[Senate Executive Report 108-2]
[From the U.S. Government Publishing Office]
108th Congress Exec. Rpt.
SENATE
1st Session 108-2
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TAX CONVENTION WITH THE UNITED KINGDOM
_______
March 13, 2003.--Ordered to be printed
_______
Mr. Lugar from the Committee on Foreign Relations,
submitted the following
R E P O R T
[To accompany Treaty Doc. 107-19]
The Committee on Foreign Relations, to which was referred
the Convention between the Government of the United States of
America and the Government of the United Kingdom of Great
Britain and Northern Ireland for the Avoidance of Double
Taxation and the Prevention of Fiscal Evasion with Respect to
Taxes on Income and on Capital Gains, signed at London on July
24, 2001, together with an Exchange of Notes, as amended by the
Protocol signed at Washington on July 19, 2002, having
considered the same, reports favorably thereon and recommends
that the Senate give its advice and consent to ratification
thereof, as set forth in this report and the accompanying
resolution of ratification.
CONTENTS
Page
I. Purpose..........................................................1
II. Background.......................................................2
III. Summary..........................................................2
IV. Entry Into Force and Termination.................................3
V. Committee Action.................................................4
VI. Committee Comments...............................................5
VII. Budget Impact...................................................16
VIII.Explanation of Proposed Treaty..................................17
IX. Text of Resolution of Ratification..............................17
I. Purpose
The principal purposes of the proposed income tax treaty
between the United States and the United Kingdom are to reduce
or eliminate double taxation of income earned by residents of
either country from sources within the other country and to
prevent avoidance or evasion of the taxes of the two countries.
The proposed treaty also is intended to continue to promote
close economic cooperation between the two countries and to
eliminate possible barriers to trade and investment caused by
overlapping taxing jurisdictions of the two countries.
II. Background
The proposed treaty was signed on July 24, 2001. The United
States and the United Kingdom exchanged notes on the same day
to provide clarification with respect to the application of the
proposed treaty. The proposed protocol was signed on July 19,
2002. The proposed treaty, together with the proposed protocol
and the exchange of notes, would replace the existing income
tax treaty between the United States and the United Kingdom
that was signed in 1975.
The proposed treaty, together with the proposed protocol
and the exchange of notes, was transmitted to the Senate for
advice and consent to its ratification on November 14, 2002
(see Treaty Doc. 107-19). The Committee on Foreign Relations
held a public hearing on the proposed treaty on March 5, 2003.
III. Summary
The proposed treaty is similar to other recent U.S. income
tax treaties, the 1996 U.S. model income tax treaty (``U.S.
model''), and the 1992 model income tax treaty of the
Organization for Economic Cooperation and Development, as
updated (``OECD model''). However, the proposed treaty contains
certain substantive deviations from these treaties and models.
As in other U.S. tax treaties, the purposes of the treaty
principally are achieved through each country's agreement to
limit, in certain specified situations, its right to tax income
derived from its territory by residents of the other country.
For example, the proposed treaty contains provisions under
which each country generally agrees not to tax business income
derived from sources within that country by residents of the
other country unless the business activities in the taxing
country are substantial enough to constitute a permanent
establishment (Article 7). Similarly, the proposed treaty
contains ``commercial visitor'' exemptions under which
residents of one country performing personal services in the
other country will not be required to pay tax in the other
country unless their contact with the other country exceeds
specified minimums (Articles 14 and 16). The proposed treaty
provides that dividends, interest, royalties, and certain
capital gains derived by a resident of either country from
sources within the other country generally may be taxed by both
countries (Articles 10, 11, 12, and 13); however, the rate of
tax that the source country may impose on a resident of the
other country on dividends, interest, and royalties may be
limited or eliminated by the proposed treaty (Articles 10, 11,
and 12). In the case of dividends, the proposed treaty contains
provisions that for the first time in a U.S. income tax treaty
would eliminate source-country tax on certain dividends in
which certain ownership thresholds and other requirements are
satisfied.
In situations in which the country of source retains the
right under the proposed treaty to tax income derived by
residents of the other country, the proposed treaty generally
provides for relief from the potential double taxation through
the allowance by the country of residence of a tax credit for
certain foreign taxes paid to the other country (Article 24).
The proposed treaty contains the standard provision (the
``saving clause'') included in U.S. tax treaties pursuant to
which each country retains the right to tax its residents and
citizens as if the treaty had not come into effect (Article 1).
In addition, the proposed treaty contains the standard
provision providing that the treaty may not be applied to deny
any taxpayer any benefits the taxpayer would be entitled under
the domestic law of a country or under any other agreement
between the two countries (Article 1).
The proposed treaty contains provisions which can operate
to deny the benefits of the dividends article (Article 10), the
interest article (Article 11), the royalties article (Article
12), the other income article (Article 22), and the insurance
excise tax provision of the business profits article (Article
7(5)) with respect to amounts paid under, or as part of, a
conduit arrangement. The proposed treaty also contains a
detailed limitation on benefits provision to prevent the
inappropriate use of the treaty by third-country residents
(Article 23).
IV. Entry Into Force and Termination
A. ENTRY INTO FORCE
The proposed treaty will enter into force upon the exchange
of instruments of ratification. The effective dates of the
treaty's provisions, however, vary.
