development
would be considered as a single project even if each house were
constructed for a different purchaser.
In applying this paragraph, time spent by a sub-contractor
on a building site is counted as time spent by the general
contractor at the site for purposes of determining whether the
general contractor has a permanent establishment. However, for
the sub-contractor itself to be treated as having a permanent
establishment, the sub-contractor's activities at the site must
last for more than 12 months. If a sub-contractor is on a site
intermittently, then, for purposes of applying the 12-month
rule, time is measured from the first day the sub-contractor is
on the site until the last day (i.e., intervening days that the
sub-contractor is not on the site are counted).
These interpretations of the Article are based on the
Commentary to paragraph 3 of Article 5 of the OECD Model, which
contains language that is substantially the same as that in the
Convention. These interpretations are consistent with the
generally accepted international interpretation of the relevant
language in paragraph 3 of Article 5 of the Convention.
If the twelve-month threshold is exceeded, the site or
project constitutes a permanent establishment from the first
day of activity.
Paragraph 4
This paragraph contains exceptions to the general rule of
paragraph 1, listing a number of activities that may be carried
on through a fixed place of business but which nevertheless do
not create a permanent establishment. The use of facilities
solely to store, display or deliver merchandise belonging to an
enterprise does not constitute a permanent establishment of
that enterprise. The maintenance of a stock of goods belonging
to an enterprise solely for the purpose of storage, display or
delivery, or solely for the purpose of processing by another
enterprise does not give rise to a permanent establishment of
the first-mentioned enterprise. The maintenance of a fixed
place of business solely for the purpose of purchasing goods or
merchandise, or for collecting information, for the enterprise,
or for other activities that have a preparatory or auxiliary
character for the enterprise, such as advertising, or the
supply of information, do not constitute a permanent
establishment of the enterprise. Moreover, subparagraph 4(f)
provides that a combination of the activities described in the
other subparagraphs of paragraph 4 will not give rise to a
permanent establishment if the combination results in an
overall activity that is of a preparatory or auxiliary
character.
Paragraph 5
Paragraphs 5 and 6 specify when activities carried on by an
agent or other person acting on behalf of an enterprise create
a permanent establishment of that enterprise. Under paragraph
5, a person is deemed to create a permanent establishment of
the enterprise if that person has and habitually exercises an
authority to conclude contracts in the name of the enterprise.
If, however, for example, his activities are limited to those
activities specified in paragraph 4 which would not constitute
a permanent establishment if carried on by the enterprise
through a fixed place of business, the person does not create a
permanent establishment of the enterprise.
The Convention adopts the OECD Model language ``in the name
of the enterprise ``rather than the U.S. Model language
``binding on the enterprise.'' This difference in language is
not intended to be a substantive difference. As indicated in
paragraph 32 to the OECD Commentaries on Article 5, paragraph 5
is intended to encompass persons who have ``sufficient
authority to bind the enterprise's participation in the
business activity in the State concerned.''
The contracts referred to in paragraph 5 are those relating
to the essential business operations of the enterprise, rather
than ancillary activities. For example, if the person has no
authority to conclude contracts in the name of the enterprise
with its customers for, say, the sale of the goods produced by
the enterprise, but it can enter into service contracts in the
name of the enterprise for the enterprise's business equipment,
this contracting authority would not fall within the scope of
the paragraph, even if exercised regularly.
Paragraph 6
Under paragraph 6, an enterprise is not deemed to have a
permanent establishment in a Contracting State merely because
it carries on business in that State through an independent
agent, including a broker or general commission agent, if the
agent is acting in the ordinary course of his business as an
independent agent. Thus, there are two conditions that must be
satisfied: the agent must be both legally and economically
independent of the enterprise, and the agent must be acting in
the ordinary course of its business in carrying out activities
on behalf of the enterprise.
Whether the agent and the enterprise are independent is a
factual determination. Among the questions to be considered are
the extent to which the agent operates on the basis of
instructions from the enterprise. An agent that is subject to
detailed instructions regarding the conduct of its operations
or comprehensive control by the enterprise is not legally
independent.
In determining whether the agent is economically
independent, a relevant factor is the extent to which the agent
bears business risk. Business risk refers primarily to risk of
loss. An independent agent typically bears risk of loss from
its own activities. In the absence of other factors that would
establish dependence, an agent that shares business risk with
the enterprise, or has its own business risk, is economically
independent because its business activities are not integrated
with those of the principal. Conversely, an agent that bears
little or no risk from the activities it performs is not
economically independent and therefore is not described in
paragraph 6.
Another relevant factor in determining whether an agent is
economically independent is whether the agent acts exclusively
or nearly exclusively for the principal. Such a relationship
may indicate that the principal has economic control over the
agent. A number of principals acting in concert also may have
economic control over an agent. The limited scope of the
agent's activities and the agent's dependence on a single
source of income may indicate that the agent lacks economic
independence. It should be borne in mind, however, that
exclusivity is not in itself a conclusive test; an agent may be
economically independent notwithstanding an exclusive
relationship with the principal if it has the capacity to
diversify and acquire other clients without substantial
modifications to its current business and without substantial
harm to its business profits. Thus, exclusivity should be
viewed merely as a pointer to further investigation of the
relationship between the principal and the agent. Each case
must be addressed on the basis of its own facts and
circumstances.
Paragraph 7
This paragraph clarifies that a company that is a resident
of a Contracting State is not deemed to have a permanent
establishment in the other Contracting State merely because it
controls, or is controlled by, a company that is a resident of
that other Contracting State, or that carries on business in
that other Contracting State. The determination whether a
permanent establishment exists is made solely on the basis of
the factors described in paragraphs 1 through 6 of the Article.
Whether a company is a permanent establishment of a related
company, therefore, is based solely on those factors and not on
the ownership or control relationship between the companies.
ARTICLE 6 (INCOME FROM IMMOVABLE PROPERTY (REAL PROPERTY))
This Article deals with the taxation of income from
immovable property (real property) situated in a Contracting
State (the ``situs State''). The Article does not grant an
exclusive taxing right to the situs State; the situs State is
merely given the primary right to tax. The Article does not
impose any limitation in terms of rate or form of tax imposed
by the situs State.
Paragraph 1
The first paragraph of Article 6 states the general rule
that income of a resident of a Contracting State derived from
real property situated in the other Contracting State may be
taxed in the Contracting State in which the property is
situated. The paragraph specifies that income from real
property includes income from agriculture and forestry.
Paragraph 2
The term ``real property'' is defined in paragraph 2 by
reference to the internal law definition in the situs State. In
the case of the United States, the term has the meaning given
to it by Reg. Sec. 1.897-1(b). In addition to the statutory
definitions in the two Contracting States, the paragraph
specifies certain additional classes of property that,
regardless of internal law definitions, are within the scope of
the term for purposes of the Convention. This expanded
definition conforms to that in the OECD Model. The definition
of ``real property'' for purposes of Article 6 is more limited
than the expansive definition of ``real property'' in paragraph
1 of Article 13 (Capital Gains). The Article 13 term includes
not only real property as defined in Article 6 but certain
other interests in real property.
Paragraph 3
Paragraph 3 makes clear that all forms of income derived
from the exploitation of real property are taxable in the
Contracting State in which the property is situated. This
includes income from any use of real property, including, but
not limited to, income from direct use by the owner (in which
case income may be imputed to the owner for tax purposes) and
rental income from the letting of real property. In the case of
a net lease of real property, if any elections to be taxed on a
net basis as may be provided under the laws of the situs State
have not been made, the gross rental payment (before deductible
expenses incurred by the lessee) is treated as income from the
property.
Other income closely associated with real property is
covered by other Articles of the Convention, however, and not
Article 6. For example, income from the disposition of an
interest in real property is not considered ``derived'' from
real property; taxation of that income is addressed in Article
13. Interest paid on a mortgage on real property would be
covered by Article 11 (Interest). Distributions by a U.S. Real
Estate Investment Trust or certain regulated investment
companies would fall under Article 13 in the case of
distributions of U.S. real property gain or Article 10
(Dividends) in the case of distributions treated as dividends.
Finally, distributions from a United States Real Property
Holding Corporation are not considered to be income from the
exploitation of real property; such payments would fall under
Article 10 or 13.
Paragraph 4
This paragraph specifies that the basic rule of paragraph 1
(as elaborated in paragraph 3) applies to income from real
property of an enterprise. This clarifies that the situs
country may tax the real property income (including rental
income) of a resident of the other Contracting State in the
absence of attribution to a permanent establishment in the
situs State. This provision represents an exception to the
general rule under Articles 7 (Business Profits) that income
must be attributable to a permanent establishment in order to
be taxable in the situs State.
ARTICLE 7 (BUSINESS PROFITS)
This Article provides rules for the taxation by a
Contracting State of the business profits of an enterprise of
the other Contracting State.
Paragraph 1
Paragraph 1 states the general rule that business profits
of an enterprise of one Contracting State may not be taxed by
the other Contracting State unless the enterprise carries on
business in that other Contracting State through a permanent
establishment (as defined in Article 5 (Permanent
Establishment)) situated there. When that condition is met, the
State in which the permanent establishment is situated may tax
the enterprise on the income that is attributable to the
permanent establishment.
Although the Convention does not include a definition of
``business profits,'' the term is intended to cover income
derived from any trade or business. In accordance with this
broad definition, the term ``business profits'' includes income
attributable to notional principal contracts and other
financial instruments to the extent that the income is
attributable to a trade or business of dealing in such
instruments or is otherwise related to a trade or business (as
in the case of a notional principal contract entered into for
the purpose of hedging currency risk arising from an active
trade or business). Any other income derived from such
instruments is, unless specifically covered in another article,
dealt with under Article 20 (Other Income).
The term ``business profits'' also includes income derived
by an enterprise from the rental of tangible personal property
(unless such tangible personal property consists of aircraft,
ships or containers, income from which is addressed by Article
8 (Shipping and Air Transport)). The inclusion of income
derived by an enterprise from the rental of tangible personal
property in business profits means that such income earned by a
resident of a Contracting State can be taxed by the other
Contracting State only if the income is attributable to a
permanent establishment maintained by the resident in that
other State, and, if the income is taxable, it can be taxed
only on a net basis. Income from the rental of tangible
personal property that is not derived in connection with a
trade or business is dealt with in Article 20.
In addition, as a result of the definitions of
``enterprise'' and ``business'' in Article 3 (General
Definitions), the term includes income derived from the
furnishing of personal services. Thus, a consulting firm
resident in one State whose employees or partners perform
services in the other State through a permanent establishment
may be taxed in that other State on a net basis under Article
7, and not under Article 14 (Income from Employment), which
applies only to income of employees. With respect to the
enterprise's employees themselves, however, their salary
remains subject to Article 14.
Because this Article applies to income earned by an
enterprise from the furnishing of personal services, the
Article also applies to income derived by a partner resident in
a Contracting State that is attributable to personal services
performed in the other Contracting State through a partnership
with a permanent establishment in that other State. Income
which may be taxed under this Article includes all income
attributable to the permanent establishment in respect of the
performance of the personal services carried on by the
partnership (whether by the partner himself, other partners in
the partnership, or by employees assisting the partners) and
any income from activities ancillary to the performance of
those services (e.g., charges for facsimile services).
The application of Article 7 to a service partnership may
be illustrated by the following example: a partnership has five
partners (who agree to split profits equally), four of whom are
resident and perform personal services only in Iceland at
Office A, and one of whom performs personal services at Office
B, a permanent establishment in the United States. In this
case, the four partners of the partnership resident in Iceland
may be taxed in the United States in respect of their share of
the income attributable to the permanent establishment, Office
B. The services giving rise to income which may be attributed
to the permanent establishment would include not only the
services performed by the one resident partner, but also, for
example, if one of the four other partners came to the United
States and worked on an Office B matter there, the income in
respect of those services. Income from the services performed
by the visiting partner would be subject to tax in the United
States regardless of whether the visiting partner actually
visited or used Office B while performing services in the
United States.
Paragraph 2
Paragraph 2 provides rules for the attribution of business
profits to a permanent establishment. The Contracting States
will attribute to a permanent establishment the profits that it
would have earned had it been a distinct and separate
enterprise engaged in the same or similar activities under the
same or similar conditions and dealing wholly independently
with the enterprise of which it is a permanent establishment.
The ``attributable to'' concept of paragraph 2 provides an
alternative to the analogous but somewhat different
``effectively connected'' concept in Code section 864(c).
Depending on the circumstances, the amount of income
``attributable to'' a permanent establishment under Article 7
may be greater or less than the amount of income that would be
treated as ``effectively connected'' to a U.S. trade or
business under Code section 864. In particular, in the case of
financial institutions, the use of internal dealings to
allocate income within an enterprise may produce results under
Article 7 that are significantly different than the results
under the effectively connected income rules. For example,
income from interbranch notional principal contracts may be
taken into account under Article 7, notwithstanding that such
transactions may be ignored for purposes of U.S. domestic law.
The profits attributable to a permanent establishment may
be from sources within or without a Contracting State. However,
the business profits attributable to a permanent establishment
include only those profits derived from the assets used, risks
assumed, and activities performed by the permanent
establishment.
Paragraph 2 of the Protocol confirms that the arm's length
method of paragraphs 2 and 3 consists of applying the OECD
Transfer Pricing Guidelines, but taking into account the
different economic and legal circumstances of a single legal
entity (as opposed to separate but associated enterprises).
Thus, any of the methods used in the Transfer Pricing
Guidelines, including profits methods, may be used as
appropriate and in accordance with the Transfer Pricing
Guidelines.
However, the use of the Transfer Pricing Guidelines applies
only for purposes of attributing profits within the legal
entity. It does not create legal obligations or other tax
consequences that would result from transactions having
independent legal significance.
One example of the different circumstances of a single
legal entity is that an entity that operates through branches
rather than separate subsidiaries generally will have lower
capital requirements because all of the assets of the entity
are available to support all of the entity's liabilities (with
some exceptions attributable to local regulatory restrictions).
This is the reason that most commercial banks and some
insurance companies operate through branches rather than
subsidiaries. The benefit that comes from such lower capital
costs must be allocated among the branches in an appropriate
manner. This issue does not arise in the case of an enterprise
that operates through separate entities, since each entity will
have to be separately capitalized or will have to compensate
another entity for providing capital (usually through a
guarantee).
Under U.S. domestic regulations, internal ``transactions''
generally are not recognized because they do not have legal
significance. In contrast, the Convention provides that such
internal dealings may be used to attribute income to a
permanent establishment in cases where the dealings accurately
reflect the allocation of risk within the enterprise. One
example is that of global trading in securities. In many cases,
banks use internal swap transactions to transfer risk from one
branch to a central location where traders have the expertise
to manage that particular type of risk. Under the Convention,
such a bank may also use such swap transactions as a means of
attributing income between the branches, if use of that method
is the ``best method'' within the meaning of regulation section
1.482-1(c). The books of a branch will not be respected,
however, when the results are inconsistent with a functional
analysis. So, for example, income from a transaction that is
booked in a particular branch (or home office) will not be
treated as attributable to that location if the sales and risk
management functions that generate the income are performed in
another location.
Because the use of profits methods is permissible under
paragraph 2, it is not necessary for the Convention to include
a provision corresponding to paragraph 4 of Article 7 of the
OECD Model.
Paragraph 3
Paragraph 3 provides that in determining the business
profits of a permanent establishment, deductions shall be
allowed for the expenses incurred for the purposes of the
permanent establishment, ensuring that business profits will be
taxed on a net basis. This rule is not limited to expenses
incurred exclusively for the purposes of the permanent
establishment, but includes expenses incurred for the purposes
of the enterprise as a whole, or that part of the enterprise
that includes the permanent establishment. Deductions are to be
allowed regardless of which accounting unit of the enterprise
books the expenses, so long as they are incurred for the
purposes of the permanent establishment. For example, a portion
of the interest expense recorded on the books of the home
office in one State may be deducted by a permanent
establishment in the other. The amount of the expense that must
be allowed as a deduction is determined by applying the arm's
length principle. And, as noted above with respect to paragraph
2 of Article 1 (General Scope), if a deduction would be allowed
under the Code in computing the U.S. taxable income, the
deduction also is allowed in computing taxable income under the
Convention. However, except where the Convention provides for
more favorable treatment, a taxpayer cannot take deductions for
expenses in computing taxable income under the Convention to a
greater extent than would be allowed under the Code where doing
so would be inconsistent with the intent of the Code. For
example, assume that a Bulgarian taxpayer with a permanent
establishment in the United States borrows $100 to purchase
U.S. tax exempt bonds, and that the $100 of tax-exempt bonds
and the $100 of related debt would be treated as assets and
liabilities of the permanent establishment. For purposes of
computing the profits attributable to the permanent
establishment under the Convention, both the tax exempt
interest from the bonds and the interest expense from the
related debt would be excluded.
As noted above, paragraph the Convention provides that the
OECD Transfer Pricing Guidelines apply, by analogy, in
determining the profits attributable to a permanent
establishment. Accordingly, a permanent establishment may
deduct payments made to its head office or another branch in
compensation for services performed for the benefit of the
branch. The method to be used in calculating that amount will
depend on the terms of the arrangements between the branches
and head office. For example, the enterprise could have a
policy, expressed in writing, under which each business unit
could use the services of lawyers employed by the head office.
At the end of each year, the costs of employing the lawyers
would be charged to each business unit according to the amount
of services used by that business unit during the year. Since
this appears to be a kind of cost-sharing arrangement and the
allocation of costs is based on the benefits received by each
business unit, such a cost allocation would be an acceptable
means of determining a permanent establishment's deduction for
legal expenses. Alternatively, the head office could agree to
employ lawyers at its own risk, and to charge an arm's length
price for legal services performed for a particular business
unit. If the lawyers were under-utilized, and the ``fees''
received from the business units were less than the cost of
employing the lawyers, then the head office would bear the
excess cost. If the ``fees'' exceeded the cost of employing the
lawyers, then the head office would keep the excess to
compensate it for assuming the risk of employing the lawyers.
If the enterprise acted in accordance with this agreement, this
method would be an acceptable alternative method for
calculating a permanent establishment's deduction for legal
expenses.
A permanent establishment cannot be funded entirely with
debt, but must have sufficient capital to carry on its
activities as if it were a distinct and separate enterprise. To
the extent that the permanent establishment has not been
attributed capital for profit attribution purposes, a
Contracting State may attribute such capital to the permanent
establishment, in accordance with the arm's length principle,
and deny an interest deduction to the extent necessary to
reflect that capital attribution. The method prescribed by U.S.
domestic law for making this attribution is found in Treas.
Reg. section 1.882-5. Both section 1.882-5 and the method
prescribed the Convention start from the premise that all of
the capital of the enterprise supports all of the assets and
risks of the enterprise, and therefore the entire capital of
the enterprise must be allocated to its various businesses and
offices.
However, section 1.882-5 does not take into account the
fact that some assets create more risk for the enterprise than
do other assets. An independent enterprise would need less
capital to support a perfectly-hedged U.S. Treasury security
than it would need to support an equity security or other asset
with significant market and/or credit risk. Accordingly, in
some cases section 1.882-5 would require a taxpayer to allocate
more capital to the United States, and therefore would reduce
the taxpayer's interest deduction more, than is appropriate. To
address these cases, the Convention allows a taxpayer to apply
a more flexible approach that takes into account the relative
risk of its assets in the various jurisdictions in which it
does business. In particular, in the case of financial
institutions other than insurance companies, the amount of
capital attributable to a permanent establishment is determined
by allocating the institution's total equity between its
various offices on the basis of the proportion of the financial
institution's risk-weighted assets attributable to each of
them. This recognizes the fact that financial institutions are
in many cases required to risk-weight their assets for
regulatory purposes and, in other cases, will do so for
business reasons even if not required to do so by regulators.
However, risk-weighting is more complicated than the method
prescribed by section 1.882-5. Accordingly, to ease this
administrative burden, taxpayers may choose to apply the
principles of Treas. Reg. section 1.882-5(c) to determine the
amount of capital allocable to its U.S. permanent
establishment, in lieu of determining its allocable capital
under the risk-weighted capital allocation method provided by
the Convention, even if it has otherwise chosen the principles
of Article 7 rather than the effectively connected income rules
of U.S. domestic law.
Paragraph 4
Paragraph 4 provides that no business profits can be
attributed to a permanent establishment merely because it
purchases goods or merchandise for the enterprise of which it
is a part. This paragraph is essentially identical to paragraph
5 of Article 7 of the OECD Model. This rule applies only to an
office that performs functions for the enterprise in addition
to purchasing. The income attribution issue does not arise if
the sole activity of the office is the purchase of goods or
merchandise because such activity does not give rise to a
permanent establishment under Article 5 (Permanent
Establishment). A common situation in which paragraph 4 is
relevant is one in which a permanent establishment purchases
raw materials for the enterprise's manufacturing operation
conducted outside the United States and sells the manufactured
product. While business profits may be attributable to the
permanent establishment with respect to its sales activities,
no profits are attributable to it with respect to its
purchasing activities.
Paragraph 5
Paragraph 5 provides that profits shall be determined by
the same method each year, unless there is good reason to
change the method used. This rule assures consistent tax
treatment over time for permanent establishments. It limits the
ability of both the Contracting State and the enterprise to
change accounting methods to be applied to the permanent
establishment. It does not, however, restrict a Contracting
State from imposing additional requirements, such as the rules
under Code section 481, to prevent amounts from being
duplicated or omitted following a change in accounting method.
Such adjustments may be necessary, for example, if the taxpayer
switches from using the domestic rules under section 864 in one
year to using the rules of Article 7 in the next. Also, if the
taxpayer switches from Convention-based rules to U.S. domestic
rules, it may need to meet certain deadlines for making
elections that are not necessary when applying the rules of the
Convention.
Paragraph 6
Paragraph 6 coordinates the provisions of Article 7 and
other provisions of the Convention. Under this paragraph, when
business profits include items of income that are dealt with
separately under other articles of the Convention, the
provisions of those articles will, except when they
specifically provide to the contrary, take precedence over the
provisions of Article 7. For example, the taxation of dividends
will be determined by the rules of Article 10 (Dividends), and
not by Article 7, except where, as provided in paragraph 6 of
Article 10, the dividend is attributable to a permanent
establishment. In the latter case the provisions of Article 7
apply. Thus, an enterprise of one State deriving dividends from
the other State may not rely on Article 7 to exempt those
dividends from tax at source if they are not attributable to a
permanent establishment of the enterprise in the other State.
By the same token, if the dividends are attributable to a
permanent establishment in the other State, the dividends may
be taxed on a net income basis at the source State full
corporate tax rate, rather than on a gross basis under Article
10.
