[Senate Executive Report 111-4]
[From the U.S. Government Publishing Office]
111th Congress Exec. Rept.
SENATE
2d Session 111-4
======================================================================
PROTOCOL AMENDING TAX CONVENTION WITH
NEW ZEALAND
_______
June 30, 2010.--Ordered to be printed
_______
Mr. Kerry, from the Committee on Foreign Relations,
submitted the following
REPORT
[To accompany Treaty Doc. 111-3]
The Committee on Foreign Relations, to which was referred
the Protocol Amending the Convention between the United States
of America and New Zealand for the Avoidance of Double Taxation
and the Prevention of Fiscal Evasion with Respect to Taxes on
Income, signed on December 1, 2008, at Washington (the
``Protocol'') (Treaty Doc. 111-3), 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.................................................3
V. Implementing Legislation.........................................3
VI. Committee Action.................................................3
VII. Committee Recommendation and Comments............................3
VIII.Text of Resolution of Advice and Consent to Ratification.........4
IX. Annex I--Technical Explanation...................................5
I. Purpose
The purpose of the Protocol, along with the underlying
treaty, is to promote and facilitate trade and investment
between the United States and New Zealand, and bring the
existing treaty with New Zealand into conformity with current
U.S. tax treaty policy. Principally, the Protocol would amend
the existing tax treaty with New Zealand (the ``Treaty'') in
order to eliminate or reduce withholding taxes on certain
cross-border dividend and royalty payments and strengthen
existing obligations against the inappropriate use of the
treaty by third-country residents and for the exchange of
information between tax authorities in both countries.
II. Background
The United States has a tax treaty with New Zealand that is
currently in force, which was concluded in 1982. The Protocol
was negotiated to modernize our relationship with New Zealand
in this area and to update the 1982 treaty to better reflect
current U.S. and New Zealand domestic tax policy.
III. Major Provisions
A detailed article-by-article analysis of the Protocol may
be found in the Technical Explanation Published by the
Department of the Treasury on November 10, 2009. In addition,
the staff of the Joint Committee on Taxation prepared an
analysis of the Protocol, JCX-51-09 (November 6, 2009), which
was of great assistance to the committee in reviewing the
Protocol. A summary of the key provisions of the Protocol is
set forth below.
Taxation of Investment Income
The withholding tax rates on investment income under the
Protocol would generally be the same or lower than those in the
existing treaty. The Protocol would reduce or eliminate source-
country taxation of intercompany dividends distributed by a
company resident in one Contracting State to a resident in the
other Contracting State. See Article X. More specifically, the
Protocol would provide for the elimination of source-country
taxation of certain direct dividends (where an 80 percent
ownership threshold is met). See Article X. The Protocol would
allow for taxation at source of 5 percent on dividends when a
10 percent ownership threshold is met, and 15 percent on all
other dividends. See Article X. The Protocol would also replace
the existing treaty's 5 percent limit on source-country
withholding tax on cross-border royalty payments with an
exemption from source-country withholding tax on such payments.
See Article XII.
Taxation of Business and Personal Services Income
The Protocol would preserve the U.S. right to impose its
branch profits tax on U.S. branches of New Zealand
corporations. See Article VII. The Protocol would replace the
existing Convention's rules regarding the taxation of
independent personal services by individuals. Under the
Protocol, an individual performing services in the other
country would become taxable in the other country only if the
individual has a fixed place of business in that country.
Limitation on Benefits
The Protocol would strengthen the existing treaty's
``Limitation of Benefits'' provision and make it more
consistent with current U.S. tax treaty practice. The new
provision is designed to address ``treaty shopping,'' which is
the inappropriate use of a tax treaty by third-country
residents. It would also incorporate updated rules that provide
that a former citizen or long-term resident of the United
States may, for the period of ten years following the loss of
such status, be taxed in accordance with the laws of the United
States.
Exchange of Information
The Protocol would replace the existing Convention's tax
information exchange provisions with updated rules that are
consistent with current U.S. tax treaty practice. The Protocol
would allow the tax authorities of each country to exchange
information relevant to carrying out the provisions of the
Convention or the domestic tax laws of either country. It would
also enable the United States to obtain information (including
from financial institutions) from New Zealand whether or not
New Zealand needs the information for its own tax purposes.
IV. Entry Into Force
The proposed Protocol will enter into force between the
United States and New Zealand on the date of the later note in
an exchange of diplomatic notes in which the Parties notify
each other that their respective applicable procedures for
ratification have been satisfied. The various provision of the
Protocol will have effect as described in paragraphs 2 and 3 of
Article XVI.
V. Implementing Legislation
As is the case generally with income tax treaties, the
Protocol is self-executing and does not require implementing
legislation for the United States.
VI. Committee Action
The committee held a public hearing on the Protocol on
November 10, 2009. Testimony was received from Manal Corwin,
International Tax Counsel, U.S. Department of Treasury, and
Thomas A. Barthold, Chief of Staff, Joint Committee on
Taxation. A
transcript of the hearing is included in Senate Executive
Report 111-3.
On April 13, 2010, the committee considered the Protocol
and ordered it favorably reported by voice vote, with a quorum
present and without objection.
VII. Committee Comments
The Committee on Foreign Relations believes that the
Protocol will stimulate increased trade and investment,
strengthen rules for denying treaty-shoppers the benefits of
the underlying tax treaty, and promote closer co-operation
between the United States and New Zealand. The committee
therefore urges the Senate to act promptly to give advice and
consent to ratification of the Protocol, as set forth in this
report and the accompanying resolution of advice and consent.
The committee has included one declaration in the
recommended resolution of advice and consent. The declaration
states that the Protocol is self-executing, as is the case
generally with income tax treaties. Prior to the 110th
Congress, the committee generally included such statements in
the committee's report, but in light of the Supreme Court
decision in Medellin v. Texas, 128 S. Ct. 1346 (2008), the
committee 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. Text of 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
Protocol Amending the Convention between the United States of
America and New Zealand for the Avoidance of Double Taxation
and the Prevention of Fiscal Evasion with Respect to Taxes on
Income, signed on December 1, 2008, at Washington (the
``Protocol'') (Treaty Doc. 111-3), 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:
The Protocol is self-executing.
IX. Annex I--Technical Explanation
----------
Department of the Treasury, Technical Explanation of the Protocol
Between the United States of America and New Zealand, Signed at
Washington on December 1, 2008, Amending the Convention and Protocol
Between the United States of America and New Zealand for the Avoidance
of Double Taxation and the Prevention of Fiscal Evasion With Respect to
Taxes on Income, Signed at Wellington on July 23, 1982
This is a technical explanation of the Protocol between the
United States and New Zealand signed at Washington on December
1, 2008 (the ``Protocol'') amending the Convention and Protocol
between the United States and New Zealand for the Avoidance of
Double Taxation and the Prevention of Fiscal Evasion with
Respect to Taxes on Income signed at Wellington on July 23,
1982 (the ``existing Convention'').
Negotiations took into account the U.S. Treasury
Department's current tax treaty policy, and the Treasury
Department's Model Income Tax Convention, published on November
15, 2006 (the ``U.S. Model''). 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. It reflects the policies behind particular
Convention provisions, as well as understandings reached during
the negotiations with respect to the application and
interpretation of the Convention. References to the ``existing
Convention'' are intended to put various provisions of the
Protocol into context. The Technical Explanation does not,
however, provide a complete comparison between the provisions
of the existing Convention and the amendments by the Protocol.
The Technical Explanation is not intended to provide a complete
guide to the existing Convention as amended by the Protocol. To
the extent that a paragraph from the existing Convention has
not been amended by the Protocol, the technical explanations to
the existing Convention remain the official explanation.
References in this Technical Explanation to ``he'' or ``his''
should be read to mean ``he or she'' or ``his and her.''
References to the ``Code'' are to the Internal Revenue Code of
1986, as amended.
ARTICLE I
Paragraph 1
Article I of the Protocol amends paragraph 3 of Article 1
(General Scope) of the existing Convention.
New paragraph 3 contains the traditional saving clause
found in all U.S. tax treaties. The Contracting States reserve
their rights, except as provided in paragraph 4, 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 New Zealand 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 New Zealand 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 894(a)). However, subparagraph
4(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 New Zealand. See paragraph 4
of Article 22 (Relief from Double Taxation).