With respect to the United States, the proposed treaty will
be effective with respect to taxes withheld at source for
amounts paid or credited on or after the first day of the
second month following the date on which the proposed treaty
enters into force. With respect to other taxes, the proposed
treaty will be effective for taxable periods beginning on or
after the first day of January next following the date on which
the proposed treaty enters into force.
With respect to the United Kingdom, the proposed treaty
will be effective with respect to taxes withheld at source for
amounts paid or credited on or after the first day of the
second month following the date on which the proposed treaty
enters into force. With respect to income taxes not described
in the preceding sentence and with respect to capital gains
taxes, the proposed treaty will be effective for any year of
assessment beginning on or after the sixth day of April next
following the date on which the proposed treaty enters into
force. With respect to the corporation tax, the proposed treaty
will be effective for any financial year beginning on or after
the first day of April next following the date on which the
proposed treaty enters into force. With respect to petroleum
revenue taxes, the proposed treaty will be effective for
chargeable periods beginning on or after the first day of
January next following the date on which the proposed treaty
enters into force.
The present treaty generally will cease to have effect in
relation to any tax from the date on which the proposed treaty
takes effect in relation to that tax. Taxpayers may elect
temporarily to continue to claim benefits under the present
treaty with respect to a period after the proposed treaty takes
effect. For such a taxpayer, the present treaty would continue
to have effect in its entirety for a twelve-month period from
the date on which the provisions of the proposed treaty would
otherwise take effect. The present treaty will terminate on the
last date on which it has effect in relation to any tax in
accordance with the provisions of this article.
Notwithstanding the entry into force of the proposed
treaty, an individual who is entitled to the benefits of
Article 21 (Students and Trainees) of the present treaty at the
time the proposed treaty enters into force will continue to be
entitled to such benefits as if the present treaty remained in
force.
The notes provide that the provisions of Article 26 (Mutual
Agreement Procedure) and Article 27 (Exchange of Information
and Administrative Assistance) of the proposed treaty will have
effect from the date of entry into force of the proposed
treaty, without regard to the taxable or chargeable period to
which the matter relates.
B. TERMINATION
The proposed treaty will remain in force until terminated
by either country. Either country may terminate the proposed
treaty by giving notice of termination to the other country
through diplomatic channels. In such case, with respect to the
United States, a termination is effective with respect to taxes
withheld at source for amounts paid or credited after six
months following notice of termination. With respect to other
taxes, a termination is effective for taxable periods beginning
on or after the date that is six months following notice of
termination.
With respect to the United Kingdom, a termination is
effective with respect to taxes withheld at source for amounts
paid or credited after six months following notice of
termination. With respect to income taxes not described in the
preceding sentence and with respect to capital gains taxes, a
termination is effective for any year of assessment beginning
on or after the date that is six months following the notice of
termination. With respect to the corporation tax, a termination
is effective for any financial year beginning on or after the
date that is six months following notice of termination. With
respect to the petroleum revenue tax, a termination is
effective for chargeable periods beginning on or after the date
that is six months following notice of termination.
V. Committee Action
The Committee on Foreign Relations held a public hearing on
the proposed treaty with the United Kingdom (Treaty Doc. 107-
19) on March 5, 2003. The hearing was chaired by Senator
Hagel.\1\ The Committee considered the proposed treaty on March
12, 2003, and ordered the proposed treaty with the United
Kingdom favorably reported by a vote of 19 in favor and 0
against, with the recommendation that the Senate give its
advice and consent to ratification of the proposed treaty.
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\1\ The transcript of this hearing will be forthcoming as a
separate Committee print.
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VI. Committee Comments
On balance, the Committee on Foreign Relations believes
that the proposed treaty with the United Kingdom is in the
interest of the United States and urges that the Senate act
promptly to give advice and consent to ratification. The
Committee has taken note of certain issues raised by the
proposed treaty and believes that the following comments may be
useful to the Treasury Department officials in providing
guidance on these matters should they arise in the course of
future treaty negotiations.
A. ZERO RATE OF WITHHOLDING TAX ON DIVIDENDS FROM 80-PERCENT-OWNED
SUBSIDIARIES
In general
The proposed treaty would eliminate withholding tax on
dividends paid by one corporation to another corporation that
owns at least 80 percent of the stock of the dividend-paying
corporation (often referred to as ``direct dividends''),
provided that certain conditions are met (subparagraph 3(a) of
Article 10 (Dividends)). The elimination of withholding tax
under these circumstances is intended to reduce further the tax
barriers to direct investment between the two countries.
Unlike the United States, the United Kingdom currently does
not impose withholding tax on dividends paid to foreign
shareholders as a matter of domestic law. Thus, the principal
immediate effect of this provision would be to exempt dividends
that U.S. subsidiaries pay to U.K. parent companies from U.S.
withholding tax. With respect to dividends paid by U.K.
subsidiaries to U.S. parent companies, the effect of this
provision would be to lock in the currently applicable zero
rate of U.K. withholding tax, regardless of how U.K. domestic
law might change in this regard.
Currently, no U.S. treaty provides for a complete exemption
from withholding tax under these circumstances, nor do the U.S.
or OECD models. However, many bilateral tax treaties to which
the United States is not a party eliminate withholding taxes
under similar circumstances, and the same result has been
achieved within the European Union under its ``Parent-
Subsidiary Directive.'' In addition, subsequent to the signing
of the proposed treaty, the United States signed proposed
protocols with Australia and Mexico that include zero-rate
provisions similar to the one in the proposed treaty.