As provided in Article 8 (Shipping and Air Transport),
income derived from shipping and air transport activities in
international traffic described in that Article is taxable only
in the country of residence of the enterprise regardless of
whether it is attributable to a permanent establishment
situated in the source State.
Paragraph 7
Paragraph 7 incorporates into the Convention the rule of
Code section 864(c)(6). Like the Code section on which it is
based, paragraph 7 provides that any income or gain
attributable to a permanent establishment during its existence
is taxable in the Contracting State where the permanent
establishment is situated, even if the payment of that income
or gain is deferred until after the permanent establishment
ceases to exist. This rule applies with respect to paragraphs 1
and 2 of Article 7 (Business Profits), paragraph 6 of Article
10, paragraph 4 of Article 11 (Interest), paragraph 3 of
Articles 12 (Royalties) and 13 (Capital Gains) and paragraph 2
of Article 20 (Other Income).
The effect of this rule can be illustrated by the following
example. Assume a company that is a resident of Iceland and
that maintains a permanent establishment in the United States
winds up the permanent establishment's business and sells the
permanent establishment's inventory and assets to a U.S. buyer
at the end of year 1 in exchange for an interest-bearing
installment obligation payable in full at the end of year 3.
Despite the fact that Article 13's threshold requirement for
U.S. taxation is not met in year 3 because the company has no
permanent establishment in the United States, the United States
may tax the deferred income payment recognized by the company
in year 3.
Relationship to Other Articles
This Article is subject to the saving clause of paragraph 4
of Article 1 (General Scope) of the Model. Thus, if a citizen
of the United States who is a resident of Iceland under the
treaty derives business profits from the United States that are
not attributable to a permanent establishment in the United
States, the United States may, subject to the special foreign
tax credit rules of paragraph 4 of Article 22 (Relief from
Double Taxation), tax those profits, notwithstanding the
provision of paragraph 1 of this Article which would exempt the
income from U.S. tax.
The benefits of this Article are also subject to Article 21
(Limitation on Benefits). Thus, an enterprise of Iceland that
derives income effectively connected with a U.S. trade or
business may not claim the benefits of Article 7 unless the
resident carrying on the enterprise qualifies for such benefits
under Article 21.
As provided in paragraph 3 of the Protocol, Articles 7 and
23 (Non-Discrimination) shall not prevent Iceland from
continuing to tax permanent establishments of United States
insurance companies in accordance with Article 70, paragraph 2,
section 3 of the Icelandic Tax Code, nor shall it prevent the
United States from continuing to tax permanent establishments
of Icelandic insurance companies in accordance with section
842(b) of the Code.
ARTICLE 8 (SHIPPING AND AIR TRANSPORT)
This Article governs the taxation of profits from the
operation of ships and aircraft in international traffic. The
term ``international traffic'' is defined in subparagraph 1(h)
of Article 3 (General Definitions).
Paragraph 1
Paragraph 1 provides that profits derived by an enterprise
of a Contracting State from the operation in international
traffic of ships or aircraft are taxable only in that
Contracting State. Because paragraph 6 of Article 7 (Business
Profits) defers to Article 8 with respect to shipping income,
such income derived by a resident of one of the Contracting
States may not be taxed in the other State even if the
enterprise has a permanent establishment in that other State.
Thus, if a U.S. airline has a ticket office in Iceland, Iceland
may not tax the airline's profits attributable to that office
under Article 7. Since entities engaged in international
transportation activities normally will have many permanent
establishments in a number of countries, the rule avoids
difficulties that would be encountered in attributing income to
multiple permanent establishments if the income were covered by
Article 7.
Paragraph 2
The income from the operation of ships or aircraft in
international traffic that is exempt from tax under paragraph 1
is defined in paragraph 2.
In addition to income derived directly from the operation
of ships and aircraft in international traffic, this definition
also includes certain items of rental income. First, income of
an enterprise of a Contracting State from the rental of ships
or aircraft on a full basis (i.e., with crew) is income of the
lessor from the operation of ships and aircraft in
international traffic and, therefore, is exempt from tax in the
other Contracting State under paragraph 1. Also, paragraph 2
encompasses income from the lease of ships or aircraft on a
bareboat basis (i.e., without crew), either when the income is
incidental to other income of the lessor from the operation of
ships or aircraft in international traffic, or when the ships
or aircraft are operated in international traffic by the
lessee. If neither of those two conditions apply, income from
the bareboat rentals would constitute business profits. The
coverage of Article 8 is therefore broader than that of Article
8 of the OECD Model, which covers bareboat leasing only when it
is incidental to other income of the lessor from the operation
of ships of aircraft in international traffic.
Paragraph 2 also clarifies, consistent with the Commentary
to Article 8 of the OECD Model, that income earned by an
enterprise from the inland transport of property or passengers
within either Contracting State falls within Article 8 if the
transport is undertaken as part of the international transport
of property or passengers by the enterprise. Thus, if a U.S.
shipping company contracts to carry property from Iceland to a
U.S. city and, as part of that contract, it transports the
property by truck from its point of origin to an airport in
Iceland (or it contracts with a trucking company to carry the
property to the airport) the income earned by the U.S. shipping
company from the overland leg of the journey would be taxable
only in the United States. Similarly, Article 8 also would
apply to all of the income derived from a contract for the
international transport of goods, even if the goods were
transported to the port by a lighter, not by the vessel that
carried the goods in international waters.
Finally, certain non-transport activities that are an
integral part of the services performed by a transport company,
or are ancillary to the enterprise's operation of ships or
aircraft in international traffic, are understood to be covered
in paragraph 1, though they are not specified in paragraph 2.
These include, for example, the provision of goods and services
by engineers, ground and equipment maintenance and staff, cargo
handlers, catering staff and customer services personnel. Where
the enterprise provides such goods to, or performs services
for, other enterprises and such activities are directly
connected with or ancillary to the enterprise's operation of
ships or aircraft in international traffic, the profits from
the provision of such goods and services to other enterprises
will fall under this paragraph.
For example, enterprises engaged in the operation of ships
or aircraft in international traffic may enter into pooling
arrangements for the purposes of reducing the costs of
maintaining facilities needed for the operation of their ships
or aircraft in other countries. For instance, where an airline
enterprise agrees (for example, under an International Airlines
Technical Pool agreement) to provide spare parts or maintenance
services to other airlines landing at a particular location
(which allows it to benefit from these services at other
locations), activities carried on pursuant to that agreement
will be ancillary to the operation of aircraft in international
traffic by the enterprise.
Also, advertising that the enterprise may do for other
enterprises in magazines offered aboard ships or aircraft that
it operates in international traffic or at its business
locations, such as ticket offices, is ancillary to its
operation of these ships or aircraft. Profits generated by such
advertising fall within this paragraph. Income earned by
concessionaires, however, is not covered by Article 8. These
interpretations of paragraph 1 also are consistent with the
Commen*tary to Article 8 of the OECD Model.
Paragraph 3
Under this paragraph, profits of an enterprise of a
Contracting State from the use, maintenance or rental of
containers (including equipment for their transport) used in
international traffic are exempt from tax in the other
Contracting State. This result obtains under paragraph 3
regardless of whether the recipient of the income is engaged in
the operation of ships or aircraft in international traffic,
and regardless of whether the enterprise has a permanent
establishment in the other Contracting State. Only income from
the use, maintenance or rental of containers that is incidental
to other income from international traffic is covered by
Article 8 of the OECD Model.
Paragraph 4
This paragraph clarifies that the provisions of paragraphs
1 and 3 also apply to profits derived by an enterprise of a
Contracting State from participation in a pool, joint business
or international operating agency. This refers to various
arrangements for international cooperation by carriers in
shipping and air transport. For example, airlines from two
countries may agree to share the transport of passengers
between the two countries. They each will fly the same number
of flights per week and share the revenues from that route
equally, regardless of the number of passengers that each
airline actually transports. Paragraph 4 makes clear that with
respect to each carrier the income dealt with in the Article is
that carrier's share of the total transport, not the income
derived from the passengers actually carried by the airline.
This paragraph corresponds to paragraph 4 of Article 8 of the
OECD Model.
Relationship to Other Articles
The taxation of gains from the alienation of ships,
aircraft or containers is not dealt with in this Article but in
paragraph 4 of Article 13 (Capital Gains).
As with other benefits of the Convention, the benefit of
exclusive residence country taxation under Article 8 is
available to an enterprise only if it is entitled to benefits
under Article 21 (Limitation on Benefits).
This Article also is subject to the saving clause of
paragraph 4 of Article 1 (General Scope) of the Model. Thus, if
a citizen of the United States who is a resident of Iceland
derives profits from the operation of ships or aircraft in
international traffic, notwithstanding the exclusive residence
country taxation in paragraph 1 of Article 8, the United States
may, subject to the special foreign tax credit rules of
paragraph 4 of Article 22 (Relief from Double Taxation), tax
those profits as part of the worldwide income of the citizen.
(This is an unlikely situation, however, because non-tax
considerations (e.g., insurance) generally result in shipping
activities being carried on in corporate form.)
ARTICLE 9 (ASSOCIATED ENTERPRISES)
This Article incorporates in the Convention the arm's-
length principle reflected in the U.S. domestic transfer
pricing provisions, particularly Code section 482. It provides
that when related enterprises engage in a transaction on terms
that are not arm's-length, the Contracting States may make
appropriate adjustments to the taxable income and tax liability
of such related enterprises to reflect what the income and tax
of these enterprises with respect to the transaction would have
been had there been an arm's-length relationship between them.
Paragraph 1
This paragraph is essentially the same as its counterpart
in the U.S. and OECD Models. It addresses the situation where
an enterprise of a Contracting State is related to an
enterprise of the other Contracting State, and there are
arrangements or conditions imposed between the enterprises in
their commercial or financial relations that are different from
those that would have existed in the absence of the
relationship. Under these circumstances, the Contracting States
may adjust the income (or loss) of the enterprise to reflect
what it would have been in the absence of such a relationship.
The paragraph identifies the relationships between
enterprises that serve as a prerequisite to application of the
Article. As the Commentary to the OECD Model makes clear, the
necessary element in these relationships is effective control,
which is also the standard for purposes of section 482. Thus,
the Article applies if an enterprise of one State participates
directly or indirectly in the management, control, or capital
of the enterprise of the other State. Also, the Article applies
if any third person or persons participate directly or
indirectly in the management, control, or capital of
enterprises of different States. For this purpose, all types of
control are included, i.e., whether or not legally enforceable
and however exercised or exercisable.
The fact that a transaction is entered into between such
related enterprises does not, in and of itself, mean that a
Contracting State may adjust the income (or loss) of one or
both of the enterprises under the provisions of this Article.
If the conditions of the transaction are consistent with those
that would be made between independent persons, the income
arising from that trans-action should not be subject to
adjustment under this Article.
Similarly, the fact that associated enterprises may have
concluded arrangements, such as cost sharing arrangements or
general services agreements, is not in itself an indication
that the two enterprises have entered into a non-arm's-length
transaction that should give rise to an adjustment under
paragraph 1. Both related and unrelated parties enter into such
arrangements (e.g., joint venturers may share some development
costs). As with any other kind of transaction, when related
parties enter into an arrangement, the specific arrangement
must be examined to see whether or not it meets the arm's-
length standard. In the event that it does not, an appropriate
adjustment may be made, which may include modifying the terms
of the agreement or re-characterizing the transaction to
reflect its substance.
It is understood that the ``commensurate with income''
standard for determining appropriate transfer prices for
intangibles, added to Code section 482 by the Tax Reform Act of
1986, was designed to operate consistently with the arm's-
length standard. The implementation of this standard in the
section 482 regulations is in accordance with the general
principles of paragraph 1 of Article 9 of the Convention, as
interpreted by the OECD Transfer Pricing Guidelines.
This Article also permits tax authorities to deal with thin
capitalization issues. They may, in the context of Article 9,
scrutinize more than the rate of interest charged on a loan
between related persons. They also may examine the capital
structure of an enterprise, whether a payment in respect of
that loan should be treated as interest, and, if it is treated
as interest, under what circumstances interest deductions
should be allowed to the payor. Paragraph 2 of the Commentary
to Article 9 of the OECD Model, together with the U.S.
observation set forth in paragraph 15, sets forth a similar
understanding of the scope of Article 9 in the context of thin
capitalization.
Paragraph 2
When a Contracting State has made an adjustment that is
consistent with the provisions of paragraph 1, and the other
Contracting State agrees that the adjustment was appropriate to
reflect arm's-length conditions, that other Contracting State
is obligated to make a correlative adjustment (sometimes
referred to as a ``corresponding adjustment'') to the tax
liability of the related person in that other Contracting
State. Although the OECD Model does not specify that the other
Contracting State must agree with the initial adjustment before
it is obligated to make the correlative adjustment, the
Commentary makes clear that the paragraph is to be read that
way.
As explained in the Commentary to Article 9 of the OECD
Model, Article 9 leaves the treatment of ``secondary
adjustments'' to the laws of the Contracting States. When an
adjustment under Article 9 has been made, one of the parties
will have in its possession funds that it would not have had at
arm's length. The question arises as to how to treat these
funds. In the United States the general practice is to treat
such funds as a dividend or contribution to capital, depending
on the relationship between the parties. Under certain
circumstances, the parties may be permitted to restore the
funds to the party that would have the funds had the
transactions been entered into on arm's length terms, and to
establish an account payable pending restoration of the funds.
See Rev. Proc. 99-32, 1999-2 C.B. 296.
The Contracting State making a secondary adjustment will
take the other provisions of the Convention, where relevant,
into account. For example, if the effect of a secondary
adjustment is to treat a U.S. corporation as having made a
distribution of profits to its parent corporation in the other
Contracting State, the provisions of Article 10 (Dividends)
will apply, and the United States may impose a 5 percent
withholding tax on the dividend. Also, if under Article 22
(Relief from Double Taxation) the other State generally gives a
credit for taxes paid with respect to such dividends, it would
also be required to do so in this case.
The competent authorities are authorized by paragraph 3 of
Article 24 (Mutual Agreement Procedure) to consult, if
necessary, to resolve any differences in the application of
these provisions. For example, there may be a disagreement over
whether an adjustment made by a Contracting State under
paragraph 1 was appropriate.
If a correlative adjustment is made under paragraph 2, it
is to be implemented, pursuant to paragraph 2 of Article 24,
notwithstanding any time limits or other procedural limitations
in the law of the Contracting State making the adjustment. If a
taxpayer has entered a closing agreement (or other written
settlement) with the United States prior to bringing a case to
the competent authorities, the U.S. competent authority will
endeavor only to obtain a correlative adjustment from Iceland.
See Rev. Proc. 2006-54, 2006-49 I.R.B.1035, Section 7.05.
Relationship to Other Articles
The saving clause of paragraph 4 of Article 1 (General
Scope) does not apply to paragraph 2 of Article 9 by virtue of
an exception to the saving clause in subparagraph 5(a) of
Article 1. Thus, even if the statute of limitations has run, a
refund of tax can be made in order to implement a correlative
adjustment. Statutory or procedural limitations, however,
cannot be overridden to impose additional tax, because
paragraph 2 of Article 1 provides that the Convention cannot
restrict any statutory benefit.
ARTICLE 10 (DIVIDENDS)
Article 10 provides rules for the taxation of dividends
paid by a company that is a resident of one Contracting State
to a beneficial owner that is a resident of the other
Contracting State. The Article provides for full residence
State taxation of such dividends and a limited source-State
right to tax. Article 10 also provides rules for the imposition
of a tax on branch profits by the State of source. Finally, the
article prohibits a State from imposing taxes on a company
resident in the other Contracting State, other than a branch
profits tax, on undistributed earnings.
Paragraph 1
The right of a shareholder's country of residence to tax
dividends arising in the source country is preserved by
paragraph 1, which permits a Contracting State to tax its
residents on dividends paid to them by a company that is a
resident of the other Contracting State. For dividends from any
other source paid to a resident, Article 20 (Other Income)
grants the residence country exclusive taxing jurisdiction
(other than for dividends attributable to a permanent
establishment in the other State).
Paragraph 2
The State of source also may tax dividends beneficially
owned by a resident of the other State, subject to the
limitations of paragraphs 2 and 3. Paragraph 2 generally limits
the rate of withholding tax in the State of source on dividends
paid by a company resident in that State to 15 percent of the
gross amount of the dividend. If, however, the beneficial owner
of the dividend is a company resident in the other State and
owns directly shares representing at least 10 percent of the
share capital, as represented as voting power of the company
paying the dividend, then the rate of withholding tax in the
State of source is limited to 5 percent of the gross amount of
the dividend. 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 benefits of paragraph 2 may be granted at the time of
payment by means of reduced rate of withholding tax at source.
It also is consistent with the paragraph 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 determination of whether the ownership threshold for
subparagraph 2(a) is met for purposes of the 5 percent maximum
rate of withholding tax is made on the date on which
entitlement to the dividend is determined. Thus, in the case of
a dividend from a U.S. company, the determination of whether
the ownership threshold is met generally would be made on the
dividend record date.
Paragraph 2 does not affect the taxation of the profits out
of which the dividends are paid. The taxation by a Contracting
State of the income of its resident companies is governed by
the internal law of the Contracting State, subject to the
provisions of paragraph 4 of Article 23 (Non-Discrimination).
The term ``beneficial owner'' is not defined in the
Convention, and is, therefore, defined as under the internal
law of the country imposing tax (i.e., the source country). 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, if a
dividend paid by a corporation that is a resident of one of the
States (as determined under Article 4 (Resident)) is received
by a nominee or agent that is a resident of the other State on
behalf of a person that is 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.
These limitations are confirmed by paragraph 12 of the
Commentary to Article 10 of the OECD Model.
Special rules, however, apply to shares that are held
through fiscally transparent entities. In that case, the rules
of paragraph 6 of Article 1 (General Scope) will apply to
determine whether the dividends should be treated as having
been derived by a resident of a Contracting State. Residence
State principles shall be used to determine who derives the
dividend, to assure that the dividends for which the source
State grants benefits of the Convention will be taken into
account for tax purposes by a resident of the residence State.
Source State principles of beneficial ownership shall then
apply to determine whether the person who derives the
dividends, or another resident of the other Contracting State,
is the beneficial owner of the dividend. The source State may
conclude that the person who derives the dividend in the
residence State is a mere nominee, agent, conduit, etc., for a
third country resident and deny benefits of the Convention. If
the person who derives the dividend under paragraph 6 of
Article 1 would not be treated under the source State's
principles for determining beneficial ownership as a nominee,
agent, custodian, conduit, etc., that person will be treated as
the beneficial owner of the income, profits or gains for
purposes of the Convention.
Assume, for instance, that a company resident in Iceland
pays a dividend to LLC, an entity which is treated as fiscally
transparent for U.S. tax purposes but is treated as a company
for Icelandic tax purposes. USCo, a company incorporated in the
United States, is the sole interest holder in LLC. Paragraph 6
of Article 1 provides that USCo derives the dividend. Iceland's
principles of beneficial ownership shall then be applied to
USCo. If under the laws of Iceland USCo is found not to be the
beneficial owner of the dividend, USCo will not be entitled to
the benefits of Article 10 with respect to such dividend. The
payment may be entitled to benefits, however, if USCo is found
to be a nominee, agent, custodian or conduit for a person who
is a resident of the United States.
Beyond identifying the person to whom the principles of
beneficial ownership shall be applied, the principles of
paragraph 6 of Article 1 will also apply when determining
whether other requirements, such as the ownership threshold of
subparagraph 2(a) have been satisfied.
For example, assume that IceCo, a company that is a
resident of Iceland, owns all of the outstanding shares in
ThirdDE, an entity that is disregarded for U.S. tax purposes
that is resident in a third country. ThirdDE owns 100% of the
stock of USCo. Iceland views ThirdDE as fiscally transparent
under its domestic law, and taxes IceCo currently on the income
derived by ThirdDE. In this case, IceCo is treated as deriving
the dividends paid by USCo under paragraph 6 of Article 1.
Moreover, IceCo is treated as owning the shares of USCo
directly. The Convention does not address what constitutes
direct ownership for purposes of Article 10. As a result,
whether ownership is direct is determined under the internal
law of the country imposing tax (i.e., the source country)
unless the context otherwise requires. Accordingly, a company
that holds stock through such an entity will generally be
considered to directly own such stock for purposes of Article
10.
This result may change, however, if ThirdDE is regarded as
non-fiscally transparent under the laws of Iceland. Assuming
that ThirdDE is treated as non-fiscally transparent by Iceland,
the income will not be treated as derived by a resident of
Iceland for purposes of the Convention. However, ThirdDE may
still be entitled to the benefits of the U.S. tax treaty, if
any, with its country of residence.
The same principles would apply in determining whether
companies holding shares through fiscally transparent entities
such as partnerships, trusts, and estates would qualify for
benefits. As a result, companies holding shares through such
entities may be able to claim the benefits of subparagraph 2(a)
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, and the
company meets the requirements of Article 1(6) (i.e., the
company's country of residence treats the intermediate entity
as fiscally transparent) with respect to the dividend. Whether
this ownership threshold is satisfied may be difficult to
determine and often will require an analysis of the partnership
or trust agreement.
Paragraph 3
Paragraph 3 imposes limitations on the rate reductions
provided by paragraphs 2 and 3 in the case of dividends paid by
RIC or a REIT.
The first sentence of subparagraph 3(a) provides that
dividends paid by a RIC or REIT are not eligible for the 5
percent rate of withholding tax of subparagraph 2(a).
The second sentence of subparagraph 3(a) provides that the
15 percent maximum rate of withholding tax of subparagraph 2(b)
applies to dividends paid by RICs.
The third sentence of subparagraph 3(a) provides that the
15 percent rate of withholding tax also applies to dividends
paid by a REIT provided that one of the three following
conditions is met. First, the beneficial owner of the dividend
is an individual or a pension fund, in either case 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 beneficial owner of the dividend is a
person holding an interest of not more than 5 percent of any
class of the REIT's shares. Third, the beneficial owner of the
dividend holds an interest in the REIT of not more than 10
percent and the REIT is ``diversified.'' A REIT is diversified
if 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. 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 restrictions set out above are intended to prevent the
use of these entities to gain inappropriate U.S. tax benefits.
For example, a company resident in Iceland that wishes to hold
a diversified portfolio of U.S. corporate shares could hold the
portfolio directly and would bear a U.S. withholding tax of 15
percent on all of the dividends that it receives.
Alternatively, it could hold the same diversified portfolio by
purchasing 10 percent or more of the interests in a RIC. If the
RIC is a pure conduit, there may be no U.S. tax cost to
interposing the RIC in the chain of ownership. Absent the
special rule in paragraph 3, such use of the RIC could
transform portfolio dividends, taxable in the United States
under the Convention at a 15 percent maximum rate of
withholding tax, into direct investment dividends taxable at a
5 percent maximum rate of withholding tax or eligible for the
elimination of source-country withholding tax on dividends paid
to pension funds as provided in paragraph 4.
