[Senate Executive Report 110-4]
[From the U.S. Government Publishing Office]
110th Congress Exec. Rept.
SENATE
1st Session 110-4
======================================================================
PROTOCOL AMENDING TAX CONVENTION
WITH FINLAND
_______
November 14, 2007.--Ordered to be printed
_______
Mr. Biden, from the Committee on Foreign Relations,
submitted the following
REPORT
[To accompany Treaty Doc. 109-18]
The Committee on Foreign Relations, to which was referred
the Protocol Amending the Convention Between the Government of
the United States of America and the Government of the Republic
of Finland for the Avoidance of Double Taxation and the
Prevention of Fiscal Evasion with Respect to Taxes on Income
and on Capital, signed at Helsinki on May 31, 2006 (the
``Protocol'') (Treaty Doc. 109-18), 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 advice and
consent.
CONTENTS
Page
I. Purpose..........................................................1
II. Background.......................................................2
III. Major Provisions.................................................2
IV. Entry Into Force; Effective Dates................................4
V. Implementing Legislation.........................................5
VI. Committee Action.................................................5
VII. Committee Reccommendation and Comments...........................5
VIII.Resolution of Advice and Consent to Ratification.................6
IX. Annex.--Technical Explanation....................................7
I. Purpose
The proposed Protocol to the existing tax treaty between
the United States and Finland is intended to promote closer
cooperation and further facilitate trade and investment between
the United States and Finland. The Protocol's principal
objectives are to eliminate the withholding tax on cross-border
royalty payments, dividends arising from certain direct
investments, and on certain dividends paid to pension funds;
strengthen the treaty's provisions that prevent the
inappropriate use of the treaty by third-country residents; and
generally modernize the existing tax treaty with Finland to
bring it into closer conformity with U.S. tax treaty law and
policy.
II. Background
The Protocol amends the Convention between the Government
of the United States of America and the Government of the
Republic of Finland for the Avoidance of Double Taxation and
the Prevention of Fiscal Evasion with Respect to Taxes on
Income and on Capital, signed at Helsinki on September 21, 1989
(the ``1989 Convention'') (Treaty Doc. 101-11; Exec. Rept. 101-
28). The 1989 Convention replaced an older tax treaty concluded
in 1970 between the United States and Finland.
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 July 17, 2007, which is reprinted
in the Annex. In addition, the staff of the Joint Committee on
Taxation prepared an analysis of the Protocol, Document JCX-48-
07 (July 13, 2007), which has been of great assistance to the
committee in reviewing the Protocol. A summary of the key
provisions of the Protocol is set forth below.
1. Taxation of Cross-border Dividend Payments
The Protocol replaces Article 10 of the 1989 Convention,
which provides rules for the taxation of dividends paid by a
company that is a resident of one treaty country to a
beneficial owner that is a resident of the other treaty
country. The new version of Article 10 generally allows full
residence-country taxation and limited source-country taxation
of dividends.
The Protocol retains both the generally applicable maximum
rate of withholding at source of 15 percent and the reduced
five-percent maximum withholding rate for dividends received by
a company owning at least 10 percent of the voting stock of the
dividend-paying company. Additionally, with some restrictions
intended to prevent treaty shopping, dividends paid by a
subsidiary in one treaty country to its parent company in the
other treaty country will be exempt from withholding tax in the
subsidiary's home country if the parent company owns (directly
or indirectly through residents of the treaty countries) at
least 80 percent of the voting power in the subsidiary for the
12-month period ending on the date entitlement to the dividend
is determined. By contrast, the 1989 Convention provides for a
maximum withholding tax rate of five percent for such
dividends.
The Protocol provides that dividends beneficially owned by
a pension fund described in Article 16(7)(j) of the treaty may
not be taxed by the country in which the company paying the
dividends is a resident, unless such dividends are derived from
the carrying on of a business by the pension fund or through an
associated enterprise.
As in the 1989 Convention, special rules apply to dividends
received from U.S. Regulated Investment Companies (RICs) and
U.S. Real Estate Investment Trusts (REITs), with some new
modifications applicable to dividends from REITs, which are
similar to provisions included in other recently concluded tax
treaties.
2. Interest
The Protocol amends Article 11 (Interest) of the 1989
Convention and adds two new exceptions to the general
prohibition on source-country taxation of interest income. One
exception is for contingent interest and the second exception
is for interest that is an excess inclusion with respect to a
residual interest in a real estate mortgage investment conduit.
These changes are consistent with U.S. tax policy and in the
case of the second exception, the change is consistent with
sections 860E(e) and 860G(b) of the Internal Revenue Code (the
``Code'').
3. Royalties
The Protocol amends Article 12 (Royalties) of the 1989
Convention to eliminate the source-country withholding tax on
cross-border royalty payments. The 1989 Convention provided for
a maximum withholding tax rate of five percent for royalty
payments received as consideration for the use of patents and
trademarks or for information concerning industrial,
commercial, or scientific experience.