Description of provision
Under the proposed treaty, the withholding tax rate is
reduced to zero on dividends beneficially owned by a company
that has owned at least 80 percent of the voting power of the
company paying the dividend for the 12-month period ending on
the date the dividend is declared (subparagraph 3(a) of Article
10 (Dividends)). Under the current U.S.-U.K. treaty, these
dividends may be taxed at a 5-percent rate (although, as noted
above, the United Kingdom currently does not exercise this
right as a matter of domestic law, whereas the United States
does).
In certain circumstances, eligibility for the zero rate
under the proposed treaty is subject to an additional
restriction designed to prevent companies from reorganizing for
the purpose of obtaining the benefits of the provision.
Specifically, in cases in which a company satisfies the
Limitation on Benefits article only under the ``active trade or
business'' and/or ``ownership/base-erosion'' tests (paragraph 4
and subparagraph 2(f), respectively, of Article 23 (Limitation
on Benefits)), the zero rate will apply only if the dividend-
receiving company owned (directly or indirectly) at least 80
percent of the voting power of the dividend-paying company
prior to October 1, 1998. In other cases, the Limitation on
Benefits article itself is considered sufficient to prevent
treaty shopping. Thus, companies that qualify for treaty
benefits under the ``public trading,'' ``derivative benefits,''
or discretionary tests (subparagraph 2(c) and paragraphs 3 and
6, respectively, of Article 23 (Limitation on Benefits)) will
not need to meet the October 1, 1998 holding requirement in
order to claim the zero rate.
Benefits and costs of adopting a zero rate with the United Kingdom
Tax treaties mitigate double taxation by resolving the
potentially conflicting claims of a residence country and a
source country to tax the same item of income. In the case of
dividends, standard international practice is for the source
country to yield mostly or entirely to the residence country.
Thus, the residence country preserves its right to tax the
dividend income of its residents, and the source country agrees
either to limit its withholding tax to a relatively low rate
(e.g., 5 percent) or to forgo it entirely.
Treaties that permit a positive rate of dividend
withholding tax allow some degree of double taxation to
persist. To the extent that the residence country allows a
foreign tax credit for the withholding tax, this remaining
double taxation may be mitigated or eliminated, but then the
priority of the residence country's claim to tax the dividend
income of its residents is not fully respected. Moreover, if a
residence country imposes limitations on its foreign tax
credit, withholding taxes may not be fully creditable as a
practical matter, thus leaving some double taxation in place.
For these reasons, dividend withholding taxes are commonly
viewed as barriers to cross-border investment. The principal
argument in favor of eliminating withholding taxes on certain
direct dividends in the proposed treaty is that it would remove
one such barrier.
Direct dividends arguably present a particularly
appropriate case in which to remove the barrier of a
withholding tax, in view of the close economic relationship
between the payor and the payee. Whether in the United States
or in the United Kingdom, the dividend-paying corporation
generally faces full net-basis income taxation in the source
country, and the dividend-receiving corporation generally is
taxed in the residence country on the receipt of the dividend
(subject to allowable foreign tax credits). If the dividend-
paying corporation is at least 80-percent owned by the
dividend-receiving corporation, it is arguably appropriate to
regard the dividend-receiving corporation as a direct investor
(and taxpayer) in the source country in this respect, rather
than regarding the dividend-receiving corporation as having a
more remote investor-type interest warranting the imposition of
a second-level source-country tax.
Since the United Kingdom does not impose a withholding tax
on these dividends under its internal law, the zero-rate
provision would principally benefit direct investment in the
United States by U.K. companies, as opposed to direct
investment in the United Kingdom by U.S. companies. In other
words, the potential benefits of the provision would accrue
mainly in situations in which the United States is importing
capital, as opposed to exporting it.
Adopting a zero-rate provision in the U.S.-U.K. treaty
would have uncertain revenue effects for the United States. The
United States would forgo the 5-percent tax that it currently
collects on qualifying dividends paid by U.S. subsidiaries to
U.K. parent companies, but since the United Kingdom currently
does not impose any tax on comparable dividends paid by U.K.
subsidiaries to U.S. parent companies, there would be no
offsetting revenue gain to the United States in the form of
decreased foreign tax credit claims with respect to withholding
taxes. However, in order to account for the recent repeal of
the U.K. advance corporation tax and related developments, the
proposed treaty also eliminates a provision of the present
treaty requiring the United States to provide a foreign tax
credit with respect to certain dividends received from U.K.
companies. On balance, these two effects are likely to increase
revenues for the U.S. fisc. Over the longer term, if capital
investment in the United States by U.K. persons is made more
attractive, total investment in the United States may increase,
ultimately creating a larger domestic tax base. However, if
increased investment in the United States by U.K. persons
displaced other foreign or U.S. investments in the United
States, there would be no increase in the domestic tax base.
Revenue considerations aside, the removal of an impediment
to the import of capital from the United Kingdom into the
United States is a not-inconsiderable economic benefit.