For purposes of the saving clause, ``residence'' is
determined under Article 4 (Residence). 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 New
Zealand 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 treaty.
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 3, 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 with
respect to income from sources within the United States
(including income deemed under the domestic law of the United
States to arise from such sources). Thus, paragraph 3 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 he
fails to certify that he has complied with U.S. tax laws during
the 5 preceding years, or 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 thresholds for the average annual net income tax are
adjusted annually for inflation. 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 if such individual is treated as a resident of
a foreign country under the provisions of a tax treaty between
the United States and the foreign country and the individual
does not waive the benefits of such treaty applicable to
residents of the foreign country.
Paragraph 2
Paragraph 2 amends Article I of the existing Convention by
adding new paragraphs 5 and 6.
New paragraph 5 specifically relates to non-discrimination
obligations of the Contracting States under the General
Agreement on Trade in Services (the ``GATS''). The provisions
of paragraph 5 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 5(a) provides that, unless the competent
authorities determine that a taxation measure is not within the
scope of the Convention, the national treatment obligations of
the GATS shall not apply with respect to that measure. Further,
any question arising as to the interpretation of the
Convention, including in particular whether a measure is within
the scope of the Convention shall be considered only by the
competent authorities of the Contracting States, and the
procedures under the Convention exclusively shall apply to the
dispute. Thus, paragraph 3 of Article XXII (Consultation) of
the GATS may not be used to bring a dispute before the World
Trade Organization unless the competent authorities of both
Contracting States have determined that the relevant taxation
measure is not within the scope of Article 23 (Non-
Discrimination) of the Convention.
The term ``measure'' for these purposes is defined broadly
in subparagraph 5(b). It would include, for example, a law,
regulation, rule, procedure, decision, administrative action or
guidance, or any other form of measure.
New paragraph 6 addresses special issues presented by
fiscally transparent entities such as partnerships and certain
estates and trusts. Because countries may take different views
as to when an entity is fiscally transparent, the risk of both
double taxation and double non-taxation is relatively high. The
intention of paragraph 6 is to eliminate a number of technical
problems that arguably would have prevented investors using
such entities from claiming treaty benefits, even though such
investors would be subject to tax on the income derived through
such entities. The provision also prevents the use of such
entities to claim treaty benefits in circumstances where the
person investing through such an entity is not subject to tax
on the income in its State of residence. The provision, and the
corresponding requirements of the substantive rules of Articles
6 (Income from Real Property) through 15 (Dependent Personal
Services) and 17 (Artistes and Athletes) through 21 (Other
Income), should be read with those two goals in mind.
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
relieved under an integrated system. 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.
Entities falling under this description in the United States
include partnerships, common investment trusts under section
584 of the Code, and grantor trusts. This paragraph also
applies to U.S. limited liability companies (``LLCs'') that are
treated as partnerships or as disregarded entities for U.S. tax
purposes.
Under paragraph 6, an item of income derived by such a
fiscally transparent entity will be considered to be derived by
a resident of a Contracting State if a resident is treated
under the taxation laws of that State as deriving the item of
income. For example, if a company that is a resident of New
Zealand pays interest to an entity that is treated as fiscally
transparent for U.S. tax purposes, the interest will be
considered derived by a resident of the United States only to
the extent that the taxation laws of the United States treats
one or more U.S. residents (whose status as U.S. residents is
determined, for this purpose, under U.S. tax law) as deriving
the interest 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 interest income
through the partnership. Also, it 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 any benefit under the
Convention for the interest paid to the entity, because they
are not residents of the United States for purposes of claiming
this treaty benefit. If, however, they are treated as residents
of a third country under the provisions of an income tax
convention which that country has with New Zealand, they may be
entitled to claim a benefit under that convention. In contrast,
if, for example, an entity is organized under U.S. laws and is
classified as a corporation for U.S. tax purposes, interest
paid by a company that is a resident of New Zealand 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.
The same result obtains even if the entity were viewed
differently under the tax laws of New Zealand (e.g., as not
fiscally transparent in the first example above where the
entity is treated as a partnership for U.S. tax purposes).
Similarly, the characterization of the entity in a third
country is also irrelevant, even if the entity is organized in
that third country. The results 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 under the laws of New Zealand.
These results also obtain regardless of where the entity is
organized (i.e., in the United States, in New Zealand or, as
noted above, in a third country).
For example, income from U.S. sources received by an entity
organized under the laws of the United States, which is treated
for tax purposes under the laws of New Zealand as a corporation
and is owned by a shareholder who is a resident of New Zealand
for its tax purposes, is not considered derived by the
shareholder of that corporation even if, under the tax laws of
the United States, the entity is treated as fiscally
transparent. Rather, for purposes of the treaty, the income is
treated as derived by the U.S. entity.
These principles also apply to trusts to the extent that
they are fiscally transparent in either Contracting State. For
example, if X, a resident of New Zealand, creates a revocable
trust in the United States and names persons resident in a
third country as the beneficiaries of the trust, the trust's
income would be regarded as being derived by a resident of New
Zealand only to the extent that the laws of New Zealand treat X
as deriving the income for its tax purposes, perhaps through
application of rules similar to the U.S. ``grantor trust''
rules.
As another example, assume income from U.S. sources is
received by a New Zealand accumulation trust created by a New
Zealand resident settlor, with a NZ trustee, and one New
Zealand beneficiary and one third-country beneficiary. For New
Zealand tax purposes, the trustee is viewed as liable for tax
because the income is being accumulated in the trust.
Therefore, the trustee, as the legal owner of the income, is
considered as deriving the income for purposes of applying the
Convention.
Paragraph 6 is not an exception to the saving clause of
paragraph 3. Accordingly, paragraph 6 does not prevent a
Contracting State from taxing an entity that is treated as a
resident of that State under its tax law. For example, if a
U.S. LLC with members who are residents of New Zealand 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 New Zealand views the LLC as
fiscally transparent.
ARTICLE II
Article II of the Protocol replaces Article 2 (Taxes
Covered) of the existing Convention. Article 2 specifies the
U.S. taxes and the taxes of New Zealand 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, however, 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 (Exchange of Information and
Administrative Assistance) applies with respect to all taxes
imposed at the national level.
Paragraph 1 of Article 2
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 of Article 2
Paragraph 2 also is based on the U.S. and OECD Models and
provides a definition of taxes on income and on capital gains.
The Convention covers taxes on total income 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. Nor does
it apply to property taxes, except with respect to Article 23.
Paragraph 3 of Article 2
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 New Zealand are identified in
subparagraph 3(a), as the income tax.
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 the investment income of foreign
private foundations (Code section 4940). Social security and
unemployment taxes (Code sections 1401, 3101, 3111 and 3301)
are excluded from coverage.
Paragraph 4 of Article 2
Paragraph 4 is in all material respects the same as
paragraph 2 of Article 2 of the existing Convention. 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 December 1, 2008, the date of
signature of the Protocol. The paragraph also provides that the
competent authorities of the Contracting States will notify
each other of any changes that have been made in their laws,
whether tax laws or non-tax laws, that significantly affect
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 III
Article III of the Protocol amends Article 3 (General
Definitions) of the existing Convention.
Paragraph 1
Paragraph 1 of the Protocol amends subparagraph 1(b) of
Article 3 of the existing Convention by including a new
definition of the term ``company.'' The term ``company'' is
defined in subparagraph 1(b) 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 16 will be applied at the
appropriate level.
Paragraph 2
Paragraph 2 of the Protocol replaces subparagraph 1(d) of
Article 3 of the existing Convention by defining the terms
``enterprise of a Contracting State'' and ``enterprise of the
other Contracting State'' 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 New
Zealand would still be a U.S. enterprise).
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 Contracting 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.
Paragraph 3
Paragraph 3 of the Protocol replaces paragraph 1(g) of
Article 3 of the existing Convention. Paragraph 3 of the
Protocol sets out the geographical scope of the Convention with
respect to the United States. 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 United States Virgin Islands, Guam the
Commonwealth of the Northern Mariana Islands 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 Code
section 638, which treats the continental shelf as part of the
United States for purposes of natural resource exploration and
exploitation.