Similarly, a resident of Iceland directly holding U.S. real
property would pay U.S. tax upon the sale of the property
either at a 30 percent rate of withholding tax on the gross
income or at graduated rates on the net income. As in the
preceding example, by placing the real property in a REIT, the
investor could, absent a special rule, transform income from
the sale of real estate into dividend income from the REIT,
taxable at the rates provided in Article 10, significantly
reducing the U.S. tax that otherwise would be imposed.
Paragraph 3 prevents this result and thereby avoids a disparity
between the taxation of direct real estate investments and real
estate investments made through REIT conduits. In the cases in
which paragraph 3 allows a dividend from a REIT to be eligible
for the 15 percent rate of withholding tax, the holding in the
REIT is not considered the equivalent of a direct holding in
the underlying real property.
Paragraph 4
Paragraph 4 provides that dividends beneficially owned by a
pension scheme or employee benefits organization may not be
taxed in the Contracting State of which the company paying the
tax is a resident. However, the exemption provided in paragraph
4 shall not apply if the dividends are derived from the
carrying on of a business, directly or indirectly, by the
pension scheme or employee benefits organization. For these
purposes, the term ``pension scheme'' is defined in
subparagraph 1(l) of Article 3 (General Definitions).
The exemption is provided because pension schemes and
employee benefits organizations normally do not pay tax (either
through a general exemption or because reserves for future
pension liabilities effectively offset all of the fund's
income), and therefore cannot benefit from a foreign tax
credit. Moreover, distributions from a pension fund generally
do not maintain the character of the underlying income, so the
beneficiaries of the pension are not in a position to claim a
foreign tax credit when they finally receive the pension, in
many cases years after the withholding tax has been paid.
Accordingly, in the absence of this rule, the dividends would
almost certainly be subject to unrelieved double taxation.
Paragraph 5
Paragraph 5 defines the term dividends broadly and
flexibly. The definition is intended to cover all arrangements
that yield a return on an equity investment 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 term includes income from shares, or other corporate
rights that are not treated as debt under the law of the source
State, that participate in the profits of the company. The term
also includes income that is subjected to the same tax
treatment as income from shares by the law of the State of
source. Thus, a constructive dividend that results from a non-
arm's length transaction between a corporation and a related
party is a dividend. In the case of the United States the term
dividend includes amounts treated as a dividend under U.S. law
upon the sale or redemption of shares or upon a transfer of
shares in a reorganization. See, e.g., Rev. Rul. 92-85, 1992-2
C.B. 69 (sale of foreign subsidiary's stock to U.S. sister
company is a deemed dividend to extent of the subsidiary's and
sister company's earnings and profits). Further, a distribution
from a U.S. publicly traded limited partnership, which is taxed
as a corporation under U.S. law, is a dividend for purposes of
Article 10. However, a distribution by a limited liability
company is not taxable by the United States under Article 10,
provided the limited liability company is not characterized as
an association taxable as a corporation under U.S. law.
Finally, a payment denominated as interest that is made by
a thinly capitalized corporation may be treated as a dividend
to the extent that the debt is recharacterized as equity under
the laws of the source State.
Paragraph 6
Paragraph 6 provides a rule for taxing dividends paid with
respect to holdings that form part of the business property of
a permanent establishment. In such case, the rules of Article 7
(Business Profits) shall apply. Accordingly, the dividends will
be taxed on a net basis using the rates and rules of taxation
generally applicable to residents of the State in which the
permanent establishment is located, as such rules may be
modified by the Convention. An example of dividends paid with
respect to the business property of a permanent establishment
would be dividends derived by a dealer in stock or securities
from stock or securities that the dealer held for sale to
customers.
Paragraph 7
The right of a Contracting State to tax dividends paid by a
company that is a resident of the other Contracting State is
restricted by paragraph 7 to cases in which the dividends are
paid to a resident of that Contracting State or are
attributable to a permanent establishment or fixed base in that
Contracting State. Thus, a Contracting State may not impose a
``secondary'' withholding tax on dividends paid by a
nonresident company out of earnings and profits from that
Contracting State
The paragraph also restricts the right of a Contracting
State to impose corporate level taxes on undistributed profits,
other than a branch profits tax. The paragraph does not
restrict a State's right to tax its resident shareholders on
undistributed earnings of a corporation resident in the other
State. Thus, the authority of the United States to impose taxes
on subpart F income and on earnings deemed invested in U.S.
property, and its tax on income of a passive foreign investment
company that is a qualified electing fund is in no way
restricted by this provision.
Paragraph 8
Paragraph 8 permits a Contracting State to impose a branch
profits tax on a company resident in the other Contracting
State. The tax is in addition to other taxes permitted by the
Convention. The term ``company'' is defined in subparagraph
1(d) of Article 3 (General Definitions).
A Contracting State may impose a branch profits tax on a
company if the company has income attributable to a permanent
establishment in that Contracting State, derives income from
real property in that Contracting State that is taxed on a net
basis under Article 6 (Income from Immovable Property (Real
Property)), or realizes gains taxable in that State under
paragraph 1 of Article 13 (Capital Gains). In the case of the
United States, the imposition of such tax is limited, however,
to the portion of the aforementioned items of income that
represents the amount of such income that is the ``dividend
equivalent amount.'' This is consistent with the relevant rules
under the U.S. branch profits tax, and the term dividend
equivalent amount is defined in paragraph 4 of the Protocol as
that portion of the income mentioned in paragraph 7 of Article
10 that is comparable to the amount that would be distributed
as a dividend if such income were earned by a subsidiary
incorporated in the United States. For any year, a foreign
corporation's dividend equivalent amount is equal to the after-
tax earnings attributable to the foreign corporation's (i)
income attributable to a permanent establishment in the United
States, (ii) income from real property in the United States
that is taxed on a net basis under Article 6 (Income from
Immovable Property (Real Property)), and (iii) gain from a real
property interest taxable by the United States under paragraph
1 of Article 13 (Capital Gains), reduced by any increase in the
foreign corporation's net investment in U.S. assets or
increased by any reduction in the foreign corporation's net
investment in U.S. assets.
The dividend equivalent amount for any year approximates
the dividend that a U.S. branch office would have paid during
the year if the branch had been operated as a separate U.S.
subsidiary company. If Iceland also imposes a branch profits
tax, the base of its tax must be limited to an amount that is
analogous to the dividend equivalent amount.
As discussed in the Technical Explanations to Articles 1(2)
and 7(2), consistency principles require that a taxpayer may
not mix and match the rules of the Code and the Convention in
an inconsistent manner. In the context of the branch profits
tax, the consistency requirement means that an enterprise that
uses the principles of Article 7 to determine its net taxable
income also must use the principles in determining the dividend
equivalent amount. Similarly, an enterprise that uses U.S.
domestic law to determine its net taxable income must also use
U.S. domestic law in complying with the branch profits tax. As
in the case of Article 7, if an enterprise switches between
domestic law and treaty principles from year to year, it will
need to make appropriate adjustments or recapture amounts that
otherwise might go untaxed.
Paragraph 9
Paragraph 9 provides that the branch profits tax shall not
be imposed at a rate exceeding the direct investment dividend
withholding rate of five percent.
Relationship to Other Articles
Notwithstanding the foregoing limitations on source country
taxation of dividends, the saving clause of paragraph 4 of
Article 1 permits the United States to tax dividends received
by its residents and citizens, subject to the special foreign
tax credit rules of paragraph 4 of Article 22 (Relief from
Double Taxation), as if the Convention had not come into
effect.
The benefits of this Article are also subject to the
provisions of Article 21 (Limitation on Benefits). Thus, if a
resident of the other Contracting State is the beneficial owner
of dividends paid by a U.S. corporation, the shareholder must
qualify for treaty benefits under at least one of the tests of
Article 21 in order to receive the benefits of this Article.
ARTICLE 11 (INTEREST)
Article 11 specifies the taxing jurisdictions over interest
income of the States of source and residence and defines the
terms necessary to apply the Article.
Paragraph 1
Paragraph 1 generally grants to the State of residence the
exclusive right to tax interest beneficially owned by its
residents and arising in the other Contracting State.
The term ``beneficial owner'' is not defined in the
Convention, and is, therefore, defined under the internal law
of the State of source. The beneficial owner of the interest
for purposes of
Article 11 is the person to which the income is
attributable under the laws of the source State. Thus, if
interest arising in a Contracting State is received by a
nominee or agent that is a resident of the other State on
behalf of a person that is not a resident of that other State,
the interest is not entitled to the benefits of Article 11.
However, interest received by a nominee on behalf of a resident
of that other State would be entitled to benefits. These
limitations are confirmed by paragraph 9 of the OECD Commentary
to Article 11.
Paragraph 2
The term ``interest'' as used in Article 11 is defined in
paragraph 2 to include, inter alia, income from debt claims of
every kind, whether or not secured by a mortgage. Penalty
charges for late payment are excluded from the definition of
interest. Interest that is paid or accrued subject to a
contingency is within the ambit of Article 11. This includes
income from a debt obligation carrying the right to participate
in profits. The term does not, however, include amounts that
are treated as dividends under Article 10 (Dividends).
The term interest also includes amounts subject to the same
tax treatment as income from money lent under the law of the
State in which the income arises. Thus, for purposes of the
Convention, amounts that the United States will treat as
interest include (i) the difference between the issue price and
the stated redemption price at maturity of a debt instrument
(i.e., original issue discount (``OID'')), which may be wholly
or partially realized on the disposition of a debt instrument
(section 1273), (ii) amounts that are imputed interest on a
deferred sales contract (section 483), (iii) amounts treated as
interest or OID under the stripped bond rules (section 1286),
(iv) amounts treated as original issue discount under the
below-market interest rate rules (section 7872), (v) a
partner's distributive share of a partnership's interest income
(section 702), (vi) the interest portion of periodic payments
made under a ``finance lease'' or similar contractual
arrangement that in substance is a borrowing by the nominal
lessee to finance the acquisition of property, (vii) amounts
included in the income of a holder of a residual interest in a
REMIC (section 860E), because these amounts generally are
subject to the same taxation treatment as interest under U.S.
tax law, and (viii) interest with respect to notional principal
contracts that are re-characterized as loans because of a
``substantial non-periodic payment.''
Paragraph 3
Paragraph 3 provides an exception to the exclusive
residence taxation rule of paragraph 1 and the source-country
gross taxation rule of paragraph 5 in cases where the
beneficial owner of the interest carries on business through a
permanent establishment in the State of source situated in that
State and the interest is attributable to that permanent
establishment. In such cases the provisions of Article 7
(Business Profits) will apply and the State of source will
retain the right to impose tax on such interest income.
In the case of a permanent establishment that once existed
in the State but that no longer exists, the provisions of
paragraph 3 also apply, by virtue of paragraph 7 of Article 7,
to interest that would be attributable to such a permanent
establishment or fixed base if it did exist in the year of
payment or accrual. See the Technical Explanation of paragraph
7 of Article 7.
Paragraph 4
Paragraph 4 provides that in cases involving special
relationships between the payor and the beneficial owner of
interest income, Article 11 applies only to that portion of the
total interest payments that would have been made absent such
special relationships (i.e., an arm's length interest payment).
Any excess amount of interest paid remains taxable according to
the laws of the United States and Iceland, respectively, with
due regard to the other provisions of the Convention. Thus, if
the excess amount would be treated under the source country's
law as a distribution of profits by a corporation, such amount
could be taxed as a dividend rather than as interest, but the
tax would be subject, if appropriate, to the rate limitations
of paragraph 2 of Article 10.
The term ``special relationship'' is not defined in the
Convention. In applying this paragraph the United States
considers the term to include the relationships described in
Article 9, which in turn corresponds to the definition of
``control'' for purposes of section 482 of the Code.
This paragraph does not address cases where, owing to a
special relationship between the payer and the beneficial owner
or between both of them and some other person, the amount of
the interest is less than an arm's-length amount. In those
cases a transaction may be characterized to reflect its
substance and interest may be imputed consistent with the
definition of interest in paragraph 3. The United States would
apply section 482 or 7872 of the Code to determine the amount
of imputed interest in those cases.
Paragraph 5
Paragraph 5 provides anti-abuse exceptions to the source-
country exemption in paragraph 1 for two classes of interest
payments.
The first class of interest, dealt with in subparagraph
5(a) is so-called ``contingent interest.'' Under this
provision, interest arising in a Contracting State that is
determined by reference to the receipts, sales, income, profits
or other cash flow of the debtor or a related person, to any
change in the value of any property of the debtor or a related
person or to any dividend, partnership distribution or similar
payment made by the debtor or a related person, and paid to a
resident of the other State may also be taxed in the
Contracting State. Any such interest may be taxed in that
Contracting State according to the laws of that State. However,
if the beneficial owner is a resident of the other Contracting
State, the gross amount of the interest may be taxed at a rate
not exceeding 15 percent.
The second class of interest is dealt with in subparagraph
5(b). This exception is consistent with the policy of Code
sections 860E(e) and 860G(b) that excess inclusions with
respect to a real estate mortgage investment conduit (REMIC)
should bear full U.S. tax in all cases. Without a full tax at
source foreign purchasers of residual interests would have a
competitive advantage over U.S. purchasers at the time these
interests are initially offered. Also, absent this rule, the
U.S. fisc would suffer a revenue loss with respect to mortgages
held in a REMIC because of opportunities for tax avoidance
created by differences in the timing of taxable and economic
income produced by these interests.
Relationship to Other Articles
Notwithstanding the foregoing limitations on source country
taxation of interest, the saving clause of paragraph 4 of
Article 1 (General Scope) permits the United States to tax its
residents and citizens, subject to the special foreign tax
credit rules of paragraph 4 of Article 22 (Relief from Double
Taxation), as if the Convention had not come into force.
As with other benefits of the Convention, the benefits of
Article 11 are available to a resident of the other State only
if that resident is entitled to those benefits under the
provisions of Article 21 (Limitation on Benefits).
ARTICLE 12 (ROYALTIES)
Article 12 provides rules for the taxation of royalties
arising in one Contracting State and paid to a beneficial owner
that is a resident of the other Contracting State.
Paragraph 1
Paragraph 1 generally grants to the State of residence the
exclusive right to tax royalties beneficially owned by its
residents and arising in the other Contracting State.
The term ``beneficial owner'' is not defined in the
Convention, and is, therefore, defined under the internal law
of the State of source. The beneficial owner of the royalty for
purposes of Article 12 is the person to which the income is
attributable under the laws of the source State. Thus, if a
royalty arising in a Contracting State is received by a nominee
or agent that is a resident of the other State on behalf of a
person that is not a resident of that other State, the royalty
is not entitled to the benefits of Article 12. However, a
royalty received by a nominee on behalf of a resident of that
other State would be entitled to benefits. These limitations
are confirmed by paragraph 4 of the OECD Commentary to Article
12.
Paragraph 2
Paragraph 2 provides that notwithstanding the provisions of
paragraph 1, the following royalties may be taxed in the
Contracting State in which they arise: royalties paid in
consideration for the use of, or the right to use a trademark
and any information concerning industrial, commercial or
scientific experience provided in connection with a rental or
franchise agreement that includes rights to use a trademark,
and royalties paid in consideration for the use of or the right
to use a motion picture film or work on film or videotape or
other means of reproduction for use in connection with
television. If, however, the beneficial owner of the royalty is
a resident of the other Contracting State, the tax may not
exceed 5 percent of the gross amount of the royalties.
Paragraph 3
Paragraph 2 defines the term ``royalties,'' as used in
Article 12, to include any consideration for the use of, or the
right to use, any copyright of literary, artistic, scientific
or other work (such as computer software and cinematographic
films), any patent, trademark, design or model, plan, secret
formula or process, or for information concerning industrial,
commercial, or scientific experience. The term ``royalties,''
however, does not include income from leasing personal
property.
The term royalties is defined in the Convention and
therefore is generally independent of domestic law. Certain
terms used in the definition are not defined in the Convention,
but these may be defined under domestic tax law. For example,
the term ``secret process or formulas'' is found in the Code,
and its meaning has been elaborated in the context of sections
351 and 367. See Rev. Rul. 55-17, 1955-1 C.B. 388; Rev. Rul.
64-56, 1964-1 C.B. 133; Rev. Proc. 69-19, 1969-2 C.B. 301.
Consideration for the use or right to use cinematographic
films, or works on film, tape, or other means of reproduction
in radio or television broadcasting is specifically included in
the definition of royalties. It is intended that, with respect
to any subsequent technological advances in the field of radio
or television broadcasting, consideration received for the use
of such technology will also be included in the definition of
royalties.
If an artist who is resident in one Contracting State
records a performance in the other Contracting State, retains a
copyrighted interest in a recording, and receives payments for
the right to use the recording based on the sale or public
playing of the recording, then the right of such other
Contracting State to tax those payments is governed by Article
12. See Boulez v. Commissioner, 83 T.C. 584 (1984), aff'd, 810
F.2d 209 (D.C. Cir. 1986). By contrast, if the artist earns in
the other Contracting State income covered by Article 16
(Entertainers and Sportsmen), for example, endorsement income
from the artist's attendance at a film screening, and if such
income also is attributable to one of the rights described in
Article 12 (e.g., the use of the artist's photograph in
promoting the screening), Article 16 and not Article 12 is
applicable to such income.
Computer software generally is protected by copyright laws
around the world. Under the Convention, consideration received
for the use, or the right to use, computer software is treated
either as royalties or as business profits, depending on the
facts and circumstances of the transaction giving rise to the
payment.
The primary factor in determining whether consideration
received for the use, or the right to use, computer software is
treated as royalties or as business profits is the nature of
the rights transferred. See Treas. Reg. section 1.861-18. The
fact that the transaction is characterized as a license for
copyright law purposes is not dispositive. For example, a
typical retail sale of ``shrink wrap'' software generally will
not be considered to give rise to royalty income, even though
for copyright law purposes it may be characterized as a
license.
The means by which the computer software is transferred are
not relevant for purposes of the analysis. Consequently, if
software is electronically transferred but the rights obtained
by the transferee are substantially equivalent to rights in a
program copy, the payment will be considered business profits.
The term ``industrial, commercial, or scientific
experience'' (sometimes referred to as ``know-how'') has the
meaning ascribed to it in paragraph 11 et seq. of the
Commentary to Article 12 of the OECD Model. Consistent with
that meaning, the term may include information that is
ancillary to a right otherwise giving rise to royalties, such
as a patent or secret process.
Know-how also may include, in limited cases, technical
information that is conveyed through technical or consultancy
services. It does not include general educational training of
the user's employees, nor does it include information developed
especially for the user, such as a technical plan or design
developed according to the user's specifications. Thus, as
provided in paragraph 11.3 of the Commentary to Article 12 of
the OECD Model, the term ``royalties'' does not include
payments received as consideration for after-sales service, for
services rendered by a seller to a purchaser under a warranty,
or for pure technical assistance.
The term ``royalties'' also does not include payments for
professional services (such as architectural, engineering,
legal, managerial, medical, software development services). For
example, income from the design of a refinery by an engineer
(even if the engineer employed know-how in the process of
rendering the design) or the production of a legal brief by a
lawyer is not income from the transfer of know-how taxable
under Article 12, but is income from services taxable under
either Article 7 (Business Profits) or Article 14 (Income from
Employment). Professional services may be embodied in property
that gives rise to royalties, however. Thus, if a professional
contracts to develop patentable property and retains rights in
the resulting property under the development contract,
subsequent license payments made for those rights would be
royalties.
Paragraph 4
This paragraph provides an exception in cases where the
beneficial owner of the royalties carries on business through a
permanent establishment in the state of source and the
royalties are attributable to that permanent establishment. In
such cases the provisions of Article 7 will apply.
The provisions of paragraph 7 of Article 7 apply to this
paragraph. For example, royalty income that is attributable to
a permanent establishment and that accrues during the existence
of the permanent establishment, but is received after the
permanent establishment no longer exists, remains taxable under
the provisions of Article 7, and not under this Article.
Paragraph 5
Paragraph 5 contains the source rule for royalties. Under
paragraph 5, royalties are treated as arising in a Contracting
State if paid by a resident of that State. As an exception,
royalties that are attributable to a permanent establishment in
a Contracting State and borne by the permanent establishment
are considered to arise in that State. Where, however, the
payor of the royalties is not a resident of either Contracting
State, and the royalties are not borne by a permanent
establishment in either Contracting State, but the royalties
are for the use of, or the right to use, in one of the
Contracting States, any property or right described in
paragraph 3, the royalties are deemed to arise in that State.
Paragraph 6
Paragraph 6 provides that in cases involving special
relationships between the payor and beneficial owner of
royalties, Article 12 applies only to the extent the royalties
would have been paid absent such special relationships (i.e.,
an arm's-length royalty). Any excess amount of royalties paid
remains taxable according to the laws of the two Contracting
States, with due regard to the other provisions of the
Convention. If, for example, the excess amount is treated as a
distribution of corporate profits under domestic law, such
excess amount will be taxed as a dividend rather than as
royalties, but the tax imposed on the dividend payment will be
subject to the rate limitations of paragraph 2 of Article 10
(Dividends).
1Relationship to Other Articles
Notwithstanding the foregoing limitations on source country
taxation of royalties, the saving clause of paragraph 4 of
Article 1 (General Scope) permits the United States to tax its
residents and citizens, subject to the special foreign tax
credit rules of paragraph 4 of Article 22 (Relief from Double
Taxation), as if the Convention had not come into force.
As with other benefits of the Convention, the benefits of
Article 12 are available to a resident of the other State only
if that resident is entitled to those benefits under Article 21
(Limitation on Benefits).
ARTICLE 13 (CAPITAL GAINS)
Article 13 assigns either primary or exclusive taxing
jurisdiction over gains from the alienation of property to the
State of residence or the State of source.
Paragraph 1
Paragraph 1 of Article 13 preserves the non-exclusive right
of the State of source to tax from the alienation of immovable
property (real property) situated in that State. For purposes
of paragraph 1, in all events the term ``immovable property
(real property) situated in the other State'' includes a United
States real property interest in the United States, as that
term is defined in the Internal Revenue Code on the date of
signature of the Convention, and as amended (without changing
the general principles of paragraph 1). Thus, the United States
preserves its right to collect the tax imposed by section 897
of the Code on gains derived by foreign persons from the
disposition of United States real property interests, including
gains arising from indirect dispositions described in section
897(h).