Further, it should be noted that, although U.K. internal law
currently does not impose a withholding tax on dividends paid
to foreign persons, there is no guarantee that this will always
be the case. Thus, the inclusion of a zero-rate provision in
the treaty would give U.S.-based enterprises somewhat greater
certainty as to the applicability of a zero rate in the United
Kingdom, which arguably would facilitate long-range business
planning for U.S. companies in their capacities as capital
exporters. Along the same lines, the provision would protect
the U.S. fisc against increased foreign tax credit claims in
the event that the U.K. were to change its internal law in this
regard.
Although the United States has never agreed bilaterally to
a zero rate of withholding tax on direct dividends, many other
countries have done so in one or more of their bilateral tax
treaties. These countries include OECD members Austria,
Denmark, France, Finland, Germany, Iceland, Ireland, Japan,
Luxembourg, Mexico, the Netherlands, Norway, Sweden,
Switzerland, and the United Kingdom, as well as non-OECD-
members Belarus, Brazil, Cyprus, Egypt, Estonia, Israel,
Latvia, Lithuania, Mauritius, Namibia, Pakistan, Singapore,
South Africa, Ukraine, and the United Arab Emirates. In
addition, a zero rate on direct dividends has been achieved
within the European Union under its ``Parent-Subsidiary
Directive.'' Finally, many countries have eliminated
withholding taxes on dividends as a matter of internal law
(e.g., the United Kingdom and Mexico). Thus, although the zero-
rate provision in the proposed treaty is unprecedented in U.S.
treaty history, there is substantial precedent for it in the
experience of other countries. It may be argued that this
experience constitutes an international trend toward
eliminating withholding taxes on direct dividends, and that the
United States would benefit by joining many of its treaty
partners in this trend and further reducing the tax barriers to
cross-border direct investment.
Committee conclusions
The Committee believes that every tax treaty must strike
the appropriate balance of benefits in the allocation of taxing
rights. The agreed level of dividend withholding for
intercompany dividends is one of the elements that make up that
balance, when considered in light of the benefits inuring to
the United States from other concessions the treaty partner may
make, the benefits of facilitating stable cross-border
investment between the treaty partners, and each partner's
domestic law with respect to dividend withholding tax.
In the case of this treaty, considered as a whole, the
Committee believes that the elimination of withholding tax on
intercompany dividends appropriately addresses a barrier to
cross-border investment. The Committee believes, however, that
the Treasury Department should only incorporate similar
provisions into future treaty or protocol negotiations on a
case-by-case basis, and it notes with approval Treasury's
statement that ``[i]n light of the range of facts that should
be considered, the Treasury Department does not view
[elimination of withholding tax on intercompany dividends] as a
blanket change in the United States' tax treaty practice.''
The Committee encourages the Treasury Department to develop
criteria for determining the circumstances under which the
elimination of withholding tax on intercompany dividends would
be appropriate in future negotiations with other countries. The
Committee expects the Treasury Department to consult with the
Committee with regard to these criteria and to the
consideration of elimination of the withholding tax on
intercompany dividends in future treaties.
B. ANTI-CONDUIT RULE
In general
The proposed treaty includes an anti-conduit rule that can
operate to deny the benefits of the dividends article (Article
10), the interest article (Article 11), the royalties article
(Article 12), the other income article (Article 22), and the
insurance excise tax provision of the business profits article
(Article 7(5)). This rule is not found in any other U.S.
treaty, and it is not included in the U.S. or OECD models. The
rule is similar to, but significantly narrower and more precise
than, the ``main purpose'' rules that the Senate rejected in
1999 in connection with its consideration of the U.S.-Italy and
U.S.-Slovenia treaties.\2\
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\2\ See Senate Committee on Foreign Relations, Report, Tax
Convention with Italy, Exec. Rpt. 106-8, Nov. 3, 1999; Senate Committee
on Foreign Relations, Report, Tax Convention with Slovenia, Exec. Rpt.
106-7, Nov. 3, 1999; see also Joint Committee on Taxation, Explanation
of Proposed Income Tax Treaty and Proposed Protocol between the United
States and the Italian Republic (JCS-9-99), October 8, 1999; Joint
Committee on Taxation, Explanation of Proposed Income Tax Treaty
between the United States and the Republic of Slovenia (JCS-11-99),
October 8, 1999.
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The rule was included at the request of the United Kingdom,
which has similar provisions in many of its tax treaties. The
purpose of the rule, from the U.K. perspective, is to prevent
residents of third countries from improperly obtaining the
reduced rates of U.K. tax provided under the treaty by
channeling payments to a third-country resident through a U.S.
resident (acting as a ``conduit'').
From the U.S. perspective, the rule is unnecessary outside
the context of the insurance excise tax, because U.S. domestic
law provides detailed rules governing arrangements to reduce
U.S. tax through the use of conduits. \3\ Thus, apart from
accommodating the request of a treaty partner, no apparent U.S.
interest is served by adding a general anti-conduit rule to the
treaty.
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\3\ See Code sec. 7701(l); Treas. Reg. sec. 1.881-3.
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Description of provision
Under the proposed general anti-conduit rule, the benefits
of the dividends, interest, royalties, and other income
articles are denied in connection with any payment made under,
or as part of, a ``conduit arrangement'' (Articles 10(9),
11(7), 12(5), and 22(4), respectively). Article 3(1)(n) defines
the term ``conduit arrangement'' as a transaction or series of
transactions that meets both of the following criteria: (1) a
resident of one contracting state receives an item of income
that generally would qualify for treaty benefits, and then pays
(directly or indirectly, at any time or in any form) all or
substantially all of that income to a resident of a third state
who would not be entitled to equivalent or greater treaty
benefits if it had received the same item of income directly;
and (2) obtaining the increased treaty benefits is the main
purpose or one of the main purposes of the transaction or
series of transactions.