4. Limitation on Benefits
The 1989 Convention already contains a ``Limitation on
Benefits'' provision (Article 16), which is designed to avoid
treaty-shopping. The Protocol amends the Convention's
Limitation on Benefits provision so as to strengthen it against
abuse by third-country residents and bring it into line with
the 2006 U.S. Model Tax Treaty (the ``U.S. Model'') and other
more recent U.S. tax treaties. Among other changes, the new
provision provides that a treaty-country company whose shares
are regularly traded on a recognized stock exchange may qualify
for treaty benefits if the company satisfies one of two tests:
either the company's principal class of shares must be
primarily traded on a recognized stock exchange in a specified
region or the company's primary place of management and control
must be in the country of residence. This new requirement is
intended to ensure an adequate connection to the company's
country of residence.
5. Scope
The Protocol replaces Article 1 (Personal Scope) of the
1989 Convention with a new provision that brings it into closer
conformity with the U.S. Model and reflects subsequent changes
in U.S. tax law.
The 1989 Convention generally provides that, with the
exception of certain benefits, either treaty country may
continue to tax its own citizens and residents as if the treaty
were not in force. The Protocol adds to this provision to make
it clear that, notwithstanding any other provision in the
treaty, either treaty country may also tax, in accordance with
its law, certain former citizens and long-term residents for
ten years following the loss of such status. This change is
consistent with section 877 of the Code, which provides special
rules for the imposition of U.S. income tax on former U.S.
citizens and long-term residents for a period of ten years
following the loss of citizenship or long-term resident status.
The Protocol also adds an additional paragraph (Paragraph
6) to Article 1, which addresses special issues presented by
fiscally transparent entities such as partnerships and certain
estates and trusts. When there is a difference of views between
the United States and Finland on whether an entity is fiscally
transparent, the entity in question may be subject to double
taxation or double non-taxation. Paragraph 6 addresses this
problem by providing that income derived through an entity that
is fiscally transparent under the laws of either treaty country
is considered to be the income of a resident of one of the
treaty countries only to the extent that the income is subject
to tax in that country as the income of a resident.
6. Exchange of Information
The Protocol replaces Article 26 (Exchange of Information)
of the 1989 Convention to bring the provision into closer
conformity with the exchange of information provision contained
in the current U.S. Model. Among other things, the Protocol
clarifies that when information is requested by a treaty
country in accordance with this Article, the other treaty
country is obligated to obtain the requested information as if
the tax in question were the tax of the requested country, even
if that other country has no direct interest in the case to
which the request relates.
IV. Entry Into Force; Effective Dates
In accordance with Article IX, the Protocol will enter into
force upon an exchange of instruments of ratification between
the United States and Finland.
The Protocol's provisions shall have effect in Finland with
respect to taxes withheld at source for income derived on or
after the first day of the second month next following the date
on which the Protocol enters into force. The Protocol's
provisions shall have effect in Finland with respect to other
covered taxes for taxable periods beginning on or after the
first day of January next following the date on which the
Protocol enters into force.
The Protocol's provisions shall have effect in the United
States with respect to taxes withheld at source for amounts
paid or credited on or after the first day of the second month
next following the date on which the Protocol enters into
force. The Protocol's provisions shall have effect in the
United States with respect to other covered taxes for taxable
years beginning on or after the first day of January next
following the date on which the Protocol enters into force.
The Protocol's provisions shall have effect in both the
United States and Finland with respect to taxes withheld at
source covered by paragraph 3 of Article 10 (Dividends), on
income derived on or after the first day of January 2007,
provided that the Protocol enters into force before December
31, 2007.
V. Implementing Legislation
As is the case generally with income tax treaties, the
Protocol is self-executing and thus does not require
implementing legislation for the United States.
VI. Committee Action
The committee held a public hearing on the Protocol on July
17, 2007 (a hearing print of this session will be forthcoming).
Testimony was received by Mr. John Harrington, International
Tax Counsel, Office of the International Tax Counsel at the
Department of the Treasury; Thomas A. Barthold, Acting Chief of
Staff of the Joint Committee on Taxation; the Honorable William
A. Reinsch, President of the National Foreign Trade Council;
and Ms. Janice Lucchesi, Chairwoman of the Board, Organization
for International Development. On October 31, 2007, the
committee considered the Protocol, and ordered it favorably
reported by voice vote, with a quorum present and without
objection.
VII. Committee Recomendation and Comments
The Committee on Foreign Relations believes that the
Protocol will stimulate increased investment, further
strengthen the provision in the 1989 Convention that prevents
treaty shopping, and promote closer cooperation and facilitate
trade and investment between the United States and Finland. 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 taken note, however, of two
issues and has the following comments to offer the Executive
Branch on these matters.
A. TECHNICAL EXPLANATIONS
The Treasury Department traditionally prepares a Technical
Explanation for each bilateral tax treaty, as was done for the
Protocol. The Technical Explanation serves as an official guide
to the treaty from a domestic legal perspective and purportedly
includes understandings reached during the negotiations with
respect to the interpretation and application of the Protocol.
The Treasury Department has explained in response to a question
for the record that it does not currently have a practice of
sharing the Department's technical explanation with the other
relevant treaty partner at the end of a negotiation and before
its public release, although there have been periods in the
past when the Treasury Department's practice was to do so as a
matter of courtesy.