Paragraph 2
This paragraph defines the term ``immovable property (real
property) situated in the other Contracting State.'' The term
includes real property referred to in Article 6 (i.e., an
interest in the real property itself), rights to assets to be
produced by the exploration or exploitation of the seabed and
subsoil of that other State and their natural resources,
including rights to interests in or the benefit of such assets,
a ``United States real property interest'' (when the United
States is the other Contracting State under paragraph 1), and,
as specified in subparagraph 2(d), an equivalent interest in
immovable property (real property) situated in Iceland.
Under section 897(c) of the Code the term ``United States
real property interest'' includes shares in a U.S. corporation
that owns sufficient U.S. real property interests to satisfy an
asset-ratio test on certain testing dates. The term also
includes certain foreign corporations that have elected to be
treated as U.S. corporations for this purpose. Section 897(i).
Paragraph 3
Paragraph 3 of Article 13 deals with the taxation of
certain gains from the alienation of movable property forming
part of the business property of a permanent establishment that
an enterprise of a Contracting State has in the other
Contracting State. This also includes gains from the alienation
of such a permanent establishment (alone or with the whole
enterprise). Such gains may be taxed in the State in which the
permanent establishment is located.
A resident of Iceland that is a partner in a partnership
doing business in the United States generally will have a
permanent establishment in the United States as a result of the
activities of the partnership, assuming that the activities of
the partnership rise to the level of a permanent establishment.
Rev. Rul. 91-32, 1991-1 C.B. 107. Further, under paragraph 3,
the United States generally may tax a partner's distributive
share of income realized by a partnership on the disposition of
movable property forming part of the business property of the
partnership in the United States.
The gains subject to paragraph 3 may be taxed in the State
in which the permanent establishment is located, regardless of
whether the permanent establishment exists at the time of the
alienation. This rule incorporates the rule of section
864(c)(6) of the Code. Accordingly, income that is attributable
to a permanent establishment, but that is deferred and received
after the permanent establishment no longer exists, may
nevertheless be taxed by the State in which the permanent
establishment was located.
Paragraph 4
This paragraph limits the taxing jurisdiction of the State
of source with respect to gains from the alienation of ships,
aircraft or containers operated in international traffic by the
enterprise alienating the ship or aircraft and from property
(other than real property) pertaining to the operation or use
of such ships, aircraft, or containers.
Under paragraph 4, such income is taxable only in the
Contracting State in which the alienator is resident.
Notwithstanding paragraph 3, the rules of this paragraph apply
even if the income is attributable to a permanent establishment
maintained by the enterprise in the other Contracting State.
This result is consistent with the allocation of taxing rights
under Article 8 (Shipping and Air Transport).
Paragraph 5
Paragraph 5 grants to the State of residence of the
alienator the exclusive right to tax gains from the alienation
of property other than property referred to in paragraphs 1
through 4. For example, gain derived from shares, other than
shares described in paragraphs 2 or 3, debt instruments and
various financial instruments, may be taxed only in the State
of residence, to the extent such income is not otherwise
characterized as income taxable under another article (e.g.,
Article 10 (Dividends) or Article 11 (Interest)). Similarly
gain derived from the alienation of tangible personal property,
other than tangible personal property described in paragraph 3,
may be taxed only in the State of residence of the alienator.
Gains derived by a resident of a Contracting State from
real property located in a third state are not taxable in the
other Contracting State, even if the sale is attributable to a
permanent establishment located in the other Contracting State.
Paragraph 6
Paragraph 6 sets forth a rule which permits the imposition
of certain expatriation taxes. This rule provides that
notwithstanding paragraph 5 a Contracting State may tax gains
from the alienation of shares or rights in a company, the
capital of which is wholly or partly divided into shares, and
that is a resident of that State, if the person alienating the
shares or rights is an individual resident in the other
Contracting State, but only if such individual was a resident
of the first-mentioned State at any time during the five-year
period preceding the alienation.
Relationship to Other Articles
Notwithstanding the foregoing limitations on taxation of
certain gains by the State of source, the saving clause of
paragraph 4 of Article 1 (General Scope) permits the United
States to tax its citizens and residents as if the Convention
had not come into effect. Thus, any limitation in this Article
on the right of the United States to tax gains does not apply
to gains of a U.S. citizen or resident.
The benefits of this Article are also subject to the
provisions of Article 21 (Limitation on Benefits). Thus, only a
resident of a Contracting State that satisfies one of the
conditions in Article 21 is entitled to the benefits of this
Article.
Additionally, the provisions of paragraph 6 shall be
applied in conjunction with subparagraph 2(b) of Article 22
(Relief from Double Taxation).
ARTICLE 14 (INCOME FROM EMPLOYMENT)
Article 14 apportions taxing jurisdiction over remuneration
derived by a resident of a Contracting State as an employee
between the States of source and residence.
Paragraph 1
The general rule of Article 14 is contained in paragraph 1.
Remuneration derived by a resident of a Contracting State as an
employee may be taxed by the State of residence, and the
remuneration also may be taxed by the other Contracting State
to the extent derived from employment exercised (i.e., services
performed) in that other Contracting State. Paragraph 1 also
provides that the more specific rules of Articles 15
(Directors' Fees), 17 (Pensions, Social Security, and
Annuities), and 19 (Government Service) apply in the case of
employment income described in one of those articles. Thus,
even though the State of source has a right to tax employment
income under Article 14, it may not have the right to tax that
income under the Convention if the income is described, for
example, in Article 17 (Pensions, Social Security, and
Annuities) and is not taxable in the State of source under the
provisions of that article.
Article 14 applies to any form of compensation for
employment, including payments in kind. Paragraph 1.1 of the
Commentary to Article 16 of the OECD Model now confirms that
interpretation.
Consistent with section 864(c)(6) of the Code, Article 14
also applies regardless of the timing of actual payment for
services. Consequently, a person who receives the right to a
future payment in consideration for services rendered in a
Contracting State would be taxable in that State even if the
payment is received at a time when the recipient is a resident
of the other Contracting State. Thus, a bonus paid to a
resident of a Contracting State with respect to services
performed in the other Contracting State with respect to a
particular taxable year would be subject to Article 14 for that
year even if it was paid after the close of the year. An
annuity received for services performed in a taxable year could
be subject to Article 14 despite the fact that it was paid in
subsequent years. In that case, it would be necessary to
determine whether the payment constitutes deferred
compensation, taxable under Article 14, or a qualified pension
subject to the rules of Article 17 (Pensions, Social Security,
and Annuities). Article 14 also applies to income derived from
the exercise of stock options granted with respect to services
performed in the host State, even if those stock options are
exercised after the employee has left the source country. If
Article 14 is found to apply, whether such payments were
taxable in the State where the employment was exercised would
depend on whether the tests of paragraph 2 were satisfied in
the year in which the services to which the payment relates
were performed.
Paragraph 2
Paragraph 2 sets forth an exception to the general rule
that employment income may be taxed in the State where it is
exercised. Under paragraph 2, the State where the employment is
exercised may not tax the income from the employment if three
conditions are satisfied: (a) the individual is present in the
other Contracting State for a period or periods not exceeding
183 days in any 12-month period that begins or ends during the
relevant taxable year (i.e., in the United States, the calendar
year in which the services are performed); (b) the remuneration
is paid by, or on behalf of, an employer who is not a resident
of that other Contracting State; and (c) the remuneration is
not borne as a deductible expense by a permanent establishment
that the employer has in that other State. In order for the
remuneration to be exempt from tax in the source State, all
three conditions must be satisfied. This exception is identical
to that set forth in the OECD Model.
The 183-day period in condition (a) is to be measured using
the ``days of physical presence'' method. Under this method,
the days that are counted include any day in which a part of
the day is spent in the host country. (Rev. Rul. 56-24, 1956-1
C.B. 851.) Thus, days that are counted include the days of
arrival and departure; weekends and holidays on which the
employee does not work but is present within the country;
vacation days spent in the country before, during or after the
employment period, unless the individual's presence before or
after the employment can be shown to be independent of his
presence there for employment purposes; and time during periods
of sickness, training periods, strikes, etc., when the
individual is present but not working. If illness prevented the
individual from leaving the country in sufficient time to
qualify for the benefit, those days will not count. Also, any
part of a day spent in the host country while in transit
between two points outside the host country is not counted. If
the individual is a resident of the host country for part of
the taxable year concerned and a nonresident for the remainder
of the year, the individual's days of presence as a resident do
not count for purposes of determining whether the 183-day
period is exceeded.
Conditions (b) and (c) are intended to ensure that a
Contracting State will not be required to allow a deduction to
the payor for compensation paid and at the same time to exempt
the employee on the amount received. Accordingly, if a foreign
person pays the salary of an employee who is employed in the
host State, but a host State corporation or permanent
establishment reimburses the payor with a payment that can be
identified as a reimbursement, neither condition (b) nor (c),
as the case may be, will be considered to have been fulfilled.
The reference to remuneration ``borne by'' a permanent
establishment is understood to encompass all expenses that
economically are incurred and not merely expenses that are
currently deductible for tax purposes. Accordingly, the
expenses referred to include expenses that are capitalizable as
well as those that are currently deductible. Further, salaries
paid by residents that are exempt from income taxation may be
considered to be borne by a permanent establishment
notwithstanding the fact that the expenses will be neither
deductible nor capitalizable since the payor is exempt from
tax.
Paragraph 3
Paragraph 3 contains a special rule applicable to
remuneration for services performed by a resident of a
Contracting State as an employee aboard a ship or aircraft
operated in international traffic. Such remuneration may be
taxed only in the State of residence of the employee if the
services are performed as a member of the regular complement of
the ship or aircraft. The ``regular complement'' includes the
crew. In the case of a cruise ship, for example, it may also
include others, such as entertainers, lecturers, etc., employed
by the shipping company to serve on the ship throughout its
voyage. The use of the term ``regular complement'' is intended
to clarify that a person who exercises his employment as, for
example, an insurance salesman while aboard a ship or aircraft
is not covered by this paragraph.
If a U.S. citizen who is resident in Iceland performs
services as an employee in the United States and meets the
conditions of paragraph 2 for source country exemption, he
nevertheless is taxable in the United States by virtue of the
saving clause of paragraph 4 of Article 1 (General Scope),
subject to the special foreign tax credit rule of paragraph 4
of Article 22 (Relief from Double Taxation).
ARTICLE 15 (DIRECTORS' FEES)
This Article provides that a Contracting State may tax the
fees and other compensation paid by a company that is a
resident of that State for services performed by a resident of
the other Contracting State in his capacity as a director of
the company. This rule is an exception to the more general
rules of Articles 7 (Business Profits) and 14 (Income from
Employment). Thus, for example, in determining whether a
director's fee paid to a non-employee director is subject to
tax in the country of residence of the corporation, it is not
relevant to establish whether the fee is attributable to a
permanent establishment in that State.
Under this Article, a resident of one Contracting State who
is a director of a corporation that is resident in the other
Contracting State is subject to tax in that other State in
respect of his directors' fees regardless of where the services
are performed. Under U.S. law, however, services performed by a
nonresident may not be taxed unless they are performed in the
United States (unless that nonresident is a U.S. citizen, and
therefore subject to the saving clause of paragraph 4 of
Article 1 (General Scope)).
ARTICLE 16 (ENTERTAINERS AND SPORTSMEN)
This Article deals with the taxation in a Contracting State
of entertainers and sportsmen resident in the other Contracting
State from the performance of their services as such. The
Article applies both to the income of an entertainer or
sportsman who performs services on his own behalf and one who
performs services on behalf of another person, either as an
employee of that person, or pursuant to any other arrangement.
The rules of this Article take precedence, in some
circumstances, over those of Articles 7 (Business Profits) and
14 (Income from Employment).
This Article applies only with respect to the income of
entertainers and sportsmen. Others involved in a performance or
athletic event, such as producers, directors, technicians,
managers, coaches, etc., remain subject to the provisions of
Articles 7 and 14. In addition, except as provided in paragraph
2, income earned by juridical persons is not covered by Article
16.
Paragraph 1
Paragraph 1 describes the circumstances in which a
Contracting State may tax the performance income of an
entertainer or sportsman who is a resident of the other
Contracting State. Under the paragraph, income derived by an
individual resident of a Contracting State from activities as
an entertainer or sportsman exercised in the other Contracting
State may be taxed in that other State if the amount of the
gross receipts derived by the performer exceeds $20,000 (or its
equivalent in Icelandic kronur) for the taxable year. The
$20,000 includes expenses reimbursed to the individual or borne
on his behalf. If the gross receipts exceed $20,000, the full
amount, not just the excess, may be taxed in the State of
performance.
The Convention introduces the monetary threshold to
distinguish between two groups of entertainers and athletes--
those who are paid relatively large sums of money for very
short periods of service, and who would, therefore, normally be
exempt from host country tax under the standard personal
services income rules, and those who earn relatively modest
amounts and are, therefore, not easily distinguishable from
those who earn other types of personal service income.
Tax may be imposed under paragraph 1 even if the performer
would have been exempt from tax under Article 7 or 14. On the
other hand. if the performer would be exempt from host-country
tax under Article 16, but would be taxable under either Article
7 or 14, tax may be imposed under either of those Articles.
Thus, for example, if a performer derives remuneration from his
activities in an independent capacity, and the performer does
not have a permanent establishment in the host State, he may be
taxed by the host State in accordance with Article 16 if his
remuneration exceeds $20,000 annually, despite the fact that he
generally would be exempt from host State taxation under
Article 7. However, a performer who receives less than the
$20,000 threshold amount and therefore is not taxable under
Article 16 nevertheless may be subject to tax in the host
country under Article 7 or 14 if the tests for host-country
taxability under the relevant Article are met. For example, if
an entertainer who is an independent contractor earns $14,000
of income in a State for the calendar year, but the income is
attributable to his permanent establishment in the State of
performance, that State may tax his income under Article 7.
Nothing shall preclude a Contracting State from withholding
tax from such payments according to its domestic laws. However,
if according to the provisions of this Article, such
remuneration or income may only be taxed in the other
Contracting State, the first-mentioned Contracting State shall
make a refund of the tax so withheld upon a duly filed claim.
Such claim must be filed with the tax authorities that have
collected the withholding tax within five years after the close
of the calendar year in which the tax was withheld.
As explained in paragraph 9 of the Commentary to Article 17
of the OECD Model, Article 16 of the Convention applies to all
income connected with a performance by the entertainer, such as
appearance fees, award or prize money, and a share of the gate
receipts. Income derived from a Contracting State by a
performer who is a resident of the other Contracting State from
other than actual performance, such as royalties from record
sales and payments for product endorsements, is not covered by
this Article, but by other articles of the Convention, such as
Article 12 (Royalties) or Article 7. For example, if an
entertainer receives royalty income from the sale of live
recordings, the royalty income would be subject to the
provisions of Article 12, even if the performance was conducted
in the source country, although the entertainer could be taxed
in the source country with respect to income from the
performance itself under Article 16 if the dollar threshold is
exceeded.
In determining whether income falls under Article 16 or
another article, the controlling factor will be whether the
income in question is predominantly attributable to the
performance itself or to other activities or property rights.
For instance, a fee paid to a performer for endorsement of a
performance in which the performer will participate would be
considered to be so closely associated with the performance
itself that it normally would fall within Article 16.
Similarly, a sponsorship fee paid by a business in return for
the right to attach its name to the performance would be so
closely associated with the performance that it would fall
under Article 16 as well. As indicated in paragraph 9 of the
Commentary to Article 17 of the OECD Model, however, a
cancellation fee would not be considered to fall within Article
16 but would be dealt with under Article 7 or 14.
As indicated in paragraph 4 of the Commentary to Article 17
of the OECD Model, where an individual fulfills a dual role as
performer and non-performer (such as a player-coach or an
actor-director), but his role in one of the two capacities is
negligible, the predominant character of the individual's
activities should control the characterization of those
activities. In other cases there should be an apportionment
between the performance-related compensation and other
compensation.
Consistent with Article 14, Article 16 also applies
regardless of the timing of actual payment for services. Thus,
a bonus paid to a resident of a Contracting State with respect
to a performance in the other Contracting State during a
particular taxable year would be subject to Article 16 for that
year even if it was paid after the close of the year. The
determination as to whether the $20,000 threshold has been
exceeded is determined separately with respect to each year of
payment. Accordingly, if an actor who is a resident of one
Contracting State receives residual payments over time with
respect to a movie that was filmed in the other Contracting
State, the payments do not have to be aggregated from one year
to another to determine whether the total payments have finally
exceeded $20,000. Otherwise, residual payments received many
years later could retroactively subject all earlier payments to
tax by the other Contracting State. Paragraph 2
Paragraph 2 is intended to address the potential for
circumvention of the rule in paragraph 1 when a performer's
income does not accrue directly to the performer himself, but
to another person. Foreign performers frequently perform in the
United States as employees of, or under contract with, a
company or other person.
The relationship may truly be one of employee and employer,
with no circumvention of paragraph 1 either intended or
realized. On the other hand, the ``employer'' may, for example,
be a company established and owned by the performer, which is
merely acting as the nominal income recipient in respect of the
remuneration for the performance (a ``star company''). The
performer may act as an ``employee,'' receive a modest salary,
and arrange to receive the remainder of the income from his
performance from the company in another form or at a later
time. In such case, absent the provisions of paragraph 2, the
income arguably could escape host-country tax because the
company earns business profits but has no permanent
establishment in that country. The performer may largely or
entirely escape host-country tax by receiving only a small
salary, perhaps small enough to place him below the dollar
threshold in paragraph 1. The performer might arrange to
receive further payments in a later year, when he is not
subject to host-country tax, perhaps as dividends or
liquidating distributions.
Paragraph 2 seeks to prevent this type of abuse while at
the same time protecting the taxpayers' rights to the benefits
of the Convention when there is a legitimate employee-employer
relationship between the performer and the person providing his
services. Under paragraph 2, when the income accrues to a
person other than the performer, and the performer or related
persons participate, directly or indirectly, in the receipts or
profits of that other person, the income may be taxed in the
Contracting State where the performer's services are exercised,
without regard to the provisions of the Convention concerning
business profits or income from employment (Article 14). In
cases where paragraph 2 is applicable, the income of the
``employer'' may be subject to tax in the host Contracting
State even if it has no permanent establishment in the host
country. Taxation under paragraph 2 is on the person providing
the services of the performer. This paragraph does not affect
the rules of paragraph 1, which applyto the performer himself.
The income taxable by virtue of paragraph 2 is reduced to the
extent of salary payments to the performer, which fall under
paragraph 1.
For purposes of paragraph 2, income is deemed to accrue to
another person (i.e., the person providing the services of the
performer) if that other person has control over, or the right
to receive, gross income in respect of the services of the
performer. Direct or indirect participation in the profits of a
person may include, but is not limited to, the accrual or
receipt of deferred remuneration, bonuses, fees, dividends,
partnership income or other income or distributions.
Paragraph 2 does not apply if it is established that
neither the performer nor any persons related to the performer
participate directly or indirectly in the receipts or profits
of the person providing the services of the performer. Assume,
for example, that a circus owned by a U.S. corporation performs
in the other Contracting State, and promoters of the
performance in the other State pay the circus, which, in turn,
pays salaries to the circus performers. The circus is
determined to have no permanent establishment in that State.
Since the circus performers do not participate in the profits
of the circus, but merely receive their salaries out of the
circus' gross receipts, the circus is protected by Article 7
and its income is not subject to host-country tax. Whether the
salaries of the circus performers are subject to host-country
tax under this Article depends on whether they exceed the
$20,000 threshold in paragraph 1.
Since pursuant to Article 1 (General Scope) the Convention
only applies to persons who are residents of one of the
Contracting States, income of the star company would not be
eligible for benefits of the Convention if the company is not a
resident of one of the Contracting States.
Relationship to Other Articles
This Article is subject to the provisions of the saving
clause of paragraph 4 of Article 1 (General Scope). Thus, if an
entertainer or a sportsman who is resident in the other
Contracting State is a citizen of the United States, the United
States may tax all of his income from performances in the
United States without regard to the provisions of this Article,
subject, however, to the special foreign tax credit provisions
of paragraph 4 of Article 22 (Relief From Double Taxation). In
addition, benefits of this Article are subject to the
provisions of Article 21 (Limitation On Benefits).
ARTICLE 17 (PENSIONS, SOCIAL SECURITY, AND ANNUITIES)
This Article deals with the taxation of private (i.e., non-
government service) pensions, social security benefits, and
annuities.
Paragraph 1
Paragraph 1 provides that distributions from pensions and
other similar remuneration paid to a resident of a Contracting
State in consideration of past employment are taxable only in
the State of residence of the beneficiary. The term ``pensions
and other similar remuneration'' includes both periodic and
single sum payments.
The phrase ``pensions and other similar remuneration'' is
intended to encompass payments made by qualified private
retirement plans. In the United States, the plans encompassed
by Paragraph 1 include: qualified plans under section 401(a),
individual retirement plans (including individual retirement
plans that are part of a simplified employee pension plan that
satisfies section 408(k), individual retirement accounts and
section 408(p) accounts), section 403(a) qualified annuity
plans, and section 403(b) plans. Distributions from section 457
plans may also fall under Paragraph 1 if they are not paid with
respect to government services covered by Article 19. In
Iceland, the term pension applies to any pension fund or
pension plan qualified under the Pension Act or any identical
or substantially similar schemes which are created under any
law enacted after the signature of the Convention. The
competent authorities may agree that distributions from other
plans that generally meet similar criteria to those applicable
to the listed plans also qualify for the benefits of Paragraph
1.
Pensions in respect of government services covered by
Article 18 are not covered by this paragraph. They are covered
either by paragraph 2 of this Article, if they are in the form
of social security benefits, or by paragraph 2 of Article 18
(Government Service). Thus, Article 18 generally covers section
457(g), 401(a), 403(a), and 403(b) plans established for
government employees, including the Thrift Savings Plan
(section 7701(j)).
Paragraph 2
The treatment of social security benefits is dealt with in
paragraph 2. This paragraph provides that, notwithstanding the
provision of paragraph 1 under which private pensions are
taxable exclusively in the State of residence of the beneficial
owner, payments made by one of the Contracting States under the
provisions of its social security or similar legislation to a
resident of Iceland or to a citizen of the United States will
be taxable only in the Contracting State making the payment.
The reference to U.S. citizens is necessary to ensure that a
social security payment by Iceland to a U.S. citizen who is not
resident in the United States will not be taxable by the United
States.
This paragraph applies to social security beneficiaries
whether they have contributed to the system as private sector
or Government employees. The phrase ``similar legislation'' is
intended to refer to United States tier 1 Railroad Retirement
benefits.