The inclusion of the first criterion above limits the scope
of the rule to situations involving objectively defined conduit
payments. Thus, the rule is less vague and more narrowly
targeted than the similar rules that the Senate rejected in the
proposed U.S.-Italy and U.S.-Slovenia treaties, which would
have applied to any transaction that met a ``main purpose''
test similar to the second criterion described above.
Issues
The proposed general anti-conduit rule may create
confusion, because it applies not only to conduit arrangements
in which a reduction in U.K. tax is claimed, but also to
conduit arrangements in which a reduction in U.S. tax is
claimed, despite the fact that there is no apparent reason for
the rule to apply in the latter circumstance, in view of the
existence of anti-conduit provisions under U.S. domestic law.
To the extent that the proposed treaty's anti-conduit rule and
the U.S. domestic-law anti-conduit rules are not consistent in
every particular, taxpayers may be confused as to which set of
rules the United States will apply in certain situations.
In order to mitigate this potential confusion, as well as
to provide guidance as to how the United Kingdom will apply the
anti-conduit rule in situations in which a reduction in U.K.
tax is claimed, the parties executed an exchange of letters in
July 2002, in which they described in some detail how they
intend to apply the anti-conduit rule.
The U.S. letter suggests that the United States simply will
continue to apply its domestic law, without regard to the
treaty rule:
With respect to the United States, we intend to
interpret the conduit arrangement provisions of the
Convention in accordance with U.S. domestic law as it
may evolve over time. The relevant law currently
includes in particular the rules of regulation section
1.881-3 and other regulations adopted under the
authority of section 7701(l) of the Internal Revenue
Code. Therefore, the inclusion of the conduit
arrangement rules in the Convention does not constitute
an expansion (or contraction) of U.S. domestic anti-
abuse principles (except with respect to the
application of anti-conduit principles to the insurance
excise tax).\4\
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\4\ See Letter from Barbara M. Angus, International Tax Counsel,
Department of the Treasury, to Gabriel Makhlouf, Director, Inland
Revenue, International Division, July 19, 2002.
An annex to the U.S. letter provides six examples
illustrating how the United States intends to apply the rule in
a manner consistent with current U.S. domestic law. This
statement of intent from the U.S. perspective should
substantially mitigate the potential uncertainty regarding how
the United States will treat conduit arrangements.
The U.K. letter includes an annex that evaluates examples
analogous to those set forth in the annex to the U.S. letter,
reaching results consistent with those of the U.S. letter. The
U.K. letter thus provides helpful guidance as to how the anti-
conduit rules of the proposed treaty will be applied in cases
in which a reduction in U.K. tax is claimed.
On balance, the Committee believes that the exchange of
letters along with the attached examples provide adequate
guidance as to the application of these anti-conduit rules that
were included in the proposed treaty at the request of the
United Kingdom.
C. CREDITABILITY OF U.K. PETROLEUM REVENUE TAX
Treatment under the proposed treaty
The proposed treaty extends coverage to the U.K. Petroleum
Revenue Tax (paragraph 3(b)(iv) of Article 2 (Taxes Covered)).
Article 24 of the proposed treaty (Relief from Double Taxation)
further provides, among other things, that the U.K. Petroleum
Revenue Tax is to be considered an income tax that is
creditable against U.S. tax on income, subject to the
provisions and limitations of that provision of the proposed
treaty.
Specifically, the proposed treaty provides that the amount
that the United States will allow as a credit against U.S. tax
on income for U.K. Petroleum Revenue Taxes imposed on income
from the extraction of minerals from oil or gas wells is
limited to the amount attributable to U.K.-source taxable
income. The proposed treaty further limits the creditable
amount, however, to: (1) the product of the maximum statutory
U.S. rate applicable to a corporation (i.e., 35 percent) and
the amount of such extraction income; less (2) the amount of
other U.K. taxes imposed on such extraction income. The
proposed treaty provides that U.K. Petroleum Revenue Taxes from
the extraction of minerals from oil or gas wells in excess of
the above limitation may be used as a credit in the two
preceding or five succeeding taxable years in accordance with
the limitation described above. The proposed treaty further
provides that its special rules on creditability apply
separately and in the same way to the amount of U.K. Petroleum
Revenue Tax imposed on income from the initial transportation,
initial treatment, and initial storage of minerals from oil or
gas wells in the United Kingdom.
To the extent that a taxpayer would obtain a more favorable
result with respect to the creditability of the U.K. Petroleum
Revenue Tax under the Code than under the proposed treaty, the
taxpayer could choose not to rely on the proposed treaty. The
Technical Explanation to Article 24 of the proposed treaty
states that if a person chooses in any year not to rely on the
proposed treaty to claim a credit for U.K. Petroleum Revenue
Taxes, then the special limitations under the proposed treaty
would not apply for that year. Instead, the current overall
foreign tax credit limitations of the Code would apply, and
U.K. Petroleum Revenue Taxes creditable under the Code could be
used, subject to the Code's limitations, to offset U.S. tax on
other income from U.K. and other foreign sources.