Paragraph 4
Paragraph 4 of the Protocol replaces paragraph 1(h) of
Article 3 of the existing Convention. Paragraph 4 of the
Protocol sets out the geographical scope of the Convention with
respect to New Zealand. The term ``New Zealand'' encompasses
the territory of New Zealand but does not include Tokelau; it
also includes any area beyond the territorial sea designated
under New Zealand legislation and in accordance with
international law as an area in which New Zealand may exercise
sovereign rights with respect to natural resources.
Paragraph 5
Paragraph 5 of the Protocol amends paragraph 1(j) of
Article 3 of the existing Convention by deleting the final
period and replacing it with a comma.
Paragraph 6
Paragraph 6 of the Protocol amends paragraph 1 of Article 3
of the existing Convention by adding four new subparagraphs
(k), (l), (m), and (n) to paragraph 1 of Article 3 of the
existing Convention.
Subparagraph l(k) defines the term ``national,'' as it
relates to the United States and to New Zealand. This term is
relevant for purposes of Articles 19 (Government Service) and
23 (Non-Discrimination). A national of one of the Contracting
States is (1) an individual who is a citizen 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 (l) defines the term ``pension fund'' to
include any person established in a Contracting State 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 and in the case of the United States is
generally exempt from income taxation. In the case of New
Zealand, the term refers to a superannuation scheme registered
under the Superannuation Schemes Act 1989, a KiwiSaver Scheme
registered under the KiwiSaver Act 2006, the New Zealand
Superannuation Fund, or the Government Superannuation Fund.
For application of the Convention by the United States, the
term ``pension fund'' 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 Rev. Rul. 81100,
1981-1 C.B. 326, and meeting the conditions of Rev. Rul. 2004-
67, 2204-2 C.B. 28, qualify as pension funds to the extent they
are covered by Code section 401(a) plans and other pension
funds.
Subparagraph (m) 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 (n) provides that it includes the performance of
professional services and other activities of an independent
character. The introduction of this definition is necessary in
connection with the deletion of Article 14 (Independent
Personal Services) as provided in Article X of the Protocol.
Both subparagraphs are identical to definitions recently added
to the OECD Model in connection with the deletion of Article 14
from the OECD Model. The inclusion of the two definitions in
subparagraph (m) and (n) 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 21 (Other Income).
Paragraph 7
Paragraph 7 of the Protocol replaces paragraph 3 of Article
3 of the existing Convention and addresses the terms that are
not defined in the Convention.
New paragraph 3 of Article 3 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 paragraph 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 new paragraph 3 to the internal law of a
Contracting State means the law in effect at the time the
Convention is being applied, not the law as in effect at the
time the Convention 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 Convention was negotiated and ratified. The
reference in both paragraphs 1 and 3 of the Convention to the
``context otherwise requir[ing]'' a definition different from
the Convention definition, in paragraph 1, or from the internal
law definition of the Contracting State whose tax is being
imposed, under paragraph 3, 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 IV
Paragraph 1
Paragraph 1 of Article IV of the Protocol replaces
paragraph 1 of Article 4 (Residence) of the existing
Convention. 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 New Zealand 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 Convention. 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.
Under paragraph 1 of Article 4 of the Convention, a person
who is liable to tax in a Contracting State only in respect of
income from sources within that State 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 New
Zealand 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 New Zealand 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 amends subparagraph 2(c) of Article 4 of the
existing Convention by deleting the word ``citizen'' and
replacing it with the word ``national.''
Paragraph 3
Paragraph 3 amends subparagraph 2(d) of Article 4 of the
existing Convention by deleting the word ``citizen'' and
replacing it with the word ``national.''
Paragraph 4
Paragraph 4 amends paragraph 4 of Article 4 of the existing
Convention by deleting the words ``shall be treated as a
resident of neither Contracting State for purposes of the
Convention'' and replacing them with the words ``will not be
treated as a resident of either Contracting Stated for purposes
of its claiming any benefits provided by the Convention.''
Dual residents other than individuals (such as companies,
trusts, or estates) are addressed by paragraph 4. If such a
person is, under the rules of paragraph 1 or 2, 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 dual
resident may not claim any benefit accorded to residents of a
Contracting State by the Convention. The dual resident may,
however, claim any benefits that are not limited to residents,
such as those provided by paragraph 1 of Article 23 (Non-
Discrimination). Thus, for example, a State cannot impose
discriminatory taxation on a dual resident company.
Dual residents also 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 New Zealand, 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 New Zealand, 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
residents can be exchanged under the Convention because, by its
terms, Article 25 (Exchange of Information and Administrative
Assistance) is not limited to residents of the Contracting
States.
ARTICLE V
Article V of the Protocol amends Article 7 (Business
Profits) of the existing Convention by adding new paragraphs 8
and 9.
New paragraph 8 incorporates into the existing Convention
the rule of Code section 864(c)(6). Like the Code section on
which it is based, paragraph 8 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, paragraph 6 of Article 10 (Dividends),
paragraph 4 of Article 11 (Interest), paragraph 4 of Articles
12 (Royalties) and paragraph 6 of Article 13 (Capital Gains).
The effect of this rule can be illustrated by the following
example. Assume a company that is a resident of New Zealand 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.
New paragraph 9 clarifies the treatment of fiscally
transparent entities (including trusts) and beneficial owners
thereof under Article 7 of the Convention. New Zealand
requested this clarification because, under New Zealand law,
the trustees of a trust, as the legal owner of the trust
property, might be regarded as the only person having a
permanent establishment (rather than the beneficiaries of the
trust, who have a beneficial entitlement to the income but no
legal ownership). Thus, absent this clarification, any
permanent establishment resulting from that trade or business
might be considered to be that of the trustees, rather than
that of the beneficiaries.
New paragraph 9 provides that if a fiscally transparent
entity (or trustee) has a permanent establishment in a
Contracting State and a resident of the other Contracting State
is beneficially entitled to a share of the business profits
from the business that is carried on by the fiscally
transparent entity (or trustee) through that permanent
establishment, then the beneficial owner is treated as carrying
on a business through a permanent establishment in that
Contracting State, and its share of business profits therefrom
are attributed to the permanent establishment. Thus, if a trust
with a U.S. beneficiary carries on a business in New Zealand
through its trustee, and that trustee's actions rise to the
level of a permanent establishment, then the U.S. beneficiary
will be treated as having a permanent establishment in New
Zealand and the profits of the trust associated with that
permanent establishment will be treated as business profits
under Article 7. Since paragraph 9 is added solely to address
the New Zealand law relating to trusts, the absence of similar
language in other U.S. tax treaties should not be read as
implying that a resident may avoid permanent establishment
treatment and business profits by investing through a fiscally
transparent entity.
ARTICLE VI
Article VI of the Protocol replaces Article 10 (Dividends)
of the existing Convention. 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 country taxation of such dividends and a limited
source-State right to tax. Article 10, as amended by the
Protocol, 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 of Article 10
Paragraph 1 is in all material respects the same as
paragraph 1 of Article 10 of the existing Convention. 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 State
of residence exclusive taxing jurisdiction (other than for
dividends attributable to a permanent establishment in the
other State).
Paragraph 2 of Article 10
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
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. For purposes of
the application of paragraph 2, the term ``voting power''
refers to the voting stock in a company. 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 State granting treaty benefits (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 New
Zealand 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 New Zealand 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. New Zealand's principles of beneficial ownership
shall then be applied to USCo. If under the laws of New Zealand
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 NZCo, a company that is a resident
of New Zealand, owns all of the outstanding shares in ThirdDE,
an entity that is disregarded for U.S. tax purposes and that is
resident in a third country. ThirdDE owns 100 percent of the
stock of USCo. New Zealand views ThirdDE as fiscally
transparent under its domestic law, and taxes NZCo currently on
the income derived by ThirdDE. In this case, NZCo is treated as
deriving the dividends paid by USCo under paragraph 6 of
Article 1. Moreover, NZCo 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 State granting treaty benefits (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 New Zealand.
Assuming that ThirdDE is treated as non-fiscally transparent by
New Zealand, the income will not be treated as derived by a
resident of New Zealand 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 (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 provides for exclusive residence country
taxation of dividends (i.e., an elimination of withholding tax)
with respect to certain dividends distributed by a company
resident in one Contracting State to a company resident in the
other Contracting State. As described further below, this
elimination of withholding tax is available with respect to
certain inter-company dividends.