Paragraph 3
Under paragraph 3, annuities that are derived and
beneficially owned by a resident of a Contracting State are
taxable only in that State. An annuity, as the term is used in
this paragraph, means a stated sum paid periodically at stated
times during a specified number of years, under an obligation
to make the payment in return for adequate and full
consideration (other than for services rendered). An annuity
received in consideration for services rendered would be
treated as either deferred compensation that is taxable in
accordance with Article 14 (Income from Employment) or a
pension that is subject to the rules of paragraph 1.
Paragraph 4
Paragraph 4 provides that, if a resident of a Contracting
State participates in a pension fund established in the other
Contracting State, the State of residence will not tax the
income of the pension fund with respect to that resident until
a distribution is made from the pension fund. Thus, for
example, if a U.S. citizen contributes to a U.S. qualified plan
while working in the United States and then establishes
residence in Iceland, paragraph 1 prevents Iceland from taxing
currently the plan's earnings and accretions with respect to
that individual. When the resident receives a distribution from
the pension fund, that distribution may be subject to tax in
the State of residence, subject to paragraph 1.
Relationship to Other Articles
Paragraphs 1 and 3 of Article 17 are subject to the saving
clause of paragraph 4 of Article 1 (General Scope). Thus, a
U.S. citizen who is resident in the other Contracting State,
and receives either a pension, annuity or alimony payment from
the United States, may be subject to U.S. tax on the payment,
notwithstanding the rules in those three paragraphs that give
the State of residence of the recipient the exclusive taxing
right. Paragraphs 2 and 4 are excepted from the saving clause
by virtue of subparagraph 5(a) of Article 1. Thus, the United
States will not tax U.S. citizens and residents on the income
described in those paragraphs even if such amounts otherwise
would be subject to tax under U.S. law.
ARTICLE 18 (GOVERNMENT SERVICE)
Paragraph 1
Subparagraphs 1(a) and 1(b) deal with the taxation of
government compensation (other than a pension addressed in
paragraph 2). Subparagraph 1(a) provides that remuneration paid
from the public funds of a Contracting State or its political
subdivisions or local authorities to any individual who is
rendering services to that State, political subdivision or
local authority,which are in the discharge of governmental
functions, is exempt from tax by the other State. Under
subparagraph 1(b), such payments are, however, taxable
exclusively in the other State (i.e., the host State) if the
services are rendered in that other State and the individual is
a resident of that State who is either a national of that State
or a person who did not become resident of that State solely
for purposes of rendering the services. The paragraph applies
to anyone performing services for a government, whether as a
government employee, an independent contractor, or an employee
of an independent contractor.
Paragraph 2
Paragraph 2 deals with the taxation of pensions paid by, or
out of funds created by, one of the States, or a political
subdivision or a local authority thereof, to an individual in
respect of services rendered in the discharge of functions of a
governmental nature to that State or subdivision or authority.
Subparagraph 1(a) provides that such pensions are taxable only
in that State. Subparagraph 1(b) provides an exception under
which such pensions are taxable only in the other State if the
individual is a resident of, and a national of, that other
State.
Pensions paid to retired civilian and military employees of
a Government of either State are intended to be covered under
paragraph 2. When benefits paid by a State in respect of
services rendered to that State or a subdivision or authority
are in the form of social security benefits, however, those
payments are covered by paragraph 2 of Article 17 (Pensions,
Social Security, Annuities, Alimony, and Child Support). As a
general matter, the result will be the same whether Article 17
or 19 applies, since social security benefits are taxable
exclusively by the source country and so are government
pensions. The result will differ only when the payment is made
to a citizen and resident of the other Contracting State, who
is not also a citizen of the paying State. In such a case,
social security benefits continue to be taxable at source while
government pensions become taxable only in the residence
country.
Paragraph 3
Paragraph 3 provides that the remuneration described in
paragraph 1 will be subject to the rules of Articles 14 (Income
from Employment), 15 (Directors' Fees), 16 (Entertainers and
Sportsmen) or 17 if the recipient of the income is employed by
a business conducted by a government.
Relationship to Other Articles
Under subparagraph 5(b) of Article 1 (General Scope), the
saving clause (paragraph 4 of Article 1) does not apply to the
benefits conferred by one of the States under Article 18 if the
recipient of the benefits is neither a citizen of that State,
nor a person who has been admitted for permanent residence
there (i.e., in the United States, a ``green card'' holder).
Thus, a resident of a Contracting State who in the course of
performing functions of a governmental nature becomes a
resident of the other State (but not a permanent resident),
would be entitled to the benefits of this Article. Similarly,
an individual who receives a pension paid by the Government of
Iceland in respect of services rendered to the Government of
Iceland shall be taxable on this pension only in Iceland unless
the individual is a U.S. citizen or acquires a U.S. green card.
ARTICLE 19 (STUDENTS AND TRAINEES)
This Article provides rules for host-country taxation of
visiting students and business trainees. Persons who meet the
tests of the Article will be exempt from tax in the State that
they are visiting with respect to designated classes of income.
Several conditions must be satisfied in order for an individual
to be entitled to the benefits of this Article.
Paragraph 1
Paragraph 1 provides that an individual who is a resident
of one Contracting State at the time he becomes temporarily
present in the other Contracting State and who is temporarily
present therein for the primary purpose of studying at a
university or other recognized educational institution in that
other Contracting State, securing training required to qualify
him to practice a profession or professional specialty, or
studying or doing research as a recipient of a grant,
allowance, or award from a governmental, religious, charitable,
scientific, literary, or educational organization, will be
exempt from tax by that other Contracting State for a period
not exceeding five taxable years from the date of his arrival
in that other Contracting State on:
(1) Gifts from abroad for the purpose of his
maintenance, education, study, research or training;
(2) The grant, allowance, or award; and
(3) Income from personal services performed in the
other Contracting State not in excess of $9,000 or its
equivalent in Icelandic kronur for any taxable year.
Paragraph 2
Under paragraph 2, an individual who is a resident of one
Contracting State at the time he becomes temporarily present in
the other Contracting State and who is temporarily present
therein as an employee of, or under contract with, a resident
of the first-mentioned Contracting State, for the primary
purpose of acquiring technical, professional, or business
experience from a person other than that resident of the first-
mentioned Contracting State or other than a person related to
such resident, or studying at a university or other recognized
educational institution in that other Contracting State, will
be exempt from tax by that other Contracting State for a period
of twelve consecutive months on income from personal services
not in excess of $9,000 or its equivalent in Icelandic kronur.
Paragraph 3
Paragraph 3 provides an exemption for residents of one
Contracting State who become temporarily present in the other
Contracting State for purposes of training, research or study
in a program sponsored by the other Contracting State. The
exemption is available to an individual who is a resident of
one Contracting State at the time he becomes temporarily
present in the other Contracting State and who is temporarily
present in that other Contracting State for a period not
exceeding one year, as a participant in a program sponsored by
the other Contracting State, for the primary purpose of
training, research, or study. A person meeting these
requirements will be exempt from tax by the other Contracting
State with respect to his income from personal services in
respect of such training, research, or study performed in that
other Contracting State in an aggregate amount not in excess of
$9,000 or its equivalent in Icelandic kronur.
Relationship to Other Articles
The saving clause of paragraph 4 of Article 1 (General
Scope) does not apply to this Article with respect to an
individual who is neither a citizen of the host State nor an
individual who has been admitted for permanent residence there.
The saving clause, however, does apply with respect to citizens
and permanent residents of the host State. Thus, a U.S. citizen
who is a resident of Iceland and who visits the United States
as a full-time student at an accredited university will not be
exempt from U.S. tax on remittances from abroad that otherwise
constitute U.S. taxable income. An individual, however, who is
not a U.S. citizen, and who visits the United States as a
student and remains long enough to become a resident under U.S.
law, but does not become a permanent resident (i.e., does not
acquire a green card), will be entitled to the full benefits of
the Article.
ARTICLE 20 (OTHER INCOME)
Article 20 generally assigns taxing jurisdiction over
income not dealt with in the other articles (Articles 6 (Income
from Immovable Property (Real Property)) through 19 (Students
and Trainees)) of the Convention to the State of residence of
the beneficial owner of the income. In order for an item of
income to be ``dealt with'' in another article it must be the
type of income described in the article and, in most cases, it
must have its source in a Contracting State. For example, all
royalty income that arises in a Contracting State and that is
beneficially owned by a resident of the other Contracting State
is ``dealt with'' in Article 12 (Royalties). However, profits
derived in the conduct of a business are ``dealt with'' in
Article 7 (Business Profits) whether or not they have their
source in one of the Contracting States.
Examples of items of income covered by Article 20 include
income from gambling, punitive (but not compensatory) damages
and covenants not to compete. The article would also apply to
income from a variety of financial transactions, where such
income does not arise in the course of the conduct of a trade
or business. For example, income from notional principal
contracts and other derivatives would fall within Article 20 if
derived by persons not engaged in the trade or business of
dealing in such instruments, unless such instruments were being
used to hedge risks arising in a trade or business. It would
also apply to securities lending fees derived by an
institutional investor. Further, in most cases guarantee fees
paid within an intercompany group would be covered by Article
20, unless the guarantor were engaged in the business of
providing such guarantees to unrelated parties.
Article 20 also applies to items of income that are not
dealt with in the other articles because of their source or
some other characteristic. For example, Article 11 (Interest)
addresses only the taxation of interest arising in a
Contracting State. Interest arising in a third State that is
not attributable to a permanent establishment, therefore, is
subject to Article 20.
Distributions from partnerships are not generally dealt
with under Article 20 because partnership distributions
generally do not constitute income. Under the Code, partners
include in income their distributive share of partnership
income annually, and partnership distributions themselves
generally do not give rise to income. This would also be the
case under U.S. law with respect to distributions from trusts.
Trust income and distributions that, under the Code, have the
character of the associated distributable net income would
generally be covered by another article of the Convention. See
Code section 641 et seq.
Paragraph 1
The general rule of Article 20 is contained in paragraph 1.
Items of income not dealt with in other articles and
beneficially owned by a resident of a Contracting State will be
taxable only in the State of residence. This exclusive right of
taxation applies whether or not the residence State exercises
its right to tax the income covered by the Article.
The reference in this paragraph to ``items of income
beneficially owned by a resident of a Contracting State''
rather than simply ``items of income of a resident of a
Contracting State,'' as in the OECD Model, is intended merely
to make explicit the implicit understanding in other treaties
that the exclusive residence taxation provided by paragraph 1
applies only when a resident of a Contracting State is the
beneficial owner of the income. Thus, source taxation of income
not dealt with in other articles of the Convention is not
limited by paragraph 1 if it is nominally paid to a resident of
the other Contracting State, but is beneficially owned by a
resident of a third State. However, income received by a
nominee on behalf of a resident of that other State would be
entitled to benefits.
The term ``beneficially owned'' is not defined in the
Convention, and is, therefore, defined as under the internal
law of the country imposing tax (i.e., the source country). The
person who beneficially owns the income for purposes of Article
20 is the person to which the income is attributable for tax
purposes under the laws of the source State.
Paragraph 2
This paragraph provides an exception to the general rule of
paragraph 1 for income that is attributable to a permanent
establishment maintained in a Contracting State by a resident
of the other Contracting State. The taxation of such income is
governed by the provisions of Article 7 (Business Profits).
Therefore, income arising outside the United States that is
paid in respect of a right or property that is effectively
connected with a permanent establishment maintained in the
United States by a resident of Iceland generally would be
taxable by the United States under the provisions of Article 7.
This would be true even if the income is sourced in a third
state.
Relationship to Other Articles
This Article is subject to the saving clause of paragraph 4
of Article 1 (General Scope). Thus, the United States may tax
the income of a resident of Iceland that is not dealt with
elsewhere in the Convention, if that resident is a citizen of
the United States. The Article is also subject to the
provisions of Article 21 (Limitation On Benefits). Thus, if a
resident of Iceland earns income that falls within the scope of
paragraph 1 of Article 21, but that is taxable by the United
States under U.S. law, the income would be exempt from U.S. tax
under the provisions of Article 20 only if the resident
satisfies one of the tests of Article 21 for entitlement to
benefits.
ARTICLE 21 (LIMITATION ON BENEFITS)
Article 21 contains anti-treaty-shopping provisions that
are intended to prevent residents of third countries from
benefiting from what is intended to be a reciprocal agreement
between two countries. In general, the provision does not rely
on a determination of purpose or intention but instead sets
forth a series of objective tests. A resident of a Contracting
State that satisfies one of the tests will receive benefits
regardless of its motivations in choosing its particular
business structure.
The structure of the Article is as follows: Paragraph 1
states the general rule that residents are entitled to benefits
otherwise accorded to residents only to the extent provided in
the Article. Paragraph 2 lists a series of attributes of a
resident of a Contracting State, the presence of any one of
which will entitle that person to all the benefits of the
Convention. Paragraph 3 provides a so-called ``derivative
benefits'' test under which certain categories of income may
qualify for benefits. Paragraph 4 provides that, regardless of
whether a person qualifies for benefits under paragraph 2,
benefits may be granted to that person with regard to certain
income earned in the conduct of an active trade or business.
Paragraph 5 provides special rules for so-called ``triangular
cases'' notwithstanding the other provisions of Article 21.
Paragraph 6 provides special rules for income from so-called
``disproportionate shares'' notwithstanding the other
provisions of Article 21. Paragraph 7 provides that benefits
also may be granted if the competent authority of the State
from which benefits are claimed determines that it is
appropriate to provide benefits in that case. Paragraph 8
defines certain terms used in the Article.
Paragraph 1
Paragraph 1 provides that a resident of a Contracting State
will be entitled to the benefits otherwise accorded to
residents of a Contracting State under the Convention only to
the extent provided in the Article. The benefits otherwise
accorded to residents under the Convention include all
limitations on source-based taxation under Articles 6 (Income
from Immovable Property (Real Property) through 20 (Other
Income), the treaty-based relief from double taxation provided
by Article 22 (Relief from Double Taxation), and the protection
afforded to residents of a Contracting State under Article 23
(Non-Discrimination). Some provisions do not require that a
person be a resident in order to enjoy the benefits of those
provisions. Article 24 (Mutual Agreement Procedure) is not
limited to residents of the Contracting States, and Article 26
(Members of Diplomatic Missions and Consular Posts) applies to
diplomatic agents or consular officials regardless of
residence. Article 21 accordingly does not limit the
availability of treaty benefits under these provisions.
Article 21 and the anti-abuse provisions of domestic law
complement each other, as Article 21 effectively determines
whether an entity has a sufficient nexus to the Contracting
State to be treated as a resident for treaty purposes, while
domestic anti-abuse provisions (e.g., business purpose,
substance-over-form, step transaction or conduit principles)
determine whether a particular transaction should be recast in
accordance with its substance. Thus, internal law principles of
the source Contracting State may be applied to identify the
beneficial owner of an item of income, and Article 21 then will
be applied to the beneficial owner to determine if that person
is entitled to the benefits of the Convention with respect to
such income.
Paragraph 2
Paragraph 2 has five subparagraphs, each of which describes
a category of residents that are entitled to all benefits of
the Convention.
It is intended that the provisions of paragraph 2 will be
self executing. Unlike the provisions of paragraph 7, discussed
below, claiming benefits under paragraph 2 does not require
advance competent authority ruling or approval. The tax
authorities may, of course, on review, determine that the
taxpayer has improperly interpreted the paragraph and is not
entitled to the benefits claimed.
Individuals--Subparagraph 2(a)
Subparagraph 2(a) provides that individual residents of a
Contracting State will be entitled to all treaty benefits. If
such an individual receives income as a nominee on behalf of a
third country resident, benefits may be denied under the
respective articles of the Convention by the requirement that
the beneficial owner of the income be a resident of a
Contracting State.
Governments--Subparagraph 2(b)
Subparagraph 2(b) provides that the Contracting States and
any political subdivision or local authority thereof will be
entitled to all benefits of the Convention.
Publicly-Traded Corporations--Subparagraph 2(c)(i)
Subparagraph 2(c) applies to two categories of companies:
publicly traded companies and subsidiaries of publicly traded
companies. A company resident in a Contracting State is
entitled to all the benefits of the Convention under clause (i)
of subparagraph 2(c) if the principal class of its shares is
regularly traded on one or more recognized stock exchanges and
the company satisfies at least one of the following additional
requirements: first, the company's principal class of shares is
primarily traded on one or more recognized stock exchanges
located in the Contracting State of which the company is a
resident; or, second, the company's primary place of management
and control is in its State of residence.
The term ``recognized stock exchange'' is defined in
subparagraph 8(b). It includes (i) the NASDAQ System and any
stock exchange registered with the Securities and Exchange
Commission as a national securities exchange for purposes of
the Securities Exchange Act of 1934; (ii) the Icelandic Stock
Exchange; (iii) the stock exchanges of Amsterdam, Brussels,
Copenhagen, Frankfurt, Hamburg, Helsinki, London, Oslo, Paris,
Stockholm, Sydney, Tokyo, and Toronto; and (iv) any other stock
exchange agreed upon by the competent authorities of the
Contracting States.
If a company has only one class of shares, it is only
necessary to consider whether the shares of that class meet the
relevant trading requirements. If the company has more than one
class of shares, it is necessary as an initial matter to
determine which class or classes constitute the ``principal
class of shares''. The term ``principal class of shares'' is
defined in subparagraph 8(a) to mean the ordinary or common
shares of the company representing the majority of the
aggregate voting power and value of the company. If the company
does not have a class of ordinary or common shares representing
the majority of the aggregate voting power and value of the
company, then the ``principal class of shares'' is that class
or any combination of classes of shares that represents, in the
aggregate, a majority of the voting power and value of the
company. Although in a particular case involving a company with
several classes of shares it is conceivable that more than one
group of classes could be identified that account for more than
50% of the shares, it is only necessary for one such group to
satisfy the requirements of this subparagraph in order for the
company to be entitled to benefits. Benefits would not be
denied to the company even if a second, non-qualifying, group
of shares with more than half of the company's voting power and
value could be identified.
The term ``regularly traded'' is not defined in the
Convention. In accordance with paragraph 2 of Article 3
(General Definitions), this term will be defined by reference
to the domestic tax laws of the State from which treaty
benefits are sought, generally the source State. In the case of
the United States, this term is understood to have the meaning
it has under Treas. Reg. section 1. 884-5(d)(4)(i)(B), relating
to the branch tax provisions of the Code. Under these
regulations, a class of shares is considered to be ``regularly
traded'' if two requirements are met: trades in the class of
shares are made in more than de minimis quantities on at least
60 days during the taxable year, and the aggregate number of
shares in the class traded during the year is at least 10
percent of the average number of shares outstanding during the
year. Sections 1.884-5(d)(4)(i)(A), (ii) and (iii) will not be
taken into account for purposes of defining the term
``regularly traded'' under the Convention.
The regular trading requirement can be met by trading on
any recognized exchange or exchanges located in either State.
Trading on one or more recognized stock exchanges may be
aggregated for purposes of this requirement. Thus, a U.S.
company could satisfy the regularly traded requirement through
trading, in whole or in part, on a recognized stock exchange
located in Iceland. Authorized but unissued shares are not
considered for purposes of this test.
The term ``primarily traded'' is not defined in the
Convention. In accordance with paragraph 2 of Article 3, this
term will have the meaning it has under the laws of the State
concerning the taxes to which the Convention applies, generally
the source State. In the case of the United States, this term
is understood to have the meaning it has under Treas. Reg.
section 1.884-5(d)(3), relating to the branch tax provisions of
the Code. Accordingly, stock of a corporation is ``primarily
traded'' if the number of shares in the company's principal
class of shares that are traded during the taxable year on all
recognized stock exchanges in the Contracting State of which
the company is a resident exceeds the number of shares in the
company's principal class of shares that are traded during that
year on established securities markets in any other single
foreign country.
A company whose principal class of shares is regularly
traded on a recognized exchange but cannot meet the primarily
traded test may claim treaty benefits if its primary place of
management and control is in its country of residence. This
test should be distinguished from the ``place of effective
management'' test which is used in the OECD Model and by many
other countries to establish residence. In some cases, the
place of effective management test has been interpreted to mean
the place where the board of directors meets. By contrast, the
primary place of management and control test looks to where
day-to-day responsibility for the management of the company
(and its subsidiaries) is exercised. The company's primary
place of management and control will be located in the State in
which the company is a resident only if the executive officers
and senior management employees exercise day-to-day
responsibility for more of the strategic, financial and
operational policy decision making for the company (including
direct and indirect subsidiaries) in that State than in the
other State or any third state, and the staff that support the
management in making those decisions are also based in that
State. Thus, the test looks to the overall activities of the
relevant persons to see where those activities are conducted.
In most cases, it will be a necessary, but not a sufficient,
condition that the headquarters of the company (that is, the
place at which the Chief Executive Officer and other top
executives normally are based) be located in the Contracting
State of which the company is a resident.
To apply the test, it will be necessary to determine which
persons are to be considered ``executive officers and senior
management employees''. In most cases, it will not be necessary
to look beyond the executives who are members of the Board of
Directors (the ``inside directors'') in the case of a U.S.
company. That will not always be the case, however; in fact,
the relevant persons may be employees of subsidiaries if those
persons make the strategic, financial and operational policy
decisions. Moreover, it would be necessary to take into account
any special voting arrangements that result in certain board
members making certain decisions without the participation of
other board members.
Subsidiaries of Publicly-Traded Corporations--Subparagraph
2(c)(ii)
A company resident in a Contracting State is entitled to
all the benefits of the Convention under clause (ii) of
subparagraph 2(c) if five or fewer publicly traded companies
described in clause (i) are the direct or indirect owners of at
least 50 percent of the aggregate vote and value of the
company's shares. If the publicly-traded companies are indirect
owners, however, each of the intermediate companies must be a
resident of one of the Contracting States.
Thus, for example, a company that is a resident of Iceland,
all the shares of which are owned by another company that is a
resident of Iceland, would qualify for benefits under the
Convention if the principal class of shares of the parent
company are regularly and primarily traded on a recognized
stock exchange in Iceland. However, such a subsidiary would not
qualify for benefits under clause (ii) if the publicly traded
parent company were a resident of a third state, for example,
and not a resident of the United States or Iceland.
Furthermore, if a parent company in Iceland indirectly owned
the bottom-tier company through a chain of subsidiaries, each
such subsidiary in the chain, as an intermediate owner, must be
a resident of the United States or Iceland in order for the
subsidiary to meet the test in clause (ii).