Thus, the proposed treaty operates to create a separate
``per country'' limitation with respect to each U.S. category
of extraction income, and initial transportation, treatment,
and storage income on which U.K. Petroleum Revenue Tax is
assessed. Accordingly, U.K. Petroleum Revenue Tax paid with
respect to extraction income cannot be used as a credit to
offset U.S. tax on: (1) oil and gas extraction income arising
in another country; (2) U.K.-source transportation, treatment,
or storage income on which U.K. Petroleum Revenue Tax is
assessed; or (3) other U.K.-source non-oil related income.
U.K. internal law
The U.K. Petroleum Revenue Tax, introduced in 1975, is
currently imposed at a rate of 50 percent on assessable profits
from oil and gas extraction and certain other activities in the
United Kingdom (including the North Sea) on a field-by-field
basis. Under a separate Ring Fence Tax, oil and gas companies
are required to segregate their income and expenses
attributable to oil and gas related activities, and pay a
separate corporate income tax for taxable income from unrelated
activities. The U.K. Petroleum Revenue Tax is imposed in
addition to, and separate from, this Ring Fence Tax. The amount
of U.K. Petroleum Revenue Tax paid is allowed as a deduction
for purposes of computing the Ring Fence Tax. The U.K.
Petroleum Revenue Tax applies to fields approved for
development on or before March 15, 1993. Revenues from fields
approved after March 15, 1993, are only subject to regular U.K.
corporate income tax.
The U.K. Petroleum Revenue Tax is imposed on income
relating to the extraction of oil and gas in the United Kingdom
including such areas as the North Sea, income earned by
taxpayers providing transportation, treatment, and other
services relating to oil and gas resources in such areas, and
income relating to the sale of such oil and gas related assets.
With the exception of interest expense, most significant costs
and expenses are currently deductible in determining taxable
income. Operating losses may be carried back or forward without
limit to income associated with a particular field.
Various other deductions and allowances are available
against income assessed for these purposes, including: a
supplemental uplift charge equal to 35 percent of most capital
expenditures relating to a field; an oil allowance or exemption
from the U.K. Petroleum Revenue Tax for each field up to a
certain amount of metric tons of oil; a tariff receipts
allowance for transportation receipts up to a certain amount,
and certain non-field specific expenses such as research.
The proposed treaty treats the U.K. Petroleum Revenue Tax,
and any substantially similar tax, as a creditable tax for U.S.
foreign tax credit purposes. The United States Tax Court has
recently addressed the creditability under the Code and the
regulations under Code section 901 of the U.K. Petroleum
Revenue Tax in the case of Exxon v. Commissioner.\5\
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\5\ 113 T.C. 338 (1999).
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In Exxon v. Commissioner, the United Kingdom granted
licenses to Exxon for the exploitation of petroleum resources
in the U.K.'s segment of the North Sea. Under those licenses,
Exxon paid royalties, upfront fees, and annual fees. After the
grant of the licenses, the U.K. enacted a modified version of
the U.K. corporate income tax (the Ring Fence Tax) and the U.K.
Petroleum Revenue Tax for oil production activities. The Tax
Court considered whether the U.K. Petroleum Revenue Tax
satisfied the net income requirement under the section 901
regulations and whether the U.K. Petroleum Revenue Tax was paid
in exchange for a specific economic benefit (e.g., a royalty
and not a tax). With respect to the net income issue, the court
held that, notwithstanding the nondeductibility of interest
expense in computing taxable income, the various allowances
against the U.K. Petroleum Revenue Tax (particularly the 35
percent uplift charge which based on the Court's findings
significantly exceeded interest expense) resulted in the
predominant character of the tax being in the nature of an
income or profits tax in the U.S. sense. With respect to the
specific economic benefit issue, the court held that the U.K.
Petroleum Revenue Tax paid for the years in question (1983-
1988) constituted taxes and not payments for specific economic
benefits. In so holding, the court relied on the fact that
Exxon acquired its licenses to extract oil from the North Sea
before the U.K. Petroleum Revenue Tax was enacted and that it
received no new or additional benefits as a result of paying
the U.K. Petroleum Revenue Tax.\6\ The court thus found the
U.K. Petroleum Revenue Tax paid by Exxon to be creditable under
U.S. law.
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\6\ The Court further based its holding that Exxon did not pay the
U.K. Petroleum Revenue Tax in exchange for specific economic benefits
based on the following: (1) the royalties and other fees paid by Exxon
represented substantial and reasonable compensation, (2) the U.K.'s
purposes in enacting the U.K. Petroleum Revenue Tax was to take
advantage of increases in oil prices and to assure itself of a share of
those excess profits, and (3) the U.K. Petroleum Revenue Tax had all of
the characteristics of a tax and was intended to be a tax.
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The Internal Revenue Service acquiesced in the Exxon
decision, but only as to its results.\7\ The Internal Revenue
Service indicated in its acquiescence that it will only follow
the opinion in disposing of cases involving the U.K. Petroleum
Revenue Tax where the facts are substantially similar to those
in the Exxon case. Since such determinations are inherently
factual, the determination of the creditability of the U.K.
Petroleum Revenue Tax under U.S. law as a general matter is
unclear.