Subparagraph 3(a) provides for the elimination of
withholding tax on dividends beneficially owned by a company
that has owned 80 percent or more of the voting power of the
company paying the dividend for the 12-month period ending on
the date entitlement to the dividend is determined. The
determination of whether the beneficial owner of the dividends
owns at least 80 percent of the voting power of the paying
company is made by taking into account stock owned both
directly and indirectly through one or more residents of either
Contracting State.
Eligibility for the elimination of withholding tax provided
by subparagraph (a) is subject to additional restrictions based
on, and supplementing, the rules of Article 16 (Limitation of
Benefits). Accordingly, a company that meets the holding
requirements described above will qualify for the benefits of
paragraph 3 only if it also: (1) meets the ``publicly traded''
test of subparagraph 2(c) of Article 16, (2) meets the
``ownership-base erosion'' and ``active trade or business''
tests described in clause (i) and (ii) of subparagraph 2(e) and
paragraph 3 of Article 16, or (3) is granted the benefits of
paragraph 3 of Article 10 by the competent authority of the
source State pursuant to paragraph 4 of Article 16.
These restrictions are necessary because of the increased
pressure on the limitation of benefits tests resulting from the
fact that the United States has relatively few treaties that
provide for such elimination of withholding tax on inter-
company dividends. The additional restrictions are intended to
prevent companies from reorganizing in order to become eligible
for the elimination of withholding tax in circumstances where
the limitation of benefits provision does not provide
sufficient protection against treaty shopping.
For example, assume that ThirdCo is a company resident in a
third country that does not have a tax treaty with the United
States providing for the elimination of withholding tax on
intercompany dividends. ThirdCo owns directly 100 percent of
the issued and outstanding voting stock of USCo, a U.S.
company, and of NZCo, a New Zealand company. NZCo is a
substantial company that manufactures widgets; USCo distributes
those widgets in the United States. If ThirdCo contributes to
NZCo all the stock of USCo, dividends paid by USCo to NZCo
would qualify for treaty benefits under the active trade or
business test of paragraph 3 of Article 16. However, allowing
ThirdCo to qualify for the elimination of withholding tax,
which is not available to it under the third state's treaty
with the United States (if any), would encourage treaty-
shopping.
In order to prevent this type of treaty shopping, paragraph
3(b) of Article 10 requires NZCo to meet the ownership-base
erosion requirements of clause (i) and (ii) of subparagraph
2(e) of Article 16, in addition to the active trade or business
test of paragraph 3 of Article 16. Thus, NZCo would not qualify
for the exemption from withholding tax unless (i) on at least
half the days of the taxable year, at least 50 percent of each
class of its shares was owned by persons that are residents of
New Zealand and eligible for treaty benefits under certain
specified tests and (ii) less than 50 percent of NZCo's gross
income is paid in deductible payments to persons that are not
residents of either Contracting State eligible for benefits
under those specified tests. Because NZCo is wholly owned by a
third country resident, NZCo could not qualify for the
elimination of withholding tax on dividends from USCo under the
ownership-base erosion test and the active trade or business
test. Consequently, NZCo would need to qualify under another
test or obtain discretionary relief from the competent
authority under Article 16(4). For purposes of Article
10(3)(b), it is not sufficient for a company to qualify for
treaty benefits generally under the active trade or business
test or the ownership-base erosion test unless it qualifies for
treaty benefits under both.
Alternatively, companies that are publicly traded or
subsidiaries of publicly-traded companies will generally
qualify for the elimination of withholding tax under
subparagraph 3(a) of Article 10. Thus, a company that is a
resident of New Zealand and that meets the requirements of
clause (i) or (ii) of subparagraph 2(c) of Article 16, as
amended by the Protocol, will be entitled to the elimination of
withholding tax, subject to the 12-month holding period
requirement of Article 10(3).
If a company does not qualify for the elimination of
withholding tax under any of the foregoing objective tests, it
may request a determination from the relevant competent
authority pursuant to paragraph 4 of Article 16. Benefits may
be granted with respect to an item of income if the competent
authority of the Contracting State in which the income arises
determines that the establishment, acquisition or maintenance
of such resident and the conduct of its operations did not have
as one of its principal purposes the obtaining of benefits
under the Convention.
Paragraph 4 of Article 10
Paragraph 4 imposes limitations on the rate reductions
provided by paragraphs 2 and 3 in the case of dividends paid by
a RIC or a REIT.
The first sentence of subparagraph 4(a) provides that
dividends paid by a RIC or a REIT are not eligible for the 5
percent rate of withholding tax of subparagraph 2(a) or the
elimination of withholding tax of paragraph 3.
The second sentence of subparagraph 4(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 4(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.'' Subparagraph 4(b)
provides that 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 New Zealand 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 that in
turn held the portfolio. Absent the special rule in paragraph
4, 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 as provided in paragraph 3.
Similarly, a resident of New Zealand 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 4 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 4 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 5 of Article 10
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.
New Zealand has certain statutory instruments referred to
as ``FC1'' and ``FC2'' debentures which correspond to their
statutory numbering under The Income Tax Act of 1994. Even
though these debentures are debt instruments, New Zealand taxes
these instruments as equity and subjects them to their Foreign
Investor Tax Credit (``FITC'') regime, which provides a
mechanism for reducing company tax in respect of profits
distributed to non-residents. However, because these debentures
are regarded as profit distributions, no deductions are allowed
to the company paying them out. The FC1 debentures are debt
instruments on which the return is calculated with a reference
to profits. The FC2 debentures are debt instruments on which
the amount of the debenture is determined by reference to the
number of shares the debenture holder holds; thus, the rate is
constant but the amount of the debenture fluctuates as it is
related to the number of shares. Accordingly, returns from the
FCI and FC2 debentures will be treated as dividends under
Article 10.
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 of Article 10
Paragraph 6 is in all material respects the same as
paragraph 3 of Article 10 of the existing Convention. The only
change is the deletion of references to ``fixed base'' and
``Article 14 (Independent Personal Services),'' to conform to
changes made by Article X of the Protocol.
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 of Article 10
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 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 of Article 10
Paragraph 8 permits the United States to impose a branch
profits tax on a company resident in New Zealand. The tax is in
addition to other taxes permitted by the Convention. The term
``company'' is defined in subparagraph 1(b) of Article 3
(General Definitions).
The United States may impose a branch profits tax on a New
Zealand company if the company has income attributable to a
permanent establishment in the United States, derives income
from real property in the United States that is taxed on a net
basis under Article 6 (Income from Real Property)), or realizes
gains taxable in the United States under paragraph 1 of Article
13 (Alienation of Property). 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 under U.S. law. Section 884 of the Code
defines the dividend equivalent amount as an amount for a
particular year that is equivalent to the income described
above that is included in the corporation's effectively
connected earnings and profits for that year, after payment of
the corporate tax under Article 6, Article 7, or Article 13,
reduced for any increase in the branch's U.S. net equity during
the year or increased for any reduction in its U.S. net equity
during the year. U.S. net equity is U.S. assets less U.S.
liabilities. See Treas. Reg. section 1.884-1.
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.
Consistency principles prohibit a taxpayer from applying
provisions of the Code and this Convention inconsistently. In
the context of the branch profits tax, this consistency
requirement means that if a New Zealand company uses the
principles of Article 7 to determine its U.S. taxable income,
then it must also use those principles to determine its
dividend equivalent amount. Similarly, if the New Zealand
company instead uses the Code to determine its U.S. taxable
income it must also use the Code to determine its dividend
equivalent amount. As in the case of Article 7, if a New
Zealand company, for example, does not from year to year
consistently apply the Code or the Convention to determine its
dividend equivalent amount, then the New Zealand company must
make appropriate adjustments or recapture amounts that would
otherwise be subject to U.S. branch profits tax if it had
consistently applied the Code or the Convention to determine
its dividend equivalent amount from year to year.