Tax Exempt Organizations--Subparagraph 2(d)
Subparagraph 2(d) provides rules by which the tax exempt
organizations described in paragraph 2 of Article 4 (Resident)
will be entitled to all the benefits of the Convention. A
pension scheme described in paragraph 2(a) of Article 4 or an
employee benefits plan described in paragraph 2(b) of Article 4
will qualify for benefits if more than fifty percent of the
beneficiaries, members or participants of the organization are
individuals resident in either Contracting State. For purposes
of this provision, the term ``beneficiaries'' should be
understood to refer to the persons receiving benefits from the
organization. On the other hand, an organization resident in a
Contracting State that is established exclusively for
religious, charitable, scientific, artistic, cultural, or
educational purposes automatically qualifies for benefits,
without regard to the residence of its beneficiaries or
members.
Ownership/Base Erosion--Subparagraph 2(e)
Subparagraph 2(e) provides an additional method to qualify
for treaty benefits that applies to any form of legal entity
that is a resident of a Contracting State. The test provided in
subparagraph 2(e), the so-called ownership and base erosion
test, is a two-part test. Both prongs of the test must be
satisfied for the resident to be entitled to treaty benefits
under subparagraph 2(e).
The ownership prong of the test, under clause (i), requires
that 50 percent or more of each class of shares or other
beneficial interests in the person is owned, directly or
indirectly, on at least half the days of the person's taxable
year by persons who are residents of the Contracting State of
which that person is a resident and that are themselves
entitled to treaty benefits under subparagraphs 2(a), 2(b),
2(d) or clause (i) of subparagraph 2(c). In the case of
indirect owners, however, each of the intermediate owners must
be a resident of that Contracting State.
Trusts may be entitled to benefits under this provision if
they are treated as residents under Article 4 and they
otherwise satisfy the requirements of this subparagraph. For
purposes of this subparagraph, the beneficial interests in a
trust will be considered to be owned by its beneficiaries in
proportion to each beneficiary's actuarial interest in the
trust. The interest of a remainder beneficiary will be equal to
100 percent less the aggregate percentages held by income
beneficiaries. A beneficiary's interest in a trust will not be
considered to be owned by a person entitled to benefits under
subparagraphs 2(a), 2(b), 2(d) or clause (i) of subparagraph
2(c) if it is not possible to determine the beneficiary's
actuarial interest. Consequently, if it is not possible to
determine the actuarial interest of the beneficiaries in a
trust, the ownership test under clause i) cannot be satisfied,
unless all possible beneficiaries are persons entitled to
benefits under subparagraphs 2(a), 2(b), 2(d) or clause (i) of
subparagraph 2(c) .
The base erosion prong of clause (ii) of subparagraph 2(e)
is satisfied with respect to a person if less than 50 percent
of the person's gross income for the taxable year, as
determined under the tax law in the person's State of
residence, is paid or accrued, directly or indirectly, to
persons who are not residents of either Contracting State
entitled to benefits under subparagraphs 2(a), 2(b), 2(d) or
clause (i) of subparagraph 2(c), in the form of payments
deductible for tax purposes in the payer's State of residence.
These amounts do not include arm's-length payments in the
ordinary course of business for services or tangible property,
or payments in respect of financial obligations to a bank,
provided that where such a bank is not a resident of a
Contracting State, such payment is attributable to a permanent
establishment of that bank located in one of the Contracting
States. To the extent they are deductible from the taxable
base, trust distributions are deductible payments. However,
depreciation and amortization deductions, which do not
represent payments or accruals to other persons, are
disregarded for this purpose.
Paragraph 3
Paragraph 3 sets forth a derivative benefits test that is
potentially applicable to all treaty benefits, although the
test is applied to individual items of income. In general, a
derivative benefits test entitles the resident of a Contracting
State to treaty benefits if the owner of the resident would
have been entitled to the same benefit had the income in
question flowed directly to that owner. To qualify under this
paragraph, the company must meet an ownership test and a base
erosion test.
Clause (i) of subparagraph 3(a) sets forth the ownership
test. Under this test, at least 95 percent of the aggregate
voting power and value of the shares of the company must be
owned by seven or fewer persons that are residents of Member
States of the European Union, or of the European Economic Area,
or parties to the North American Free Trade Agreement or the
European Free Trade Agreement. Ownership may be direct or
indirect. To be considered a resident of Member States of the
European Union, or of the European Economic Area, or parties to
the North American Free Trade Agreement or the European Free
Trade Agreement for purposes of paragraph 3, a person must meet
the requirements of subparagraph 3(b). These requirements may
be met in two alternative ways.
Under one alternative, a person may be treated as a
resident of Member States of the European Union, or of the
European Economic Area, or parties to the North American Free
Trade Agreement or the European Free Trade Agreement because it
is entitled to equivalent benefits under a treaty between the
country of source and the country in which the person is a
resident. To satisfy this requirement, the person must be
entitled to all the benefits of a comprehensive income tax
convention in force between the Contracting State from which
benefits of the Convention are claimed and a qualifying state
under provisions that are analogous to the rules in
subparagraphs 2(a), 2(b), 2(d) and clause (i) of subparagraph
2(c). If the treaty in question does not have a comprehensive
limitation on benefits article, this requirement is met only if
the person would be entitled to treaty benefits under the tests
in subparagraphs 2(a), 2(b), 2(d) and clause (i) of
subparagraph 2(c) of this Article if the person were a resident
of one of the Contracting States.
In order to satisfy this alternative with respect to
dividends, interest, royalties or branch tax, the person must
be entitled to a rate of tax that is at least as low as the tax
rate that would apply under the Convention to such income.
Thus, the rates to be compared are: (1) the rate of tax that
the source State would have imposed if a qualified resident of
the other Contracting State was the beneficial owner of the
income; and (2) the rate of tax that the source State would
have imposed if the third State resident received the income
directly from the source State. For example, USCo is a wholly
owned subsidiary of IceCo, a company resident in Iceland. IceCo
is wholly owned by CanCo, a corporation resident in Canada.
Assuming IceCo satisfies the requirements of paragraph 2 of
Article 10 (Dividends), IceCo would be eligible for a dividend
withholding tax rate of 5 percent. The dividend withholding tax
rate in the treaty between the United States and Canada is also
5 percent. Thus, if CanCo received the dividend directly from
USCo, CanCo would have been subject to a 5 percent rate of
withholding tax on the dividend. Because CanCo would be
entitled to a rate of withholding tax that is at least as low
as the rate that would apply under the Convention to such
income, CanCo is treated as a resident of Member States of the
European Union, or of the European Economic Area, or parties to
the North American Free Trade Agreement or the European Free
Trade Agreement with respect to the elimination of withholding
tax on dividends.
The requirement that a person be entitled to ``all the
benefits'' of a comprehensive tax treaty eliminates those
persons that qualify for benefits with respect to only certain
types of income. Accordingly, the fact that a Canadian parent
of an Icelandic company is engaged in the active conduct of a
trade or business in Canada and therefore would be entitled to
the benefits of the U. S.-Canada treaty if it received
dividends directly from a U.S. subsidiary of the Icelandic
company is not sufficient for purposes of this paragraph.
Further, the Canadian company cannot be an equivalent
beneficiary if it qualifies for benefits only with respect to
certain income as a result of a ``derivative benefits''
provision in the U.S.-Canada treaty.
However, it would be possible to look through the Canadian
company to its parent company to determine whether the parent
company is an equivalent beneficiary.
The second alternative requirement for treatment as a
resident of Member States of the European Union, or of the
European Economic Area, or parties to the North American Free
Trade Agreement or the European Free Trade Agreement is
available only to residents of one of the two Contracting
States. U.S. or Icelandic residents who are eligible for treaty
benefits by reason of subparagraphs 2(a), 2(b), 2(d) or clause
(i) of subparagraph 2(c) are treated as residents of Member
States of the European Union, or of the European Economic Area,
or parties to the North American Free Trade Agreement or the
European Free Trade Agreement under the second alternative.
Thus, an Icelandic individual will qualify without regard to
whether the individual would have been entitled to receive the
same benefits if it received the income directly. A resident of
a third country cannot qualify for treaty benefits under any of
those subparagraphs or any other rule of the treaty, and
therefore does not qualify under this alternative. Thus, a
resident of a third country will be treated as a resident of
Member States of the European Union, or of the European
Economic Area, or parties to the North American Free Trade
Agreement or the European Free Trade Agreement only if it would
have been entitled to equivalent benefits had it received the
income directly.
The second alternative was included in order to clarify
that ownership by certain residents of a Contracting State
would not disqualify a U.S. or Icelandic company under this
paragraph. Thus, for example, if 90 percent of an Icelandic
company is owned by five companies that are resident in member
states of the European Union who satisfy the requirements of
clause (ii), and 10 percent of the Icelandic company is owned
by a U.S. or Icelandic individual, then the Icelandic company
still can satisfy the requirements of subparagraph 3(b).
Clause (ii) of subparagraph 3(a) sets forth the base
erosion test. A company meets this base erosion test if less
than 50 percent of its gross income (as determined in the
company's State of residence) for the taxable period is paid or
accrued, directly or indirectly, to a person or persons who are
not residents of Member States of the European Union, or of the
European Economic Area, or parties to the North American Free
Trade Agreement or the European Free Trade Agreement in the
form of payments deductible for tax purposes in company's State
of residence.
Paragraph 4
Paragraph 4 sets forth an alternative test under which a
resident of a Contracting State may receive treaty benefits
with respect to certain items of income that are connected to
an active trade or business conducted in its State of
residence. A resident of a Contracting State may qualify for
benefits under paragraph 4 whether or not it also qualifies
under paragraph 2 or 3.
Subparagraph 4(a) sets forth the general rule that a
resident of a Contracting State engaged in the active conduct
of a trade or business in that State may obtain the benefits of
the Convention with respect to an item of income derived in the
other Contracting State. The item of income, however, must be
derived in connection with or incidental to that trade or
business.
The term ``trade or business'' is not defined in the
Convention. Pursuant to paragraph 2 of Article 3 (General
Definitions), when determining whether a resident of Iceland is
entitled to the benefits of the Convention under paragraph 3 of
this Article with respect to an item of income derived from
sources within the United States, the United States will
ascribe to this term the meaning that it has under the law of
the United States. Accordingly, the U.S. competent authority
will refer to the regulations issued under section 3 67(a) for
the definition of the term ``trade or business.'' In general,
therefore, a trade or business will be considered to be a
specific unified group of activities that constitute or could
constitute an independent economic enterprise carried on for
profit. Furthermore, a corporation generally will be considered
to carry on a trade or business only if the officers and
employees of the corporation conduct substantial managerial and
operational activities.
The business of making or managing investments for the
resident's own account will be considered to be a trade or
business only when part of banking, insurance or securities
activities conducted by a bank, an insurance company, or a
registered securities dealer. Such activities conducted by a
person other than a bank, insurance company or registered
securities dealer will not be considered to be the conduct of
an active trade or business, nor would they be considered to be
the conduct of an active trade or business if conducted by a
bank, insurance company or registered securities dealer but not
as part of the company's banking, insurance or dealer business.
Because a headquarters operation is in the business of managing
investments, a company that functions solely as a headquarters
company will not be considered to be engaged in an active trade
or business for purposes of paragraph 3.
An item of income is derived in connection with a trade or
business if the income-producing activity in the State of
source is a line of business that ``forms a part of'' or is
``complementary'' to the trade or business conducted in the
State of residence by the income recipient.
A business activity generally will be considered to form
part of a business activity conducted in the State of source if
the two activities involve the design, manufacture or sale of
the same products or type of products, or the provision of
similar services. The line of business in the State of
residence may be upstream, downstream, or parallel to the
activity conducted in the State of source. Thus, the line of
business may provide inputs for a manufacturing process that
occurs in the State of source, may sell the output of that
manufacturing process, or simply may sell the same sorts of
products that are being sold by the trade or business carried
on in the State of source.
Example 1. USCo is a corporation resident in the United
States. USCo is engaged in an active manufacturing business in
the United States. USCo owns 100 percent of the shares of ICo,
a corporation resident in Iceland. ICo distributes USCo
products in Iceland. Since the business activities conducted by
the two corporations involve the same products, ICo's
distribution business is considered to form a part of USCo's
manufacturing business.
Example 2. The facts are the same as in Example 1, except
that USCo does not manufacture. Rather, USCo operates a large
research and development facility in the United States that
licenses intellectual property to affiliates worldwide,
including ICo. ICo and other USCo affiliates then manufacture
and market the USCo-designed products in their respective
markets. Since the activities conducted by ICo and USCo involve
the same product lines, these activities are considered to form
a part of the same trade or business.
For two activities to be considered to be
``complementary,'' the activities need not relate to the same
types of products or services, but they should be part of the
same overall industry and be related in the sense that the
success or failure of one activity will tend to result in
success or failure for the other. Where more than one trade or
business is conducted in the State of source and only one of
the trades or businesses forms a part of or is complementary to
a trade or business conducted in the State of residence, it is
necessary to identify the trade or business to which an item of
income is attributable. Royalties generally will be considered
to be derived in connection with the trade or business to which
the underlying intangible property is attributable. Dividends
will be deemed to be derived first out of earnings and profits
of the treaty-benefited trade or business, and then out of
other earnings and profits. Interest income may be allocated
under any reasonable method consistently applied. A method that
conforms to U.S. principles for expense allocation will be
considered a reasonable method.
Example 3. Americair is a corporation resident in the
United States that operates an international airline. IceSub is
a wholly-owned subsidiary of Americair resident in Iceland.
IceSub operates a chain of hotels in Iceland that are located
near airports served by Americair flights. Americair frequently
sells tour packages that include air travel to Iceland and
lodging at Ice Sub hotels. Although both companies are engaged
in the active conduct of a trade or business, the businesses of
operating a chain of hotels and operating an airline are
distinct trades or businesses. Therefore IceSub's business does
not form a part of Americair's business. However, IceSub's
business is considered to be complementary to Americair's
business because they are part of the same overall industry
(travel) and the links between their operations tend to make
them interdependent.
Example 4. The facts are the same as in Example 3, except
that IceSub owns an office building in Iceland instead of a
hotel chain. No part of Americair's business is conducted
through the office building. IceSub's business is not
considered to form a part of or to be complementary to
Americair's business. They are engaged in distinct trades or
businesses in separate industries, and there is no economic
dependence between the two operations.
Example 5. USFlower is a corporation resident in the United
States. USFlower produces and sells flowers in the United
States and other countries. USFlower owns all the shares of
IceHolding, a corporation resident in Iceland. IceHolding is a
holding company that is not engaged in a trade or business.
IceHolding owns all the shares of three corporations that are
resident in Iceland: IceFlower, IceLawn, and IceFish. IceFlower
distributes USFlower flowers under the USFlower trademark in
Iceland. IceLawn markets a line of lawn care products in
Iceland under the USFlower trademark. In addition to being sold
under the same trademark, IceLawn and IceFlower products are
sold in the same stores and sales of each company's products
tend to generate increased sales of the other's products.
IceFish imports fish from the United States and distributes it
to fish wholesalers in Iceland. For purposes of paragraph 3,
the business of IceFlower forms a part of the business of
USFlower, the business of IceLawn is complementary to the
business of USFlower, and the business of IceFish is neither
part of nor complementary to that of USFlower.
An item of income derived from the State of source is
``incidental to'' the trade or business carried on in the State
of residence if production of the item facilitates the conduct
of the trade or business in the State of residence. An example
of incidental income is the temporary investment of working
capital of a person in the State of residence in securities
issued by persons in the State of source.
Subparagraph 4(b) states a further condition to the general
rule in subparagraph 4(a) in cases where the trade or business
generating the item of income in question is carried on either
by the person deriving the income or by any associated
enterprises. Subparagraph 4(b) states that the trade or
business carried on in the State of residence, under these
circumstances, must be substantial in relation to the activity
in the State of source. The substantiality requirement is
intended to prevent a narrow case of treaty-shopping abuses in
which a company attempts to qualify for benefits by engaging in
de minimis connected business activities in the treaty country
in which it is resident (i.e., activities that have little
economic cost or effect with respect to the company business as
a whole).
The determination of substantiality is made based upon all
the facts and circumstances and takes into account the
comparative sizes of the trades or businesses in each
Contracting State the nature of the activities performed in
each Contracting State, and the relative contributions made to
that trade or business in each Contracting State.
The determination in subparagraph 4(b) also is made
separately for each item of income derived from the State of
source. It therefore is possible that a person would be
entitled to the benefits of the Convention with respect to one
item of income but not with respect to another. If a resident
of a Contracting State is entitled to treaty benefits with
respect to a particular item of income under paragraph 3, the
resident is entitled to all benefits of the Convention insofar
as they affect the taxation of that item of income in the State
of source.
Subparagraph 4(c) provides special attribution rules for
purposes of applying the substantive rules of subparagraph
4(a). Thus, these rules apply for purposes of determining
whether a person meets the requirement in subparagraph 4(a)
that it be engaged in the active conduct of a trade or business
and that the item of income is derived in connection with that
active trade or business. Subparagraph 4(c) attributes to a
person activities conducted by a partnership in which that
person is a partner and activities conducted by persons
``connected'' to such person. A person (``X'') is connected to
another person (``Y'') if X possesses 50 percent or more of the
beneficial interest in Y (or if Y possesses 50 percent or more
of the beneficial interest in X). For this purpose, X is
connected to a company if X owns shares representing fifty
percent or more of the aggregate voting power and value of the
company or fifty percent or more of the beneficial equity
interest in the company. X also is connected to Y if a third
person possesses, directly or indirectly, fifty percent or more
of the beneficial interest in both X and Y. For this purpose,
if X or Y is a company, the threshold relationship with respect
to such company or companies is fifty percent or more of the
aggregate voting power and value or fifty percent or more of
the beneficial equity interest. Finally, X is connected to Y
if, based upon all the facts and circumstances, X controls Y, Y
controls X, or X and Y are controlled by the same person or
persons.
Paragraph 5
Paragraph 5 deals with the treatment of income in the
context of a so-called ``triangular case.''
The term ``triangular case'' refers to the use of the
following structure by a resident of Iceland to earn, in this
case, interest income from the United States. The resident of
Iceland, who is assumed to qualify for benefits under one or
more of the provisions of Article 16 (Limitation on Benefits),
sets up a permanent establishment in a third jurisdiction that
imposes only a low rate of tax on the income of the permanent
establishment. The Icelandic resident lends funds into the
United States through the permanent establishment. The
permanent establishment, despite its third-jurisdiction
location, is an integral part of a Icelandic resident.
Therefore the income that it earns on those loans, absent the
provisions of paragraph 5, is entitled to exemption from U.S.
withholding tax under the Convention. Under a current Icelandic
income tax treaty with the host jurisdiction of the permanent
establishment, the income of the permanent establishment is
exempt from Icelandic tax (alternatively, Iceland may choose to
exempt the income of the permanent establishment from Icelandic
income tax). Thus, the interest income is exempt from U.S. tax,
is subject to little tax in the host jurisdiction of the
permanent establishment, and is exempt from Icelandic tax.
Paragraph 5 applies reciprocally. However, the United
States does not exempt the profits of a third-jurisdiction
permanent establishment of a U.S. resident from U.S. tax,
either by statute or by treaty.
Paragraph 5 provides that the tax benefits that would
otherwise apply under the Convention will not apply to any item
of income if the combined tax actually paid in the residence
State and the third state is less than 60 percent of the tax
that would have been payable in the residence State if the
income were earned in that State by the enterprise and were not
attributable to the permanent establishment in the third state.
In the case of dividends, interest and royalties to which this
paragraph applies, the withholding tax rates under the
Convention are replaced with a 15 percent withholding tax. Any
other income to which the provisions of paragraph 5 apply is
subject to tax under the domestic law of the source State,
notwithstanding any other provisions of the Convention.
In general, the principles employed under Code section
954(b) (4) will be employed to determine whether the profits
are subject to an effective rate of taxation that is above the
specified threshold.
Notwithstanding the level of tax on interest and royalty
income of the permanent establishment, paragraph 5 will not
apply under certain circumstances. In the case of royalties,
paragraph 5 will not apply if the royalties are received as
compensation for the use of, or the right to use, intangible
property produced or developed by the permanent establishment
itself. In the case of any other income, paragraph 5 will not
apply if that income is derived in connection with, or is
incidental to, the active conduct of a trade or business
carried on by the permanent establishment in the third state.
The business of making, managing or simply holding investments
is not considered to be an active trade or business, unless
these are banking or securities activities carried on by a bank
or registered securities dealer.
Paragraph 6
Paragraph 6 provides a special rule where a company
resident in a Contracting State, or a company that controls
such a company directly or indirectly, has a class of shares
that is subject to terms or other arrangements that entitle the
holder to a larger portion of the company's income than the
portion the holders would receive absent such terms or
arrangements (``the disproportionate part of the income'').
Where 50 percent or more of such a class of shares is owned by
persons who are not entitled to benefits under paragraph 2, the
benefits of the Convention shall not apply with respect to the
disproportionate part of the income of the Company.
The following example illustrates this result.
Example. IceCo is a corporation resident in Iceland. IceCo
has two classes of shares: Common and Preferred. The Common
shares are listed and regularly traded on the Icelandic Stock
Exchange. The Preferred shares have no voting rights and are
entitled to receive dividends equal in amount to interest
payments that IceCo receives from unrelated borrowers in the
United States. The Preferred shares are owned entirely by a
single investor that is a resident of a third country. The
Common shares account for more than 50 percent of the value of
IceCo and for 100 percent of the voting power. Because the
owner of the Preferred shares is entitled to receive payments
corresponding to the U.S. source interest income earned by
IceCo, the Preferred shares are a disproportionate class of
shares. Because the Preferred shares are not owned by persons
entitled to benefits under paragraph 2, the benefits of the
Convention shall not apply with respect to IceCo's U.S.-source
interest income.
Paragraph 7
Paragraph 7 provides that a resident of one of the States
that is not entitled to the benefits of the Convention as a
result of paragraphs 1 through 5 still shall be granted
benefits under the Convention if the competent authority of the
State from which benefits are claimed determines that the
establishment, acquisition, or maintenance of the person
seeking benefits under the Convention, or the conduct of such
person's operations, has or had as one of its principal
purposes the obtaining of benefits under the Convention.
Benefits will not be granted, however, solely because a company
was established prior to the effective date of a treaty or
protocol. In that case a company would still be required to
establish, to the satisfaction of the competent authority,
clear non-tax business reasons for its formation in a
Contracting State, or that the allowance of benefits would not
otherwise be contrary to the purposes of the treaty. Thus,
persons that establish operations in one of the States with a
principal purpose of obtaining the benefits of the Convention
ordinarily will not be granted relief under paragraph 7.
The competent authority's discretion is quite broad. It may
grant all of the benefits of the Convention to the taxpayer
making the request, or it may grant only certain benefits. For
instance, it may grant benefits only with respect to a
particular item of income in a manner similar to paragraph 3.