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\7\ 2001-31 I.R.B. 98 (August 20, 2001).
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If the U.K. Petroleum Revenue Tax would generally be
considered creditable under the Code, then there may be a
question as to the need for the additional limitations provided
under the proposed treaty for determining the amount of
creditable U.K. Petroleum Revenue Tax. Taxpayers are likely to
rely on the proposed treaty only to the extent that it provides
them with a more favorable foreign tax credit result than would
otherwise result from the application of the Code. In addition,
since the U.K. Petroleum Revenue Tax has been eliminated with
respect to fields approved after March 15, 1993, it is unclear
to what extent these creditability issues will remain important
in future years.
On the other hand, to the extent that it is unclear whether
the U.K. Petroleum Revenue Tax is generally considered to be
creditable under U.S. law, the primary issue is the extent to
which treaties should be used to provide a credit for taxes
that may not otherwise be fully creditable and, in cases where
a treaty does provide creditability, to what extent the treaty
should impose limitations not contained in the Code. A related
issue is whether a controversial matter in U.S. tax policy such
as the tax credits to be allowed U.S. oil companies on their
foreign extraction operations should be resolved through the
treaty process rather than through the normal legislative
process.
Similar provisions making Denmark's Hydrocarbon Tax,
Norway's Submarine Petroleum Resource Tax, and the
Netherlands's Profit Share creditable are contained in the
U.S.-Denmark income tax treaty, the protocol to the U.S.-Norway
income tax treaty, and the U.S.-Netherlands income tax treaty,
respectively. Also at issue, therefore, is whether the United
Kingdom should be denied a special treaty credit for taxes on
oil and gas extraction income when Denmark, Norway, and the
Netherlands, its North Sea competitors, now receive a similar
treaty credit under the U.S. income tax treaties with those
countries currently in force. On the one hand, it would appear
fair to treat the United Kingdom like Denmark, Norway, and the
Netherlands. On the other hand, the United States should not
view any particular treaty concession to one country as
requiring identical or similar concessions to other
countries.The present treaty contains a similar provision
providing for the creditability of the U.K. Petroleum Revenue
Tax. During Senate consideration of the third protocol to the
present treaty, a reservation was proposed to apply similar
per-country limitations to prevent U.S. oil companies from
using the U.K. Petroleum Revenue Tax as a credit against their
U.S. tax liability on extraction income from other countries.
\8\ The reservation was withdrawn and the per-country
limitations were included in that protocol to the present
treaty.
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\8\ The text of the proposed reservation is reprinted at 124 Cong.
Rec. S9559 (daily ed., June 27, 1978).
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D. TEACHERS, STUDENTS, AND TRAINEES
Treatment under proposed treaty
The proposed treaty generally would not change the
application of income taxes to certain individuals who visit
the United States or United Kingdom as students, teachers,
academic researchers, or so-called ``business apprentices''
engaged in full-time training. The present treaty (Article 20)
provides that a professor or teacher who visits the United
States from the United Kingdom or the United Kingdom from the
United States for a period of two years or less to engage in
teaching or research at a university or college is exempt from
tax by the host country on any remuneration received for such
teaching or research. In addition, the present treaty (Article
21) provides that certain payments that a student or business
apprentice who visits the United States from the United Kingdom
or the United Kingdom from the United States to pursue full-
time education at a university or college or to engage in full-
time training are exempt from taxation by the host country. The
exempt payments are limited to those payments the individual
may receive for his or her maintenance, education or training
as long as such payments are from sources outside the host
country. Under Article 20 of the proposed treaty, U.S.
taxpayers who are visiting the United Kingdom and individuals
who immediately prior to visiting the United States were
resident in the United Kingdom will be exempt from income tax
in the host country on certain payments received if the purpose
of their visit is to engage in full-time education at a
university or college or to engage in full-time training. The
exempt payments are limited to those payments the individual
may receive for his or her maintenance, education or training
as long as such payments are from sources outside the host
country. In the case of individuals engaged in full-time
training, the exemption from income tax in the host country
applies only for a period of one year or less.
Under Article 20A of the proposed treaty, U.S. taxpayers
who are visiting the United Kingdom and individuals who
immediately prior to visiting the United States were resident
in the United Kingdom will be exempt from income tax in the
host country on remuneration they receive for teaching or
research at a university, college, or other recognized
educational institution. The exemption is limited to visiting
periods of two years or less.
Transition rule
Under the entry in force provisions of the proposed treaty
(Article 29), taxpayers may elect temporarily to continue to
claim benefits under the present treaty with respect to a
period after the proposed treaty takes effect. For an
individual engaged in full-time training, Article 21 of the
present treaty would continue to have effect in its entirety
until such time as the individual had completed his or her
training. For some individuals this special rule may provide
benefits under the present treaty that exceed those available
under the general transition rule. The general transition rule
would provide that an individual would have the benefits of the
present treaty for twelve months from the date on which the
proposed treaty comes into force.