Paragraph 9 of Article 10
Paragraph 9 provides that the tax referred to in paragraph
8, the branch profits tax, shall not be imposed at a rate
exceeding the rate specified in subparagraph 2(a), the direct
investment dividend withholding rate of five percent. However,
this tax shall not be imposed on a company that satisfies
either the public trading requirements of clause (i) or (ii) of
subparagraph 2(c) of Article 16 (Limitation on Benefits), the
ownership and base erosion conditions of clause (i) and (ii) of
subparagraph 2(e) of Article 16 provided that the company
satisfies the active trade or business test of paragraph 3 of
Article 16 with respect to an item of income, profit or gain
described in paragraph 8 of the Article, as revised by the
Protocol, or that has received a determination by the competent
authorities pursuant to paragraph 4 of Article 16.
It is intended that paragraph 9 apply equally if a taxpayer
determines its taxable income under the laws of a Contracting
State or under the provisions of Article 7. For example, as
discussed above in the explanation to paragraph 8, consistency
principles require a New Zealand company that determines its
U.S. taxable income under the Code to also determine its
dividend equivalent amount under the Code. In that case,
paragraph 9 would apply even though the New Zealand company did
not determine its dividend equivalent amount using the
principles of Article 7.
Relationship to Other Articles
Notwithstanding the foregoing limitations on source country
taxation of dividends, the saving clause of paragraph 3 of
Article 1 (General Scope) 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 16. Thus, if a resident of New Zealand 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 16 in order to receive the benefits
of this Article.
ARTICLE VII
Article VII of the Protocol replaces Article 11 (Interest)
of the existing Convention and specifies the taxing
jurisdictions over interest arising in one Contracting State
and paid to a resident of the other Contracting State.
Paragraph 1 of Article 11
Paragraph 1 is in all material respects the same as
paragraph 1 of Article 11 of the existing Convention. Paragraph
1 generally grants to the State of residence the non-exclusive
right to tax interest arising in the other Contracting State
and paid to its residents.
Paragraph 2 of Article 11
Paragraph 2 is in all material respects the same as
paragraph 2 of Article 11 of the existing Convention. Paragraph
2 provides that the State of source also may tax the interest,
but if the interest is beneficially owned by a resident of the
other Contracting State, the rate of tax will be limited to 10
percent of the gross amount of the interest.
The term ``beneficial owner'' is not defined in the
Convention, and is, therefore, defined under the internal law
of the State granting treaty benefits (i.e., 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 3 of Article 11
Paragraph 3 provides for exclusive residence-based taxation
in certain cases.
Under subparagraph 3(a), interest beneficially owned by a
Contracting State or an instrumentality of that Contracting
State which is not subject to tax on its income by that State,
(i.e., in the United States, a State or local government) is
subject to exclusive residence-based taxation.
Under subparagraph 3(b), interest beneficially owned by a
resident of a Contracting State with respect to debt
obligations guaranteed or insured by the Contracting State or
an instrumentality of that State which is not subject to tax on
its income by that State is subject to exclusive residence-
based taxation.
Under subparagraph 3(c), interest beneficially owned by a
resident of the other Contracting State that is a bank that is
unrelated to the payer of the interest or an enterprise
substantially deriving its gross income inform the active and
regular conduct of a lending of finance business involving
transactions with unrelated parties that is unrelated to the
payer of the interest is subject to exclusive residence-based
taxation.
For purposes of subparagraph 3(c), the term ``lending or
finance business'' is defined to include the business of making
loans; purchasing or discounting accounts receivable, notes, or
installment obligations; engaging in finance leasing (including
entering into finance leases and purchasing, servicing, and
disposing of finance leases and related leased assets); issuing
letters of credit or providing guarantees; or providing charge
and credit card services.
Paragraph 4 of Article 11
Paragraph 4 is in all material respects the same as
paragraph 4 of Article 11 of the existing Convention. The only
change is the deletion of references to ``fixed base'' and
``Article 14 (Independent Personal Services), to conform to
changes made by Article X of the Protocol.
Paragraph 4 provides an exception to the rules of
paragraphs 2 and 3 in cases where the beneficial owner of the
interest carries on business through a permanent establishment
in the State of source 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 4 also apply to interest that would be attributable
to such a permanent establishment if it did exist in the year
of payment or accrual. See the Technical Explanation to Article
V of the Protocol.
Paragraph 5 of Article 11
Paragraph 5 provides a source rule for determining the
source of interest that is identical in substance to the
interest source rule of the OECD Model. Interest is considered
to arise in a Contracting State if paid by that State itself, a
political subdivision, a local authority, or a resident of that
State. As an exception, interest on a debt incurred in
connection with a permanent establishment in one of the States
and borne by the permanent establishment is considered to arise
in that State. For this purpose, interest is considered to be
borne by a permanent establishment if it is allocable to
taxable income of that permanent establishment.
Paragraph 6 of Article 11
Paragraph 6 is in all material respects the same as
paragraph 6 of Article 11 of the existing Convention. Paragraph
6 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 New Zealand, 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 and 3 of Article 10 (Dividends).
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 Code section 482. This paragraph
does not address cases where, owing to a special relationship
between the payor 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
7. The United States would apply Code section 482 or 7872 to
determine the amount of imputed interest in those cases.
Paragraph 7 of Article 11
The term ``interest'' as used in Article 11 is defined in
paragraph 7 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.
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 8 of Article 11
Paragraph 8 provides anti-abuse exceptions to the rules of
paragraphs 1, 2, and 3 for two classes of interest payments.
The first class of interest, dealt with in subparagraph (a)
is so-called ``contingent interest.'' With respect to interest
arising in the United States, subparagraph (a) refers to
contingent interest of a type that does not qualify as
portfolio interest under U.S. domestic law. The cross-reference
to the U.S. definition of contingent interest, which is found
in Code section 871(h)(4), is intended to ensure that the
exceptions of Code section 871(h)(4)(c) will be applicable. Any
interest dealt with in subparagraph (a) may be taxed in the
source State at a rate not exceeding 10 percent of the gross
amount of the interest.
The second class of interest is dealt with in subparagraph
(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.
Paragraph 9 of Article 11
Paragraph 9 permits a Contracting State to impose its
branch level interest tax on a corporation resident in the
other Contracting State. The base of this tax is the excess, if
any, of the interest deductible in the first-mentioned
Contracting State in computing the profits of the corporation
that are subject to tax in the first-mentioned Contracting
State and either attributable to a permanent establishment in
the first-mentioned Contracting State or subject to tax in the
first-mentioned Contracting State under Article 6 (Income from
Real Property) or Article 13 (Alienation of Property) of the
Convention over the interest paid by the permanent
establishment or trade or business in the first-mentioned
Contracting State. Such excess interest may be taxed as if it
were interest arising in the first- mentioned Contracting State
and beneficially owned by the corporation resident in the other
Contracting State. Thus, such excess interest may be taxed by
the Contracting State of source at a rate not to exceed the 10
percent rate provided for in paragraph 2, and shall be exempt
from tax by the Contracting State of source if the recipient is
described in paragraph 3.
Paragraph 10 of Article 11
Paragraph 10 provides an exception to the rule of
subparagraph 3(c) of this Article. Interest that is
beneficially owned by a bank that is unrelated to the payer of
the interest or an enterprise substantially deriving its gross
income from the active and regular conduct of a lending or
finance business involving transactions with unrelated parties
that is unrelated to the payer of the interest may be taxed in
the State of source at a rate not exceeding 10 percent of the
gross amount of the interest if the requirements of either
subparagraph 10(a) or (b) are met.
Subparagraph 10(a) was included at the request of New
Zealand in order to clarify the coordination of this Article
with New Zealand's domestic law. New Zealand's Approved Issuer
Levy (``AIL'') regime is an alternative to the non-resident
withholding tax (the ``NRWT'') regime. The AIL regime requires
New Zealand borrowers who borrow from non-resident unrelated
lenders to pay AIL in respect of the interest. The AIL is
capped at two percent of the gross amount of the interest, and
imposed on the New Zealand borrower, rather than the non-
resident lender. The AIL mechanism requires two approvals: (1)
the financial arrangement must be a registered security, and
(2) the payer of the interest must be an approved issuer. Under
New Zealand's domestic law, if the New Zealand borrower pays
the AIL, the interest with respect to which the AIL was paid
will be exempt from NRWT.