Further, the competent authority may establish conditions, such
as setting time limits on the duration of any relief granted.
For purposes of implementing paragraph 7, a taxpayer will
be permitted to present his case to the relevant competent
authority for an advance determination based on the facts. In
these circumstances, it is also expected that, if the competent
authority determines that benefits are to be allowed, they will
be allowed retroactively to the time of entry into force of the
relevant treaty provision or the establishment of the structure
in question, whichever is later.
Finally, there may be cases in which a resident of a
Contracting State may apply for discretionary relief to the
competent authority of his State of residence. This would
arise, for example, if the benefit it is claiming is provided
by the residence country, and not by the source country. So,
for example, if a company that is a resident of the United
States would like to claim the benefit of the re-sourcing rule
of subparagraph 2(a) of Article 22, but it does not meet any of
the objective tests of paragraphs 2 through 5, it may apply to
the U.S. competent authority for discretionary relief.
Paragraph 8
Paragraph 8 defines several key terms for purposes of
Article 22. Each of the defined terms is discussed above in the
context in which it is used.
ARTICLE 22 (RELIEF FROM DOUBLE TAXATION)
This Article describes the manner in which each Contracting
State undertakes to relieve double taxation. The United States
uses the foreign tax credit method under its internal law, and
by treaty.
Paragraph 1
The United States agrees, in paragraph 1, to allow to its
citizens and residents a credit against U.S. tax for income
taxes paid or accrued to Iceland. Paragraph 1 also provides
that Iceland's covered taxes are income taxes for U.S.
purposes. This provision is based on the Treasury Department's
review of Iceland's laws.
Subparagraph 1(b) provides for a deemed-paid credit,
consistent with section 902 of the Code, to a U.S. corporation
in respect of dividends received from a corporation resident in
Iceland of which the U.S. corporation owns at least 10 percent
of the voting stock. This credit is for the tax paid by the
corporation to Iceland on the profits out of which the
dividends are considered paid.
The credits allowed under paragraph 1 are allowed in
accordance with the provisions and subject to the limitations
of U.S. law, as that law may be amended over time, so long as
the general principle of the Article, that is, the allowance of
a credit, is retained. Thus, although the Convention provides
for a foreign tax credit, the terms of the credit are
determined by the provisions, at the time a credit is given, of
the U.S. statutory credit.
Therefore, the U.S. credit under the Convention is subject
to the various limitations of U.S. law (see, e.g., Code
sections 901-908). For example, the credit against U.S. tax
generally is limited to the amount of U.S. tax due with respect
to net foreign source income within the relevant foreign tax
credit limitation category (see Code section 904(a) and (d)),
and the dollar amount of the credit is determined in accordance
with U.S. currency translation rules (see, e.g., Code section
986). Similarly, U.S. law applies to determine carryover
periods for excess credits and other inter-year adjustments.
Paragraph 2
Paragraph 2 provides a re-sourcing rule for gross income
covered by paragraph 1. Subparagraph 2(a) is intended to ensure
that a U.S. resident can obtain an appropriate amount of U.S.
foreign tax credit for income taxes paid to Iceland when the
Convention assigns to Iceland primary taxing rights over an
item of gross income.
Accordingly, if the Convention allows Iceland to tax an
item of gross income (as defined under U.S. law) derived by a
resident of the United States, the United States will treat
that item of gross income as gross income from sources within
Iceland for U.S. foreign tax credit purposes. In the case of a
U.S.-owned foreign corporation, however, section 904(g)(10) may
apply for purposes of determining the U.S. foreign tax credit
with respect to income subject to this re-sourcing rule.
Section 904(g)(10) generally applies the foreign tax credit
limitation separately to re-sourced income. Furthermore, the
subparagraph 2(a) re-sourcing rule applies to gross income, not
net income. Accordingly, U.S. expense allocation and
apportionment rules, see, e.g., Treas. Reg. section 1.861-9,
continue to apply to income resourced under subparagraph 2(a).
Subparagraph 2(b) provides that gains derived by an
individual who was a resident of the United States that are
taxed by the United States in accordance with the Convention,
and that may also be taxed in Iceland solely by reason of
Article 13 (Capital Gains) , shall be deemed to be gains from
sources in the United States. The provisions of subparagraph
2(b) ensure that the United States does not bear, from a
foreign tax credit standpoint, the cost of Iceland's
expatriation tax.
Paragraph 3
Specific rules are provided in paragraph 3 under which
Iceland, in imposing tax on its residents, provides relief for
U.S. taxes paid by those residents. Subparagraph 3(a) provides
that when a resident of Iceland derives income that, in
accordance with the provisions of the Convention, may be taxed
in the United States, Iceland shall allow as a credit against
Icelandic income taxes an amount equal to those taxes paid to
the United States.
Subparagraph 3(b) limits the credits against Icelandic
taxes to those taxes that are attributable to the income that
has been taxed by the United States.
Subparagraph 3(c) provides that when a resident of Iceland
derives income that, in accordance with the provisions of the
Convention, may be taxed by the United States, Iceland shall
allow the credit against Icelandic tax described in
subparagraph 3(b). However, subparagraph 3(c) also permits
Iceland to include the income corresponding to the U.S. tax in
the resident's tax base for purposes of determining the
Icelandic tax. This rule is a variation of the ``exemption with
progression rule,'' adapted to accommodate Iceland's credit
system. It is also similar to U.S. domestic law, which permits
credits for foreign taxes paid, while at the same time taxing
residents on worldwide income. Finally, subparagraph 3(c)
provides that for purposes of this Article, the U.S. taxes
referred to in subparagraph 3(b) and paragraph 4 of Article 2
(Taxes Covered) are considered to be income taxes and are
allowed as credits against Icelandic tax on income, subject to
all of the provisions and limitations of this paragraph.
Paragraph 4
Paragraph 4 provides special rules for the tax treatment in
both States of certain types of income derived from U.S.
sources by U.S. citizens who are residents of Iceland. Since
U.S. citizens, regardless of residence, are subject to United
States tax at ordinary progressive rates on their worldwide
income, the U.S. tax on the U.S. source income of a U.S.
citizen resident in Iceland may exceed the U.S. tax that may be
imposed under the Convention on an item of U.S. source income
derived by a resident of Iceland who is not a U.S. citizen. The
provisions of paragraph 4 ensure that Iceland does not bear the
cost of U.S. taxation of its citizens who are residents of
Iceland.
Subparagraph 4(a) provides, with respect to items of income
from sources within the United States, special credit rules for
Iceland. These rules apply to items of U. S.-source income that
would be either exempt from U.S. tax or subject to reduced
rates of U.S. tax under the provisions of the Convention if
they had been received by a resident of Iceland who is not a
U.S. citizen. The tax credit allowed under paragraph 4 with
respect to such items need not exceed the U.S. tax that may be
imposed under the Convention, other than tax imposed solely by
reason of the U.S. citizenship of the taxpayer under the
provisions of the saving clause of paragraph 4 of Article 1
(General Scope).
For example, if a U.S. citizen resident in Iceland receives
portfolio dividends from sources within the United States, the
foreign tax credit granted by Iceland would be limited to 15
percent of the dividend - the U.S. tax that may be imposed
under subparagraph 2(b) of Article 10 (Dividends) - even if the
shareholder is subject to U.S. net income tax because of his
U.S. citizenship. With respect to interest income, Iceland
would allow no foreign tax credit, because its residents are
exempt from U.S. tax on interest income under the provisions of
Articles 11 (Interest).
Subparagraph 4(b) eliminates the potential for double
taxation that can arise because subparagraph 4(a) provides that
Iceland need not provide full relief for the U.S. tax imposed
on its citizens resident in Iceland. The subparagraph provides
that the United States will credit the income tax paid or
accrued to Iceland, after the application of subparagraph 4(a).
It further provides that in allowing the credit, the United
States will not reduce its tax below the amount that is taken
into account in Iceland in applying subparagraph 4(a).
Since the income described in subparagraph 4(a) generally
will be U.S. source income, special rules are required to re-
source some of the income to Iceland in order for the United
States to be able to credit the tax paid to Iceland. This re-
sourcing is provided for in subparagraph 4(c), which deems the
items of income referred to in subparagraph 4(a) to be from
foreign sources to the extent necessary to avoid double
taxation under subparagraph 4(b). Clause (iii) of subparagraph
3(c) of Article 24 (Mutual Agreement Procedure) provides a
mechanism by which the competent authorities can resolve any
disputes regarding whether income is from sources within the
United States.
The following two examples illustrate the application of
paragraph 4 in the case of a U. S.-source portfolio dividend
received by a U.S. citizen resident in Iceland. In both
examples, the U.S. rate of tax on residents of Iceland, under
subparagraph 2(b) of Article 10 (Dividends) of the Convention,
is 15 percent. In both examples, the U.S. income tax rate on
the U.S. citizen is 35 percent. In example 1, the rate of
income tax imposed in Iceland on its resident (the U.S.
citizen) is 25 percent (below the U.S. rate), and in example 2,
the rate imposed on its resident is 40 percent (above the U.S.
rate).
------------------------------------------------------------------------
Example 1 Example 2
------------------------------------------------------------------------
Subparagraph (a)
U.S. dividend declared...................... $100.00 $100.00
Notional U.S. withholding tax (Article 15.00 15.00
10(2)(b))..................................
Taxable income in Iceland................... 100.00 100.00
Icelandic tax before credit................. 25.00 40.00
Less: tax credit for notional U.S. 15.00 15.00
withholding tax............................
Net post-credit tax paid to Iceland......... 10.00 25.00
Subparagraphs (b) and (c)
U.S. pre-tax income......................... $100.00 $100.00
U.S. pre-credit citizenship tax............. 35.00 35.00
Notional U.S. withholding tax............... 15.00 15.00
U.S. tax eligible to be offset by credit.... 20.00 20.00
Tax paid to Iceland......................... 10.00 25.00
Income re-sourced from U.S. to foreign 28.57 57.14
source (see below).........................
U.S. pre-credit tax on re-sourced income.... 10.00 20.00
U.S. credit for tax paid to Iceland......... 10.00 20.00
Net post-credit U.S. tax.................... 10.00 0.00
Total U.S. tax.............................. 25.00 15.00
------------------------------------------------------------------------
In both examples, in the application of subparagraph 4(a),
Iceland credits a 15 percent U.S. tax against its residence tax
on the U.S. citizen. In the first example, the net tax paid to
Iceland after the foreign tax credit is $10.00; in the second
example, it is $25.00. In the application of subparagraphs 4(b)
and 4(c), from the U.S. tax due before credit of $35.00, the
United States subtracts the amount of the U.S. source tax of
$15.00, against which no U.S. foreign tax credit is allowed.
This subtraction ensures that the United States collects the
tax that it is due under the Convention as the State of source.
In both examples, given the 35 percent U.S. tax rate, the
maximum amount of U.S. tax against which credit for the tax
paid to Iceland may be claimed is $20 ($35 U.S. tax minus $15
U.S. withholding tax). Initially, all of the income in both
examples was from sources within the United States. For a U.S.
foreign tax credit to be allowed for the full amount of the tax
paid to Iceland, an appropriate amount of the income must be
re-sourced to Iceland under subparagraph 4(c).
The amount that must be re-sourced depends on the amount of
tax for which the U.S. citizen is claiming a U.S. foreign tax
credit. In example 1, the tax paid to Iceland was $10. For this
amount to be creditable against U.S. tax, $28.57 ($10 tax
divided by 35 percent U.S. tax rate) must be resourced to
Iceland. When the tax is credited against the $10 of U.S. tax
on this resourced income, there is a net U.S. tax of $10 due
after credit ($20 U.S. tax eligible to be offset by credit,
minus $10 tax paid to Iceland). Thus, in example 1, there is a
total of $25 in U.S. tax ($15 U.S. withholding tax plus $10
residual U.S. tax).
In example 2, the tax paid to Iceland was $25, but, because
the United States subtracts the U.S. withholding tax of $15
from the total U.S. tax of $35, only $20 of U.S. taxes may be
offset by taxes paid to Iceland. Accordingly, the amount that
must be resourced to Iceland is limited to the amount necessary
to ensure a U.S. foreign tax credit for $20 of tax paid to
Iceland, or $57.14 ($20 tax paid to Iceland divided by 35
percent U.S. tax rate). When the tax paid to Iceland is
credited against the U.S. tax on this re-sourced income, there
is no residual U.S. tax ($20 U.S. tax minus $25 tax paid to
Iceland, subject to the U.S. limit of $20). Thus, in example 2,
there is a total of $15 in U.S. tax ($15 U.S. withholding tax
plus $0 residual U.S. tax). Because the tax paid to Iceland was
$25 and the U.S. tax eligible to be offset by credit was $20,
there is $5 of excess foreign tax credit available for
carryover.
Relationship to Other Articles
By virtue of subparagraph 5(a) of Article 1 (General
Scope), Article 22 is not subject to the saving clause of
paragraph 4 of Article 1. Thus, the United States will allow a
credit to its citizens and residents in accordance with the
Article, even if such credit were to provide a benefit not
available under the Code (such as the re-sourcing provided by
paragraph 2 and subparagraph 4(c)).
ARTICLE 23 (NON-DISCRIMINATION)
This Article ensures that nationals of a Contracting State,
in the case of paragraph 1, and residents of a Contracting
State, in the case of paragraphs 2 through 4, will not be
subject, directly or indirectly, to discriminatory taxation in
the other Contracting State. Not all differences in tax
treatment, either as between nationals of the two States, or
between residents of the two States, are violations of the
prohibition against discrimination. Rather, the non-
discrimination obligations of this Article apply only if the
nationals or residents of the two States are comparably
situated.
Each of the relevant paragraphs of the Article provides
that two persons that arecomparably situated must be treated
similarly. Although the actual words differ from paragraph to
paragraph (e.g., paragraph 1 refers to two nationals ``in the
same circumstances,'' paragraph 2 refers to two enterprises
``carrying on the same activities'' and paragraph 4 refers to
two enterprises that are ``similar''), the common underlying
premise is that if the difference in treatment is directly
related to a tax-relevant difference in the situations of the
domestic and foreign persons being compared, that difference is
not to be treated as discriminatory (i.e., if one person is
taxable in a Contracting State on worldwide income and the
other is not, or tax may be collectible from one person at a
later stage, but not from the other, distinctions in treatment
would be justified under paragraph 1). Other examples of such
factors that can lead to non-discriminatory differences in
treatment are noted in the discussions of each paragraph.
The operative paragraphs of the Article also use different
language to identify the kinds of differences in taxation
treatment that will be considered discriminatory. For example,
paragraphs 1 and 4 speak of ``any taxation or any requirement
connected therewith that is more burdensome,'' while paragraph
2 specifies that a tax ``shall not be less favorably levied.''
Regardless of these differences in language, only differences
in tax treatment that materially disadvantage the foreign
person relative to the domestic person are properly the subject
of the Article.
Paragraph 1
Paragraph 1 provides that a national of one Contracting
State may not be subject to taxation or connected requirements
in the other Contracting State that are different from or more
burdensome than the taxes and connected requirements imposed
upon a national of that other State in the same circumstances.
The term ``national'' in relation to a Contracting State is
defined in subparagraph 1(j) of Article 3 (General
Definitions). The term includes both individuals and juridical
persons.
A national of a Contracting State is afforded protection
under this paragraph even if the national is not a resident of
either Contracting State. Thus, a U.S. citizen who is resident
in a third country is entitled, under this paragraph, to the
same treatment in Iceland as a national of Iceland who is in
similar circumstances (i.e., presumably one who is resident in
a third State).
As noted above, whether or not the two persons are both
taxable on worldwide income is a significant circumstance for
this purpose. For this reason, paragraph 1 specifically states
that the United States is not obligated to apply the same
taxing regime to a national of Iceland who is not resident in
the United States as it applies to a U.S. national who is not
resident in the United States. United States citizens who are
not residents of the United States but who are, nevertheless,
subject to United States tax on their worldwide income are not
in the same circumstances with respect to United States
taxation as citizens of Iceland who are not United States
residents. Thus, for example, Article 23 would not entitle a
national of Iceland resident in a third country to taxation at
graduated rates on U.S. source dividends or other investment
income that applies to a U.S. citizen resident in the same
third country.
Paragraph 2
Paragraph 2 of the Article, provides that a Contracting
State may not tax a permanent establishment of an enterprise of
the other Contracting State less favorably than an enterprise
of that first-mentioned State that is carrying on the same
activities.
The fact that a U.S. permanent establishment of an
enterprise of Iceland is subject to U.S. tax only on income
that is attributable to the permanent establishment, while a
U.S. corporation engaged in the same activities is taxable on
its worldwide income is not, in itself, a sufficient difference
to provide different treatment for the permanent establishment.
There are cases, however, where the two enterprises would not
be similarly situated and differences in treatment may be
warranted. For instance, it would not be a violation of the
non-discrimination protection of paragraph 2 to require the
foreign enterprise to provide information in a reasonable
manner that may be different from the information requirements
imposed on a resident enterprise, because information may not
be as readily available to the Internal Revenue Service from a
foreign as from a domestic enterprise. Similarly, it would not
be a violation of paragraph 2 to impose penalties on persons
who fail to comply with such a requirement (see, e.g., sections
874(a) and 882(c)(2)). Further, a determination that income and
expenses have been attributed or allocated to a permanent
establishment in conformity with the principles of Article 7
(Business Profits) implies that the attribution or allocation
was not discriminatory.
Section 1446 of the Code imposes on any partnership with
income that is effectively connected with a U.S. trade or
business the obligation to withhold tax on amounts allocable to
a foreign partner. In the context of the Convention, this
obligation applies with respect to a share of the partnership
income of a partner resident in Iceland, and attributable to a
U.S. permanent establishment. There is no similar obligation
with respect to the distributive shares of U.S. resident
partners. It is understood, however, that this distinction is
not a form of discrimination within the meaning of paragraph 2
of the Article. No distinction is made between U.S. and non-
U.S. partnerships, since the law requires that partnerships of
both U.S. and non-U.S. domicile withhold tax in respect of the
partnership shares of non-U.S. partners. Furthermore, in
distinguishing between U.S. and non-U.S. partners, the
requirement to withhold on the non-U.S. but not the U.S.
partner's share is not discriminatory taxation, but, like other
withholding on nonresident aliens, is merely a reasonable
method for the collection of tax from persons who are not
continually present in the United States, and as to whom it
otherwise may be difficult for the United States to enforce its
tax jurisdiction. If tax has been over-withheld, the partner
can, as in other cases of over-withholding, file for a refund.
Paragraph 2 does not obligate a Contracting State to grant
to a resident of the other Contracting State any tax
allowances, reliefs, etc., that it grants to its own residents
on account of their civil status or family responsibilities.
Thus, if a sole proprietor who is a resident of Iceland has a
permanent establishment in the United States, in assessing
income tax on the profits attributable to the permanent
establishment, the United States is not obligated to allow to
the resident of Iceland the personal allowances for himself and
his family that he would be permitted to take if the permanent
establishment were a sole proprietorship owned and operated by
a U.S. resident, despite the fact that the individual income
tax rates would apply.
Paragraph 3
Paragraph 3 prohibits discrimination in the allowance of
deductions. When a resident or an enterprise of a Contracting
State pays interest, royalties or other disbursements to a
resident of the other Contracting State, the first-mentioned
Contracting State must allow a deduction for those payments in
computing the taxable profits of the resident or enterprise as
if the payment had been made under the same conditions to a
resident of the first-mentioned Contracting State. Paragraph 3,
however, does not require a Contracting State to give
nonresidents more favorable treatment than it gives to its own
residents. Consequently, a Contracting State does not have to
allow nonresidents a deduction for items that are not
deductible under its domestic law (for example, expenses of a
capital nature).
The term ``other disbursements'' is understood to include a
reasonable allocation of executive and general administrative
expenses, research and development expenses and other expenses
incurred for the benefit of a group of related persons that
includes the person incurring the expense.
An exception to the rule of paragraph 3 is provided for
cases where the provisions of paragraph 1 of Article 9
(Associated Enterprises), paragraph 4 of Article 11 (Interest)
or para-graph 6 of Article 12 (Royalties) apply. All of these
provisions permit the denial of deductions in certain
circumstances in respect of transactions between related
persons. Neither State is forced to apply the non-
discrimination principle in such cases. The exception with
respect to paragraph 4 of Article 11 would include the denial
or deferral of certain interest deductions under Code section
163(j).
Paragraph 3 also provides that any debts of an enterprise
of a Contracting State to a resident of the other Contracting
State are deductible in the first-mentioned Contracting State
for purposes of computing the capital tax of the enterprise
under the same conditions as if the debt had been contracted to
a resident of the first-mentioned Contracting State. Even
though, for general purposes, the Convention covers only income
taxes, under paragraph 6 of this Article, the nondiscrimination
provisions apply to all taxes levied in both Contracting
States, at all levels of government.
Paragraph 4
Paragraph 4 requires that a Contracting State not impose
more burdensome taxation or connected requirements on an
enterprise of that State that is wholly or partly owned or
controlled, directly or indirectly, by one or more residents of
the other Contracting State than the taxation or connected
requirements that it imposes on other similar enterprises of
that first-mentioned Contracting State. For this purpose it is
understood that ``similar'' refers to similar activities or
ownership of the enterprise.
This rule, like all non-discrimination provisions, does not
prohibit differing treatment of entities that are in differing
circumstances. Rather, a protected enterprise is only required
to be treated in the same manner as other enterprises that,
from the point of view of the application of the tax law, are
in substantially similar circumstances both in law and in fact.
The taxation of a distributing corporation under section 367(e)
on an applicable distribution to foreign shareholders does not
violate paragraph 4 of the Article because a foreign-owned
corporation is not similar to a domestically-owned corporation
that is accorded non-recognition treatment under sections 337
and 355.
For the reasons given above in connection with the
discussion of paragraph 2 of the Article, it is also understood
that the provision in section 1446 of the Code for withholding
of tax on non-U.S. partners does not violate paragraph 5 of the
Article.
It is further understood that the ineligibility of a U.S.
corporation with nonresident alien shareholders to make an
election to be an ``S'' corporation does not violate paragraph
4 of the Article. If a corporation elects to be an S
corporation, it is generally not subject to income tax and the
shareholders take into account their pro rata shares of the
corporation's items of income, loss, deduction or credit. (The
purpose of the provision is to allow an individual or small
group of individuals the protections of conducting business in
corporate form while paying taxes at individual rates as if the
business were conducted directly.) A nonresident alien does not
pay U.S. tax on a net basis, and, thus, does not generally take
into account items of loss, deduction or credit. Thus, the S
corporation provisions do not exclude corporations with
nonresident alien shareholders because such shareholders are
foreign, but only because they are not net-basis taxpayers.