Issues
Unlike the U.S. model, but like the present treaty, the
proposed treaty would provide an exemption from the host
country income tax for income an individual receives from
teaching or research in the host country. Prior to amendment by
the protocol, the proposed treaty would have followed the U.S.
model and no such exemption would have been provided. Article
20 of the present treaty and Article 20A of the proposed treaty
provide that a teacher who visits a country for the purpose of
teaching or engaging in research at a recognized educational
institution generally is exempt from tax in that country for a
period not exceeding two years. Under the proposed treaty, a
U.S. person who is a teacher or professor may receive
effectively an exemption from any income tax for income earned
related to visiting the United Kingdom for the purpose of
engaging in teaching or research for a period of two years or
less. Under the terms of the treaty, the United Kingdom would
exempt any such income of a U.S. person from U.K. income tax.
Under Code sec. 911, $80,000 would be exempt from U.S. income
tax in 2003 through 2007,\9\ and in addition certain living
expenses would be deductible from income. To the extent the
U.S. teacher's or professor's remuneration related to his or
her visit to the United Kingdom was less than $80,000, the
income would be tax free. Likewise, under the proposed treaty,
a U.K. person who is a teacher or professor may receive
effectively an exemption from any income tax for income earned
related to visiting the United States for the purpose of
engaging in teaching or research for a period of two years or
less. Under the terms of the treaty, the United States would
exempt any such income from U.S. income tax. Under the terms of
U.K. tax law, such income generally would not be taxable by the
U.K. as the individual would not be resident in the United
Kingdom.
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\9\ For years after 2007, the $80,000 amount is indexed for
inflation after 2006 (Code sec. 911(b)(2)(D)).
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The effect of the proposed treaty is to make such cross-
border visits more attractive financially. Ignoring relocation
expenses, a U.S. citizen or permanent resident may receive more
net, after-tax remuneration from teaching or research from
visiting the United Kingdom as a teacher or researcher than if
he or she had remained in the United States. Likewise a U.K.
resident may receive more net, after-tax remuneration from
teaching or research from visiting the United States as a
teacher or researcher than if he or she had remained in the
United Kingdom. Increasing the financial reward may serve to
encourage cross-border visits by academics. Such cross-border
visits by academics for teaching and research may foster the
advancement of knowledge and redound to the benefit of
residents of both countries.
On the other hand, complete exemption from income tax in
both the United States and the United Kingdom may be seen as
unfair when compared to persons engaged in other occupations
whose occupation or employment may cause them to relocate
temporarily abroad. For a U.S. citizen or permanent resident
who is not a teacher or professor, but who temporarily takes up
residence and employment in the United Kingdom, his or her
income is subject to income tax in the United Kingdom and may
be subject income tax in the United States. Likewise, for a
U.K. resident who is not a teacher or professor, but who
temporarily takes up residence and employment in the United
States, his or her income is subject to income tax in the
United States. In other words, the proposed treaty could be
said to violate the principle of horizontal equity by treating
otherwise similarly economically situated taxpayers
differently.
The proposed treaty reverses the position of the originally
proposed treaty with respect to visiting teachers and
professors. Prior to amendment by the protocol, the proposed
treaty would have followed the U.S. model and no such exemption
would have been provided. While this is the position of the
U.S. model, an exemption for visiting teachers and professors
has been included in many bilateral tax treaties. Of the more
than 50 bilateral income tax treaties in force, 30 include
provisions exempting from host country taxation the income of a
visiting individual engaged in teaching or research at an
educational institution, and an additional 10 treaties provide
a more limited exemption from taxation in the host county for a
visiting individual engaged in research. Although the proposed
protocols with Australia and Mexico would not include similar
provisions, three of the most recently ratified income tax
treaties did contain such a provision.\10\
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\10\ The treaties with Italy, Slovenia, and Venezuela, each
considered in 1999, contain provisions exempting the remuneration of
visiting teachers and professors from host country income taxation. The
treaties with Denmark, Estonia, Latvia, and Lithuania, also considered
in 1999, did not contain such an exemption, but did contain a more
limited exemption for visiting researchers.
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Committee conclusions
The Committee notes that while the provision regarding the
taxation of visiting teachers and professors is inconsistent
with the U.S. Model, over half of the bilateral income tax
treaties in force contain a similar provision. The provision in
the U.K. treaty was included in three of the seven income tax
treaties reported by the Committee in 1999. However, the
provision was not included in the proposed protocols with
Mexico and Australia under consideration by the Committee. The
Committee encourages the Treasury Department to develop
criteria for determining under what circumstances this
provision is appropriate.
VII. Budget Impact
The Committee has been informed by the staff of the Joint
Committee on Taxation that the proposed treaty is estimated to
cause a negligible change in Federal budget receipts during the
fiscal year 2003-2012 period.
VIII. Explanation of Proposed Treaty
A detailed, article-by-article explanation of the proposed
income tax treaty between the United States and the United
Kingdom can be found in the pamphlet of the Joint Committee on
Taxation entitled Explanation of Proposed Income Tax Treaty
Between the United States and the United Kingdom (JCS-4-03),
March 3, 2003.
IX. Text of Resolution of Ratification
Resolved (two-thirds of the Senators present concurring
therein), That the Senate advise and consent to the
ratification of the Convention between the Government of the
United States of America and the Government of the United
Kingdom of Great Britain and Northern Ireland for the Avoidance
of Double Taxation and the Prevention of Fiscal Evasion with
Respect to Taxes on Income and on Capital Gains, signed at
London on July 24, 2001, together with an Exchange of Notes, as
amended by the Protocol signed at Washington on July 19, 2002
(Treaty Doc. 107-19).