Subparagraph 10(a) allows source country taxation on
interest payments at a rate not exceeding 10 percent of the
gross amount of the interest if the interest is paid by a
person that has not paid the AIL in respect of the interest
payment. However, subparagraph 10(a) shall not apply if New
Zealand repeals the AIL regime, or the payer of the interest is
not eligible to elect to pay the AIL, or if the rate of the AIL
payable in respect of such interest exceeds two percent of the
gross amount of the interest. The term ``approved issuer levy''
is intended to include any identical or substantially similar
charge payable by the payer of interest arising in New Zealand
enacted after the date of this Convention in place of the AIL.
Thus, the combined effect of subparagraph 3(c) and paragraph 10
is to preserve the interest withholding exemptions currently
provided under New Zealand domestic law.
Subparagraph 10(b) allows source country taxation on
interest payments at a rate not exceeding 10 percent of the
gross amount of the interest if the interest is paid as a part
of a back-to-back loan or an arrangement that is economically
similar to and has the effect of a back-to-back loan. By
referencing arrangements that are economically similar to, and
that have the effect of, a back-to-back loan, subparagraph
(10)(b) applies to transactions that would not meet the legal
requirements of a loan, but would nevertheless serve that
purpose economically. For example, the term would encompass
securities issued at a discount, or certain swap arrangements
intended to operate as the economic equivalent of a back-to-
back loan.
Paragraph 11 of Article 11
Paragraph 11 provides that nothing in Article 11 is
intended to limit or restrict, in any manner, the right and
ability of a Contracting State to apply and enforce any anti-
avoidance provisions of its taxation laws.
Relationship to Other Articles
Notwithstanding the foregoing limitations on source country
taxation of interest, the saving clause of paragraph 3 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
this Article are available to a resident of the other State
only if that resident is entitled to those benefits under the
provisions of Article 16 (Limitation on Benefits).
ARTICLE VIII
Article 8 of the Protocol replaces Article 12 (Royalties)
of the Convention, and provides rules for the taxation of
royalties arising in one Contracting State and paid to a
resident of the other Contracting State.
Paragraph 1 of Article 12
Paragraph 1 is in all material respects the same as
paragraph 1 of Article 12 of the existing Convention. Paragraph
1 grants the State of residence the non-exclusive right to tax
a royalty arising in the other Contracting State and paid to
its residents.
Paragraph 2 of Article 12
Paragraph 2 allows the State of source to tax royalties
arising in that State. 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.
The term ``beneficial owner'' is not defined in the
Convention, and is, therefore, defined under the internal law
of the State granting treaty benefits (i.e., 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 3 of Article 12
Paragraph 3 defines the term ``royalties,'' as used in this
Article, to mean any consideration for the use of, or the right
to use, any copyright of literary, artistic, scientific or
other work (including cinematographic films and films or video
tapes for use in connection with television or tapes for use in
connection with radio broadcasting), any patent, trademark,
design or model, plan, secret formula or process, or for
information concerning industrial, commercial, or scientific
experience. The term ``royalties'' also includes gain derived
from the alienation of any right or property that would give
rise to royalties, to the extent the gain is contingent on the
productivity, use, or further alienation thereof. Gains that
are not so contingent are dealt with under Article 13
(Alienation of Property). The Protocol amends the definition of
``royalty'' by omitting from that definition payments of any
kind received as consideration for the use of, or the right to
use, industrial, commercial, or scientific equipment other than
payments under a hire-purchase agreement.
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 Code
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 and films or video tapes for use in connection with
television or tapes for use in connection with radio
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 of the Convention. See Boulez v. Commissioner, 83 T.C. 584
(1984), affd, 810 F.2d 209 (D.C. Cir. 1986). By contrast, if
the artist earns in the other Contracting State income covered
by Article 17 of the Convention (Artistes and Athletes), 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 17 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 11.4 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) of the Convention or
Article 15 (Dependent Personal Services). 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 of Article 12
Paragraph 4 is in all material respects the same as
paragraph 4 of Article 12 of the existing Convention. The only
change is the deletion of references to ``fixed base'' and
``Article 14 (Independent Personal Services), to conform with
changes made by Article X of the Protocol. This paragraph
provides an exception to the manner of allocating taxing rights
specified in paragraph 2 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 (Business Profits) will apply.
The provisions of paragraph 8 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 of Article 12
Paragraph 5 is in all material respects the same as
paragraph 5 of Article 12 of the existing Convention. The only
change is the deletion of references to ``fixed base.''
Paragraph 5 contains a source rule for determining the source
of 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 relate to 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 of Article 12
Paragraph 6 is identical to paragraph 6 of Article 12 of
the existing Convention. 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).
Relationship to Other Articles
Notwithstanding the foregoing limitations on source country
taxation of royalties, the saving clause of paragraph 3 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 16
(Limitation on Benefits).
ARTICLE IX
Article IX of the Protocol amends Article 13 (Alienation of
Property) of the existing Convention by deleting old paragraph
6 and inserting new paragraphs 6 and 7, and renumbering
paragraph 7 of the existing Convention as new paragraph 8.
Paragraph 1
Paragraph 1 of Article IX of the Protocol amends paragraph
6 of Article 13 of the existing Convention.
Paragraph 6 is in all material aspects the same as
paragraph 6 of Article 13 of the existing Convention. The only
changes are deletions of references to ``fixed base,'' and
associated language referring to ``performing independent
personal services.'' New paragraph 6 of Article 13 deals with
the taxation of certain income or gains from the alienation of
personal 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 New Zealand 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 1 of the Protocol, 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 6 of Article 13, as amended
by the Protocol, 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 2
Paragraph 2 of Article 9 of the Protocol amends Article 13
(Alienation of Property) of the existing Convention by adding
new paragraph 7.
The purpose of paragraph 2 is to provide a rule to address
the mark-to-market exit tax regime for ``covered expatriates''
under Code section 877A. This rule is intended to coordinate
United States and New Zealand taxation of gains in the case of
a timing mismatch. Such a mismatch may occur, for example,
where a U.S. resident recognizes, for U.S. tax purposes, gain
on a deemed sale of all property on the day before the
individual expatriates to New Zealand.
To avoid double taxation, new paragraph 7 of Article 13
provides that where an individual who, upon ceasing to be a
resident of one Contracting State, is treated for purposes of
taxation by that State as having alienated a property and is
taxed by that State by reason thereof, the individual may elect
to be treated for the purposes of taxation by the other
Contracting State as having sold and repurchased the property
for its fair market value on the day before the expatriation
date. The election in new paragraph 7 therefore will be
available to any individual who expatriates from the United
States to New Zealand. The effect of the election will be to
give the individual an adjusted basis for New Zealand tax
purposes equal to the fair market value of the property as of
the date of the deemed alienation in the United States, with
the result that only post-emigration gain will be subject to
New Zealand tax when there is an actual alienation of the
property while the individual is a resident of New Zealand.
If an individual recognizes in one Contracting State losses
and gains from the deemed alienation of multiple properties,
then the individual must apply new paragraph 7 consistently
with respect to all such properties. An individual who is
deemed to have alienated multiple properties may only make the
election under paragraph 7 if the deemed alienation of all such
properties results in a net gain.
Taxpayers may make the election provided by new paragraph 7
only with respect to property that is treated as sold for its
fair market value under a Contracting State's deemed
disposition rules. At the time the Protocol was signed, the
following were the types of property that were excluded from
the deemed disposition rules in the case of individuals who
cease to be citizens or long term residents of the United
States: (1) a deferred compensation item as defined under Code
Section 877A(d)(4), (2) a specified tax deferred account as
defined under Code Section 877A(e)(2), and 3) an interest in a
non-grantor trust as defined under Code Section 877A(f)(3).
Paragraph 3
Paragraph 3 of the Protocol amends Article 13 (Alienation
of Property) of the existing Convention by renumbering
paragraph 7 as new paragraph 8.
ARTICLE X
To conform to the current U.S. and OECD Model Conventions,
Article X of the Protocol deletes Article 14 (Independent
Personal Services) of the existing Convention. The subsequent
articles of the Convention are not renumbered. Under the
provisions of Article 14 prior to its deletion by the Protocol,
income from independent personal services could be taxed by the
State in which the services were performed if the individual
providing the services was present in that State for a period
or periods aggregating more than 183 days in any consecutive
twelve month period. The effect of the deletion of Article 14
is that income from independent personal services will be
governed by the provisions of Articles 5 (Permanent
Establishment) and 7 (Business Profits).