Similarly, the provisions exclude corporations with other types
of shareholders where the purpose of the provisions cannot be
fulfilled or their mechanics implemented. For example,
corporations with corporate shareholders are excluded because
the purpose of the provision to permit individuals to conduct a
business in corporate form at individual tax rates would not be
furthered by their inclusion.
Finally, it is understood that paragraph 4 does not require
a Contracting State to allow foreign corporations to join in
filing a consolidated return with a domestic corporation or to
allow similar benefits between domestic and foreign
enterprises.
Paragraph 5
Paragraph 5 of the Article confirms that no provision of
the Article will prevent either Contracting State from imposing
the branch profits tax described in paragraph 8 of Article 10
(Dividends).
Paragraph 6
As noted above, notwithstanding the specification of taxes
covered by the Convention in Article 2 (Taxes Covered) for
general purposes, for purposes of providing nondiscrimination
protection this Article applies to taxes of every kind and
description imposed by a Contracting State or a political
subdivision or local authority thereof. Customs duties are not
considered to be taxes for this purpose.
Relationship to Other Articles
The saving clause of paragraph 4 of Article 1 (General
Scope) does not apply to this Article by virtue of the
exceptions in subparagraph 5(a) of Article 1. Thus, for
example, a U.S. citizen who is a resident of Iceland may claim
benefits in the United States under this Article.
Nationals of a Contracting State may claim the benefits of
paragraph 1 regardless of whether they are entitled to benefits
under Article 21 (Limitation on Benefits), because that
paragraph applies to nationals and not residents. They may not
claim the benefits of the other paragraphs of this Article with
respect to an item of income unless they are generally entitled
to treaty benefits with respect to that income under a
provision of Article 21.
ARTICLE 24 (MUTUAL AGREEMENT PROCEDURE)
This Article provides the mechanism for taxpayers to bring
to the attention of competent authorities issues and problems
that may arise under the Convention. It also provides the
authority for cooperation between the competent authorities of
the Contracting States to resolve disputes and clarify issues
that may arise under the Convention and to resolve cases of
double taxation not provided for in the Convention. The
competent authorities of the two Contracting States are
identified in subparagraph 1(i) of Article 3 (General
Definitions).
Paragraph 1
This paragraph provides that where a resident of a
Contracting State considers that the actions of one or both
Contracting States will result in taxation that is not in
accordance with the Convention, he may present his case to the
competent authority of either Contracting State. This rule is
more generous than in most treaties, which generally allow
taxpayers to bring competent authority cases only to the
competent authority of their country of residence, or citizen-
ship/nationality. Under this more generous rule, a U.S.
permanent establishment of a corporation resident in Iceland
that faces inconsistent treatment in the two countries would be
able to bring its request for assistance to the U.S. competent
authority. If the U.S. competent authority can resolve the
issue on its own, then the taxpayer need never involve the
Icelandic competent authority. Thus, the rule provides
flexibility that might result in greater efficiency.
Although the typical cases brought under this paragraph
will involve economic double taxation arising from transfer
pricing adjustments, the scope of this paragraph is not limited
to such cases. For example, a taxpayer could request assistance
from the competent authority if one Contracting State
determines that the taxpayer has received deferred compensation
taxable at source under Article 14 (Income from Employment),
while the taxpayer believes that such income should be treated
as a pension that is taxable only in his country of residence
pursuant to Article 17 (Pensions, Social Security, and
Annuities).
It is not necessary for a person requesting assistance
first to have exhausted the remedies provided under the
national laws of the Contracting States before presenting a
case to the competent authorities, nor does the fact that the
statute of limitations may have passed for seeking a refund
preclude bringing a case to the competent authority. Unlike the
OECD Model, no time limit is provided within which a case must
be brought.
Paragraph 2
Paragraph 2 sets out the framework within which the
competent authorities will deal with cases brought by taxpayers
under paragraph 1. It provides that, if the competent authority
of the Contracting State to which the case is presented judges
the case to have merit, and cannot reach a unilateral solution,
it shall seek an agreement with the competent authority of the
otherContracting State pursuant to which taxation not in
accordance with the Convention will be avoided.
Any agreement is to be implemented even if such
implementation otherwise would be barred by the statute of
limitations or by some other procedural limitation, such as a
closing agreement. Paragraph 2, however, does not prevent the
application of domestic-law procedural limitations that give
effect to the agreement (e.g., a domestic-law requirement that
the taxpayer file a return reflecting the agreement within one
year of the date of the agreement).
Where the taxpayer has entered a closing agreement (or
other written settlement) with the United States before
bringing a case to the competent authorities, the U.S.
competent authority will endeavor only to obtain a correlative
adjustment from Iceland. See Rev. Proc. 2006-54, 2006-49
I.R.B. 1035, Sec. 7.05. Because, as specified in paragraph 2 of
Article 1 (General Scope), the Convention cannot operate to
increase a taxpayer's liability, temporal or other procedural
limitations can be overridden only for the purpose of making
refunds and not to impose additional tax.
Paragraph 3
Paragraph 3 authorizes the competent authorities to resolve
difficulties or doubts that may arise as to the application or
interpretation of the Convention. The paragraph includes a non-
exhaustive list of examples of the kinds of matters about which
the competent authorities may reach agreement. This list is
purely illustrative; it does not grant any authority that is
not implicitly present as a result of the introductory sentence
of paragraph 3.
The competent authorities may, for example, agree to the
same allocation of income, deductions, credits or allowances
between an enterprise in one Contracting State and its
permanent establishment in the other or between related
persons. These allocations are to be made in accordance with
the arm's length principle underlying Article 7 (Business
Profits) and Article 9 (Associated Enterprises). Agreements
reached under these subparagraphs may include agreement on a
methodology for determining an appropriate transfer price, on
an acceptable range of results under that methodology, or on a
common treatment of a taxpayer's cost sharing arrangement.
As indicated in subparagraphs 3(a) through 3(f), the
competent authorities also may agree to settle a variety of
conflicting applications of the Convention. They may agree to
settle conflicts regarding the characterization of particular
items of income, including the same characterization of income
that is assimilated to income from shares by the taxation law
of one of the Contracting States and that is treated as a
different class of income in the other State. They may also
agree to the characterization of persons, the application of
source rules to particular items of income, the meaning of a
term, or the timing of an item of income.
The competent authorities also may agree as to the
application of the provisions of domestic law regarding
penalties, fines, and interest in a manner consistent with the
purposes of the Convention.
Since the list under paragraph 3 is not exhaustive, the
competent authorities may reach agreement on issues not
enumerated in paragraph 3 if necessary to avoid double
taxation. For example, the competent authorities may seek
agreement on a uniform set of standards for the use of exchange
rates. Agreements reached by the competent authorities under
paragraph 3 need not conform to the internal law provisions of
either Contracting State.
Finally, paragraph 3 authorizes the competent authorities
to consult for the purpose of eliminating double taxation in
cases not provided for in the Convention and to resolve any
difficulties or doubts arising as to the interpretation or
application of the Convention. This provision is intended to
permit the competent authorities to implement the treaty in
particular cases in a manner that is consistent with its
expressed general purposes. It permits the competent
authorities to deal with cases that are within the spirit of
the provisions but that are not specifically covered. An
example of such a case might be double taxation arising from a
transfer pricing adjustment between two permanent
establishments of a third-country resident, one in the United
States and one in Iceland. Since no resident of a Contracting
State is involved in the case, the Convention does not apply,
but the competent authorities nevertheless may use the
authority of this Article to prevent the double taxation of
income.
Paragraph 4
Paragraph 4 provides that the competent authorities may
communicate with each other for the purpose of reaching an
agreement. This makes clear that the competent authorities of
the two Contracting States may communicate without going
through diplomatic channels. Such communication may be in
various forms, including, where appropriate, through face-to-
face meetings of representatives of the competent authorities.
Treaty termination in relation to competent authority dispute
resolution
A case may be raised by a taxpayer after the Convention has
been terminated with respect to a year for which a treaty was
in force. In such a case the ability of the competent
authorities to act is limited. They may not exchange
confidential information, nor may they reach a solution that
varies from that specified in its law.
Triangular competent authority solutions
International tax cases may involve more than two taxing
jurisdictions (e.g., transactions among a parent corporation
resident in country A and its subsidiaries resident in
countries B and C). As long as there is a complete network of
treaties among the three countries, it should be possible,
under the full combination of bilateral authorities, for the
competent authorities of the three States to work together on a
three-sided solution. Although country A may not be able to
give information received under Article 26 (Exchange of
Information and Administrative Assistance) from country B to
the authorities of country C, if the competent authorities of
the three countries are working together, it should not be a
problem for them to arrange for the authorities of country B to
give the necessary information directly to the tax authorities
of country C, as well as to those of country A. Each bilateral
part of the trilateral solution must, of course, not exceed the
scope of the authority of the competent authorities under the
relevant bilateral treaty.
Relationship to Other Articles
This Article is not subject to the saving clause of
paragraph 4 of Article 1 (General Scope) by virtue of the
exceptions in subparagraph 5(a) of that Article. Thus, rules,
definitions, procedures, etc. that are agreed upon by the
competent authorities under this Article may be applied by the
United States with respect to its citizens and residents even
if they differ from the comparable Code provisions. Similarly,
as indicated above, U.S. law may be overridden to provide
refunds of tax to a U.S. citizen or resident under this
Article. A person may seek relief under Article 24 regardless
of whether he is generally entitled to benefits under Article
21 (Limitation on Benefits). As in all other cases, the
competent authority is vested with the discretion to decide
whether the claim for relief is justified.
ARTICLE 25 (EXCHANGE OF INFORMATION AND ADMINISTRATIVE ASSISTANCE)
This Article provides for the exchange of information and
administrative assistance between the competent authorities of
the Contracting States.
Paragraph 1
The obligation to obtain and provide information to the
other Contracting State is set out in paragraph 1. The
information to be exchanged is that which is relevant for
carrying out the provisions of the Convention or the domestic
laws of the United States or of the Iceland concerning taxes of
every kind applied at the national level. Exchange of
information with respect to each State's domestic law is
authorized to the extent that taxation under domestic law is
not contrary to the Convention. Thus, for example, information
may be exchanged with respect to a covered tax, even if the
transaction to which the information relates is a purely
domestic transaction in the requesting State and, therefore,
the exchange is not made to carry out the Convention. An
example of such a case is provided in the OECD Commentary: a
company resident in the United States and a company resident in
Iceland transact business between themselves through a third-
country resident company. Neither Contracting State has a
treaty with the third State. To enforce their internal laws
with respect to transactions of their residents with the third-
country company (since there is no relevant treaty in force),
the Contracting States may exchange information regarding the
prices that their residents paid in their transactions with the
third-country resident.
Paragraph 1 clarifies that information may be exchanged
that relates to the assessment or collection of, the
enforcement or prosecution in respect of, or the determination
of appeals in relation to, the taxes covered by the Convention.
Thus, the competent authorities may request and provide
information for cases under examination or criminal
investigation, in collection, on appeals, or under prosecution.
The taxes covered by the Convention for purposes of this
Article constitute a broader category of taxes than those
referred to in Article 2 (Taxes Covered). Exchange of
information is authorized with respect to taxes of every kind
imposed by a Contracting State at the national level.
Accordingly, information may be exchanged with respect to U.S.
estate and gift taxes, excise taxes or, with respect to
Iceland, value added taxes.
Information exchange is not restricted by paragraph 1 of
Article 1 (General Scope). Accordingly, information may be
requested and provided under this article with respect to
persons who are not residents of either Contracting State. For
example, if a third-country resident has a permanent
establishment in Iceland, and that permanent establishment
engages in transactions with a U.S. enterprise, the United
States could request information with respect to that permanent
establishment, even though the third-country resident is not a
resident of either Contracting State. Similarly, if a third-
country resident maintains a bank account in Iceland, and the
Internal Revenue Service has reason to believe that funds in
that account should have been reported for U.S. tax purposes
but have not been so reported, information can be requested
from Iceland with respect to that person's account, even though
that person is not the taxpayer under examination.
Although the term ``United States'' does not encompass U.S.
possessions for most purposes of the Convention, Section 7651
of the Code authorizes the Internal Revenue Service to utilize
the provisions of the Internal Revenue Code to obtain
information from the U.S. possessions pursuant to a proper
request made under Article 25. If necessary to obtain requested
information, the Internal Revenue Service could issue and
enforce an administrative summons to the taxpayer, a tax
authority (or a government agency in a U.S. possession), or a
third party located in a U.S. possession.
Paragraph 1 also provides assurances that any information
exchanged will be treated as secret, subject to the same
disclosure constraints as information obtained under the laws
of the requesting State. Information received may be disclosed
only to persons, including courts and administrative bodies,
involved in the assessment, collection, or administration of,
the enforcement or prosecution in respect of, or the
determination of the of appeals in relation to, the taxes
covered by the Convention. The information must be used by
these persons in connection with the specified functions.
Information may also be disclosed to legislative bodies, such
as the tax-writing committees of Congress and the Government
Accountability Office, engaged in the oversight of the
preceding activities. Information received by these bodies must
be for use in the performance of their role in overseeing the
administration of U.S. tax laws. Information received may be
disclosed in public court proceedings or in judicial decisions.
Paragraph 2
Paragraph 2 provides that when information is requested by
a Contracting State in accordance with this Article, the other
Contracting State is obligated to obtain the requested
information as if the tax in question were the tax of the
requested State, even if that State has no direct tax interest
in the case to which the request relates. In the absence of
such a paragraph, some taxpayers have argued that subparagraph
3(a) prevents a Contracting State from requesting information
from a bank or fiduciary that the Contracting State does not
need for its own tax purposes. This paragraph clarifies that
paragraph 3 does not impose such a restriction and that a
Contracting State is not limited to providing only the
information that it already has in its own files.
Paragraph 3
Paragraph 3 provides that the obligations undertaken in
paragraphs 1 and 2 to exchange information do not require a
Contracting State to carry out administrative measures that are
at variance with the laws or administrative practice of either
State. Nor is a Contracting State required to supply
information not obtainable under the laws or administrative
practice of either State, or to disclose trade secrets or other
information, the disclosure of which would be contrary to
public policy.
Thus, a requesting State may be denied information from the
other State if the information would be obtained pursuant to
procedures or measures that are broader than those available in
the requesting State. However, the statute of limitations of
the Contracting State making the request for information should
govern a request for information. Thus, the Contracting State
of which the request is made should attempt to obtain the
information even if its own statute of limitations has passed.
In many cases, relevant information will still exist in the
business records of the taxpayer or a third party, even though
it is no longer required to be kept for domestic tax purposes.
While paragraph 3 states conditions under which a
Contracting State is not obligated to comply with a request
from the other Contracting State for information, the requested
State is not precluded from providing such information, and
may, at its discretion, do so subject to the limitations of its
internal law.
Paragraph 7 of the Protocol provides that the powers of
each Contracting State's competent authority to obtain
information include powers to obtain information held by
financial institutions, nominees, or persons acting in an
agency or fiduciary capacity (not including information that
would reveal confidential communications between a client and
an attorney, solicitor, or other legal representative, where
the client seeks legal advice), and information relating to the
ownership of legal persons. Paragraph 7 of the Protocol
acknowledges that each Contracting State's competent authority
is able to exchange such information in accordance with Article
25. The provisions of paragraph 7 of the Protocol prevent a
Contracting State from relying on paragraph 3 of the Convention
to argue that its domestic bank secrecy laws (or similar
legislation relating to disclosure of financial information by
financial institutions or intermediaries) override its
obligation to provide information under paragraph 1.
Paragraph 4
Paragraph 4 provides that the requesting State may specify
the form in which information is to be provided (e.g.,
depositions of witnesses and authenticated copies of original
documents).
The intention is to ensure that the information may be
introduced as evidence in the judicial proceedings of the
requesting State. The requested State should, if possible,
provide the information in the form requested to the same
extent that it can obtain information in that form under its
own laws and administrative practices with respect to its own
taxes.
Paragraph 5
Paragraph 5 provides for assistance in collection of taxes
to the extent necessary to ensure that treaty benefits are
enjoyed only by persons entitled to those benefits under the
terms of the Convention. Under paragraph 5, a Contracting State
will endeavor to collect on behalf of the other State only
those amounts necessary to ensure that any exemption or reduced
rate of tax at source granted under the Convention by that
other State is not enjoyed by persons not entitled to those
benefits. For example, if the payer of a U.S.-source portfolio
dividend receives a Form W-8BEN or other appropriate
documentation from the payee, the withholding agent is
permitted to withhold at the portfolio dividend rate of 15
percent. If, however, the addressee is merely acting as a
nominee on behalf of a third-country resident, paragraph 5
would obligate the other Iceland to withhold and remit to the
United States the additional tax that should have been
collected by the U.S. withholding agent.
This paragraph also makes clear that the Contracting State
asked to collect the tax is not obligated, in the process of
providing collection assistance, to carry out administrative
measures that are different from those used in the collection
of its own taxes, or that would be contrary to its sovereignty,
security or public policy.
Paragraph 6
Paragraph 6 provides that a Contracting State must notify
the competent authority of the other Contracting State before
sending representatives to enter the requested State to
interview individuals and examine books and records with the
consent of the persons subject to examination.
ARTICLE 26 (MEMBERS OF DIPLOMATIC MISSIONS AND CONSULAR POSTS)
This Article confirms that any fiscal privileges to which
diplomatic or consular officials are entitled under general
provisions of international law or under special agreements
will apply notwithstanding any provisions to the contrary in
the Convention. The agreements referred to include any
bilateral agreements, such as consular conventions, that affect
the taxation of diplomats and consular officials and any
multilateral agreements dealing with these issues, such as the
Vienna Convention on Diplomatic Relations and the Vienna
Convention on Consular Relations. The U.S. generally adheres to
the latter because its terms are consistent with customary
international law.
The Article does not independently provide any benefits to
diplomatic agents and consular officers. Article 18 (Government
Service) does so, as do Code section 893 and a number of
bilateral and multilateral agreements. In the event that there
is a conflict between the Convention and international law or
such other treaties, under which the diplomatic agent or
consular official is entitled to greater benefits under the
latter, the latter laws or agreements shall have precedence.
Conversely, if the Convention confers a greater benefit than
another agreement, the affected person could claim the benefit
of the tax treaty.
Pursuant to subparagraph 5(b) of Article 1 (General Scope),
the saving clause of paragraph 4 of Article 1 does not apply to
override any benefits of this Article available to an
individual who is neither a citizen of the United States nor
has immigrant status in the United States.
ARTICLE 27 (ENTRY INTO FORCE)
This Article contains the rules for bringing the Convention
into force and giving effect to its provisions.
Paragraph 1
Paragraph 1 provides that the Convention is subject to
ratification in accordance with the applicable procedures of
the United States and Iceland. Further, the Contracting States
shall notify each other by written notification, through
diplomatic channels, when their respective applicable
procedures have been satisfied.
In the United States, the process leading to ratification
and entry into force is as follows: Once a treaty has been
signed by authorized representatives of the two Contracting
States, the Department of State sends the treaty to the
President who formally transmits it to the Senate for its
advice and consent to ratification, which requires approval by
two-thirds of the Senators present and voting. Prior to this
vote, however, it generally has been the practice for the
Senate Committee on Foreign Relations to hold hearings on the
treaty and make a recommendation regarding its approval to the
full Senate. Both Government and private sector witnesses may
testify at these hearings. After the Senate gives its advice
and consent to ratification of the treaty, an instrument of
ratification is drafted for the President's signature.
ThePresident's signature completes the process in the United
States.
Paragraph 2
Paragraph 2 provides that the Convention will enter into
force on the date of the later of the notifications referred to
in paragraph 1. The relevant date is the date on the second of
these notification documents, and not the date on which the
second notification is provided to the other Contracting State.
The date on which a treaty enters into force is not necessarily
the date on which its provisions take effect. Paragraph 2,
therefore, also contains rules that determine when the
provisions of the treaty will have effect.
Under subparagraph 2(a), the Convention will have effect
with respect to taxes withheld at source (principally
dividends, interest and royalties) for income derived on or
after the first day of January in the first calendar year
following the date on which the Convention enters into force.
For all other taxes, subparagraph 2(b) specifies that the
Convention will have effect for taxes chargeable for any tax
year beginning on or after January 1 of the year following
entry into force.
Paragraph 3
Paragraph 3 provides an exception to the general rule of
paragraph 2. Under paragraph 3, if the prior income tax
convention between the United States and Iceland would have
afforded greater relief from tax than this Convention, that
prior convention shall, at the election of any person that was
entitled to benefits under the prior convention, continue to
have effect in its entirety for a twelve-month period from the
date on which this Convention otherwise would have had effect
with respect to such person.
Thus, a taxpayer may elect to extend the benefits of the
prior convention for one year from the date on which the
relevant provision of the new Convention would first take
effect. During the period in which the election is in effect,
the provisions of the prior convention will continue to apply
only insofar as they applied before the entry into force of the
Convention. If the grace period is elected, all of the
provisions of the prior convention must be applied for that
additional year. The taxpayer may not apply certain, more
favorable provisions of the prior convention and, at the same
time, apply other, more favorable provisions of this
Convention. The taxpayer must choose one convention in its
entirety or the other.
The prior convention shall terminate on the last date on
which it has effect with respect to any tax in accordance with
the provisions of Article 28.
Paragraph 4
Paragraph 4 provides that an individual who was entitled to
benefits under Article 21 (Teachers) of the prior convention at
the time of the entry into force of this Convention is
``grandfathered,'' and will continue to be entitled to the
benefits available under the prior convention until such time
as that individual would cease to be entitled to benefits if
the prior convention remained in force.
ARTICLE 28 (TERMINATION)
The Convention is to remain in effect indefinitely, unless
terminated by one of the Contracting States in accordance with
the provisions of Article 28. The Convention may be terminated
by giving notice of termination in writing at least six months
before the end of any calendar year. If notice of termination
is given, the provisions of the Convention with respect to
withholding at source will cease to have effect on income
derived on or after the first day of January in the first
calendar year following the year in which notice is given. For
other taxes, the Convention will cease to have effect for taxes
chargeable for any tax year beginning on or after the first day
of January in the first calendar year following the year in
which notice is given.
Article 28 relates only to unilateral termination of the
Convention by a Contracting State. Nothing in that Article
should be construed as preventing the Contracting States from
concluding a new bilateral agreement, subject to ratification,
that supersedes, amends or terminates provisions of the
Convention without the notification period.
Customary international law observed by the United States
and other countries, as reflected in the Vienna Convention on
Treaties, allows termination by one Contracting State at any
time in the event of a ``material breach'' of the agreement by
the other Contracting State.