Article X of the Protocol also makes corresponding
adjustments to remove references to Article 14 and the term
``fixed base'' from paragraph 4 of Article 6 (Income from Real
Property), paragraph 2(c) of Article 15 (Dependent Personal
Services), paragraphs 1 and 2 of Article 17 (Artistes and
Athletes), and paragraph 3 of Article 19 (Government Service).
ARTICLE XI
Article XI of the Protocol replaces Article 16 (Limitation
on Benefits) of the existing Convention. Article 16 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 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 4
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 5 provides special rules for so-called
``triangular cases'' notwithstanding paragraphs 1 through 4 of
the Article. Paragraph 6 defines certain terms used in the
Article.
Paragraph 1 of Article 16
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 Real Property) through 15 (Dependent Personal Services)
and 17 (Artistes and Athletes) through 21 (Other Income), the
treaty-based relief from double taxation provided by Article 22
(Relief from Double Taxation), and the protection against
discrimination 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 (Diplomatic Agents and Consular
Officers) applies to diplomatic agents or consular officials
regardless of residence. Article 16 accordingly does not limit
the availability of treaty benefits under these provisions.
Article 16 and the anti-abuse provisions of domestic law
complement each other, as Article 16 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 16 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 of Article 16
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 4, discussed
below, claiming benefits under paragraph 2 does not require an
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 (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 (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 (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 (c) if the principal class of its shares, and
any disproportionate class of 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 6(a). 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 New Zealand Stock
Market; and (iii) 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 6(b) 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.
A company whose principal class of shares is regularly
traded on a recognized stock exchange will nevertheless not
qualify for benefits under subparagraph 2(c) if it has a
disproportionate class of shares that is not regularly traded
on a recognized stock exchange. The term ``disproportionate
class of shares'' is defined in subparagraph 6(c). A company
has a disproportionate class of shares if it has outstanding 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, profit, or gain in the other Contracting State than
that to which the holder would be entitled in the absence of
such terms or arrangements. Thus, for example, a company
resident in New Zealand has a disproportionate class of shares
if it has outstanding a class of ``tracking stock'' that pays
dividends based upon a formula that approximates the company's
return on its assets employed in the United States.
The following example illustrates this result.
Example. NZCo is a corporation resident in New Zealand.
NZCo has two classes of shares: Common and Preferred. The
Common shares are listed and regularly traded on the New
Zealand Stock Market. The Preferred shares have no voting
rights and are entitled to receive dividends equal in amount to
interest payments that NZCo receives from unrelated borrowers
in the United States. The Preferred shares are owned entirely
by a single investor that is a resident of a country with which
the United States does not have a tax treaty. The Common shares
account for more than 50 percent of the value of NZCo 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 NZCo, the
Preferred shares are a disproportionate class of shares.
Because the Preferred shares are not regularly traded on a
recognized stock exchange, NZCo will not qualify for benefits
under subparagraph 2(c).
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 New Zealand. 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
(General Definitions) , 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 (and at least 50 percent of any
disproportionate class of 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 New
Zealand, all the shares of which are owned by another company
that is a resident of New Zealand, would qualify for benefits
under the Convention if the principal class of shares (and any
disproportionate classes of shares) of the parent company are
regularly and primarily traded on a recognized stock exchange
in New Zealand. 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 New Zealand. Furthermore, if
a parent company in New Zealand 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 New Zealand 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 subparagraphs 1(a) and (b) of
Article 4 (Resident) will be entitled to all the benefits of
the Convention. A pension fund, as defined in subparagraph 1(1)
of Article 3 (General Definitions), 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, a tax-exempt organization other than a pension fund
automatically qualifies for benefits, without regard to the
residence of its beneficiaries or members. Entities qualifying
under this rule are those that are generally exempt from tax in
their State of residence and that are organized and operated
exclusively to fulfill religious, charitable, scientific,
artistic, cultural, or educational purposes.
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 (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 at least 50 percent of the aggregate voting power and
value (and at least 50 percent of any disproportionate class of
shares) 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), (b), (c)(i), or (d). In the case of indirect owners, 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 (Resident) 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
the other provisions of paragraph 2 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), (b),
(c)(i), or (d).
The base erosion prong of clause (ii) of subparagraph (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 (a), (b), (c)(i), or
(d), in the form of payments deductible for tax purposes in the
payor'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 such bank is not related
to the payor. 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 of Article 16
Paragraph 3 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 3 whether or not it also qualifies
under paragraph 2.
Subparagraph 3(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 3 of Article 3, when
determining whether a resident of New Zealand 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 Code section 367(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 NZCo,
a corporation resident in New Zealand. NZCo distributes USCo
products in New Zealand. Since the business activities
conducted by the two corporations involve the same products,
NZCo'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 NZCo. NZCo and other USCo affiliates then manufacture
and market the USCo-designed products in their respective
markets. Since the activities conducted by NZCo 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. NZSub is
a wholly-owned subsidiary of Americair resident in New Zealand.
NZSub operates a chain of hotels in New Zealand that are
located near airports served by Americair flights. Americair
frequently sells tour packages that include air travel to New
Zealand and lodging at NZSub 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 NZSub's
business does not form a part of Americair's business. However,
NZSub'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 NZSub owns an office building in New Zealand instead of a
hotel chain. No part of Americair's business is conducted
through the office building. NZSub'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
NZHolding, a corporation resident in New Zealand. NZHolding is
a holding company that is not engaged in a trade or business.
NZHolding owns all the shares of three corporations that are
resident in New Zealand: NZFlower, NZLawn, and NZFish. NZFlower
distributes USFlower flowers under the USFlower trademark in
New Zealand. NZLawn markets a line of lawn care products in New
Zealand under the USFlower trademark. In addition to being sold
under the same trademark, NZLawn and NZFlower products are sold
in the same stores and sales of each company's products tend to
generate increased sales of the other's products. NZFish
imports fish from the United States and distributes it to fish
wholesalers in New Zealand. For purposes of paragraph 3, the
business of NZFlower forms a part of the business of USFlower,
the business of NZLawn is complementary to the business of
USFlower, and the business of NZFish 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 3(b) states a further condition to the general
rule in subparagraph (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 (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 3(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.
The application of the substantiality requirement only to
income from related parties focuses only on potential abuse
cases, and does not hamper certain other kinds of non-abusive
activities, even though the income recipient resident in a
Contracting State may be very small in relation to the entity
generating income in the other Contracting State. For example,
if a small U.S. research firm develops a process that it
licenses to a very large, unrelated, pharmaceutical
manufacturer in New Zealand, the size of the U.S. research firm
would not have to be tested against the size of the
manufacturer. Similarly, a small U.S. bank that makes a loan to
a very large unrelated company operating a business in New
Zealand would not have to pass a substantiality test to receive
treaty benefits under paragraph 3.
Subparagraph 3(c) provides special attribution rules for
purposes of applying the substantive rules of subparagraphs (a)
and (b). These rules apply for purposes of determining whether
a person meets the requirement in subparagraph (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, and for making the comparison required by
the ``substantiality'' requirement in subparagraph (b).
Subparagraph (c) attributes to a person 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 4 of Article 16
Paragraph 4 provides that a resident of one of the States
that is not entitled to the benefits of the Convention as a
result of paragraphs 2 through 3 still may be granted benefits
under the Convention at the discretion of the competent
authority of the State from which benefits are claimed. Under
paragraph 4, that competent authority will determine whether
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 4.
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 4, 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 the resident 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 paragraph 4 of Article 22, but it does not
meet any of the objective tests of this Article, it may apply
to the U.S. competent authority for discretionary relief.
Paragraph 5 of Article 16
Paragraph 5 deals with the treatment of income in the
context of a so-called ``triangular case.''
An example of a triangular case would be a structure under
which a resident of New Zealand earns interest income from the
United States. The resident of New Zealand, who is assumed to
qualify for benefits under one or more of the provisions of
Article 16, 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 New Zealand 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 New Zealand
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
New Zealand income tax treaty with the host jurisdiction of the
permanent establishment, the income of the permanent
establishment is exempt from New Zealand tax (alternatively,
New Zealand may choose to exempt the income of the permanent
establishment from New Zealand income tax by statute). 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 New Zealand 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 of Article 16
Paragraph 6 defines several key terms for purposes of
Article 16. Each of the defined terms is discussed above in the
context in which it is used.
ARTICLE XII
Paragraph 1
Paragraph 1 of Article XII of the Protocol deletes and
replaces the last sentence of paragraph 1 of Article 22 (Relief
from Double Taxation) of the existing Convention, so that for
purposes of this paragraph, the taxes set out in subparagraph
3(a) and paragraph 4 of Article 2 (Taxes Covered) shall be
considered income taxes.
Paragraph 2
Paragraph 2 of Article XII of the Protocol deletes the
final sentence from paragraph 2 of Article 22 (Relief from
Double Taxation) of the existing Convention to account for
changes to New Zealand's domestic law.
Paragraph 3
Paragraph 3 of Article 12 of the Protocol replaces
paragraph 5 of Article 22 of the existing Convention to conform
with changes to Article 2 (Taxes Covered) made in Article II of
the Protocol.
ARTICLE XIII
Article XIII of the Protocol replaces Article 23 (Non-
discrimination) of the existing Convention. 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 5, 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 are comparably 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 nondiscriminatory 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 of Article 23
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 more burdensome than
the taxes and connected requirements imposed upon a national of
that other State in the same circumstances. The OECD Model
language would prohibit taxation that is ``other than or more
burdensome'' than that imposed on U.S. persons. This Convention
omits the reference to taxation that is ``other than'' that
imposed on U.S. persons because the only relevant question
under this provision should be whether the requirement imposed
on a national of the other Contracting State is more
burdensome. A requirement may be different from the
requirements imposed on U.S. nationals without being more
burdensome.
The term ``national'' in relation to a Contracting State is
defined in subparagraph 1(k) 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 New Zealand as a national
of New Zealand 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 I specifically states
that the United States is not obligated to apply the same
taxing regime to a national of New Zealand 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 New Zealand who are not United
States residents. Thus, for example, Article 23 would not
entitle a national of New Zealand 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 of Article 23
Paragraph 2 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 New Zealand 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., Code
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 New Zealand, 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 3 of Article 23
Paragraph 3 makes clear that the provisions of paragraphs 1
and 2 do 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 New Zealand 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 New Zealand 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 4 of Article 23
Paragraph 4 is identical to paragraph 3 of Article 23 of
the existing Convention. Paragraph 4 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 4, however, does not require a
Contracting State to give non-residents more favorable
treatment than it gives to its own residents. Consequently, a
Contracting State does not have to allow non-residents 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 4 is provided for
cases where the provisions of paragraph 1 of Article 9
(Associated Enterprises), paragraph 6 of Article 11 (Interest)
or paragraph 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 6 of Article 11 would include the denial
or deferral of certain interest deductions under Code section
163(j).
Paragraph 5 of Article 23
Paragraph 5 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 Code section
367(e) on an applicable distribution to foreign shareholders
does not violate paragraph 5 of the Article because a foreign-
owned corporation is not similar to a domestically-owned
corporation that is accorded non-recognition treatment under
Code 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 Code section 1446 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
5 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 5 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 6 of Article 23
Paragraph 6 of the Article confirms that no provision of
the Article will prevent either Contracting State from imposing
either the branch profits tax described in paragraph 8 of
Article 10 (Dividends).
Paragraph 7 of Article 23
Paragraph 7 of the Article states that the Article shall
not apply to any provision of the taxation laws of the
Contracting State which is reasonably designed to prevent or
defeat the avoidance or evasion of taxes.
Relationship to Other Articles
The saving clause of paragraph 3 of Article 1 (General
Scope) does not apply to this Article by virtue of the
exceptions in paragraph 4(a) of Article 1. Thus, for example, a
U.S. citizen who is a resident of New Zealand 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 16 (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 16.
ARTICLE XIV
Article XIV of the Protocol replaces Article 25 (Exchange
of Information and Administrative Assistance) of the existing
Convention. This Article provides for the exchange of
information and administrative assistance between the competent
authorities of the Contracting States.
Paragraph 1 of Article 25
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 may be relevant for
carrying out the provisions of the Convention or the domestic
laws of the United States or of New Zealand concerning taxes of
every kind applied at the national level. This language
incorporates the standard in 26 U.S.C. Section 7602 which
authorizes the IRS to examine ``any books, papers, records, or
other data which may be relevant or material.'' (Emphasis
added.) In United States v. Arthur Young & Co., 465 U.S. 805,
814 (1984), the Supreme Court stated that the language ``may
be'' reflects Congress's express intention to allow the IRS to
obtain ``items of even potential relevance to an ongoing
investigation, without reference to its admissibility.''
(Emphasis in original.) However, the language ``may be'' would
not support a request in which a Contracting State simply asked
for information regarding all bank accounts maintained by
residents of that Contracting State in the other Contracting
State, or even all accounts maintained by its residents with
respect to a particular bank.
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 New Zealand 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 New
Zealand, 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 New Zealand, 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 New Zealand, 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 New Zealand 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 2 of Article 25
Paragraph 2 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 3 of Article 25
Paragraph 3 is in all material respects the same as
paragraph 3 of Article 25 of the existing Convention. 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 4 of Article 25
Paragraph 4 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 paragraph
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 5 of Article 25
Paragraph 5 provides that a Contracting State may not
decline to provide information because that information is held
by financial institutions, nominees or persons acting in an
agency or fiduciary capacity. Thus, paragraph 5 would
effectively prevent a Contracting State from relying on
paragraph 3 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. This paragraph also requires the disclosure of information
regarding the beneficial owner of an interest in a person, such
as the identity of a beneficial owner of bearer shares.
Paragraph 6 of Article 25
Paragraph 6 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 7 of Article 25
Paragraph 7 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 7, 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 7
would obligate the other Contracting State 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 8 of Article 25
Paragraph 8 provides that the requested State shall allow
representatives of the applicant State to enter the requested
State to interview individuals and examine books and records
with the consent of the persons subject to examination.
Treaty effective dates and termination in relation to exchange of
information
Once the Protocol is in force, the competent authority may
seek information under the Convention with respect to a year
prior to the entry into force of the Protocol. Even if an
earlier Convention with more restrictive provisions, or even no
Convention, was in effect during the years in which the
transaction at issue occurred, the exchange of information
provisions of the Protocol apply. In that case, the competent
authorities have available to them the full range of
information exchange provisions afforded under this Article.
Paragraph 3 of Article 28 (Entry into Force) confirms this
understanding with respect to the effective date of the
Article.
A tax administration may also seek information with respect
to a year for which a treaty was in force after the treaty has
been terminated. In such a case the ability of the other tax
administration to act is limited. The treaty no longer provides
authority for the tax administrations to exchange confidential
information. They may only exchange information pursuant to
domestic law or other international agreement or arrangement.
ARTICLE XV
Article XV of the Protocol deletes and replaces Paragraph 1
of the Protocol to the existing Convention, signed in 1982.
Paragraph 1
With reference to Articles 11 (Interest) and 12 (Royalties)
if in any future double taxation convention with any other
country New Zealand agrees to limit its taxation at source on
any interest or royalties to rates lower than the ones provided
in this Convention, then New Zealand shall notify the United
States, and the Contracting States shall, at the request of the
United States, and without undue delay, consult each other with
a view to concluding an additional protocol to incorporate such
lower rates into this Convention.
ARTICLE XVI
Article XVI of the Protocol contains the rules for bringing
the Protocol into force and giving effect to its provisions.
Paragraph 1
Paragraph 1 provides that the Protocol is subject to
ratification in accordance with the applicable procedures of
the United States and New Zealand. 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. The
President's signature completes the process in the United
States.
Paragraph 2
Paragraph 2 provides that the Protocol 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 Protocol 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 the second month in the first calendar
year following the date on which the Protocol enters into
force.
In the United States, for all other taxes, subparagraph
2(b) specifies that the Protocol will have effect for taxes
chargeable for any tax year beginning on or after January 1 of
the year following entry into force of the Protocol.
In New Zealand, for all other taxes, subparagraph 2(c)
specifies that the Protocol will have effect for taxes
chargeable for any tax year beginning on or after April 1 of
the year following entry into force of the Protocol.
Paragraph 3
The powers afforded under Article 25 (Exchange of
Information and Administrative Assistance) apply retroactively
to taxable periods preceding entry into force.