In the committee's view, sharing the Technical Explanation
developed by the Treasury Department with the relevant treaty
partner would be a prudent step to again include in its regular
practice, with possible exceptions made under unusual
circumstances. It should be understood that the committee is
not suggesting that the Executive Branch attempt to elicit
agreement with the relevant treaty partner on the content of
the Technical Explanation. The purpose of sharing the document
would be to improve its international legal status, to confirm
and cement common understandings regarding the application and
implementation of the treaty, and to identify, before the
treaty enters into force, any misunderstandings that might
otherwise arise unexpectedly after entry into force of the
treaty between the two countries.
B. TREATY SHOPPING
The Protocol, like a number of U.S. tax treaties, generally
limits treaty benefits for treaty country residents so that
only those residents with a sufficient nexus to a treaty
country will receive benefits. Although the Protocol, and the
1989 Convention it would amend, is intended to benefit
residents of Finland and the United States, residents of third
countries sometimes attempt to use a treaty to obtain
beneficial tax rates to which they would not otherwise be
entitled. This is known as ``treaty shopping.''
The anti-treaty-shopping provision in the Protocol,
otherwise known as the ``Limitation on Benefits'' provision,
improves upon the Limitation on Benefits provision currently in
force under the 1989 Convention (Article 16). In general
though, as in the case of the 1989 Convention, the new
provision does not rely on a determination of purpose or
intention but instead sets forth a series of objective tests
intended to ensure that there is a sufficient nexus between the
resident seeking benefits under the treaty and the treaty
country in question.
The committee views the anti-treaty-shopping provision in
the Protocol as an improvement and continues to believe that
the United States should maintain its policy of limiting
treaty-shopping opportunities whenever possible. Of course, as
the United States negotiates stronger anti-treaty-shopping
provisions with additional countries, treaty-shopping through
countries with which the United States has tax treaties without
such provisions may become more of a problem. The committee
therefore urges the Treasury Department to further strengthen
anti-treaty-shopping provisions in tax treaties whenever
possible, but particularly to focus on those countries with
which we have treaties that do not contain anti-treaty-shopping
provisions and attempt to close this loophole. This could be
achieved either through an update of the entire treaty or, if a
full update does not appear achievable, through a Limitation on
Benefits Protocol that addresses this issue specifically.
VIII. Resolution of Advice and Consent to Ratification
Resolved (two-thirds of the Senators present concurring
therein),The Senate advises and consents to the ratification of
the Protocol Amending the Convention between the Government of
the United States of America and the Government of the Republic
of Finland for the Avoidance of Double Taxation and the
Prevention of Fiscal Evasion with Respect to Taxes on Income
and on Capital, signed at Helsinki on May 31, 2006 (Treaty Doc.
109-18).
IX. Annex.--Technical Explanation
DEPARTMENT OF THE TREASURY TECHNICAL EXPLANATION OF THE PROTOCOL SIGNED
AT HELSINKI ON MAY 31, 2006 AMENDING THE CONVENTION BETWEEN THE
GOVERNMENT OF THE UNITED STATES OF AMERICA AND THE GOVERNMENT OF
FINLAND FOR THE AVOIDANCE OF DOUBLE TAXATION AND THE PREVENTION OF
FISCAL EVASION WITH RESPECT TO TAXES ON INCOME AND ON CAPITAL, SIGNED
AT HELSINKI ON SEPTEMBER 21, 1989
This is a technical explanation of the Protocol signed at
Washington on May 31, 2006 (the ``Protocol''), amending the
Convention between the United States of America and the
Government of Finland for the avoidance of double taxation and
the prevention of fiscal evasion with respect to taxes on
income, signed at Helsinki on September 21, 1989 (the
``Convention'').
Negotiations took into account the U.S. Department of the
Treasury's current tax treaty policy and Treasury's Model
Income Tax Convention, published on September 20, 1996 (the
``U.S. Model''). Negotiations also took into account the Model
Tax Convention on Income and on Capital, published by the
Organization for Economic Cooperation and Development (the
``OECD Model''), and recent tax treaties concluded by both
countries.
This Technical Explanation is an official guide to the
Protocol. It explains policies behind particular provisions, as
well as understandings reached during the negotiations with
respect to the interpretation and application of the Protocol.
This technical explanation is not intended to provide a
complete guide to the Convention as amended by the Protocol. To
the extent that the Convention has not been amended by the
Protocol, the Technical Explanation of the Convention remains
the official explanation. References in this technical
explanation to ``he'' or ``his'' should be read to mean ``he or
she'' or ``his or her.''
ARTICLE I
Article I of the Protocol replaces Article 1 (Personal
Scope) of the Convention.
Paragraph 1
Paragraph 1 of Article 1 provides that the Convention
applies to residents of the United States or Finland except
where the terms of the Convention provide otherwise. Under
Article 4 (Residence) of the Convention a person is generally
treated as a resident of a Contracting State if that person is,
under the laws of that State, liable to tax therein by reason
of his domicile, residence, or other similar criteria. However,
if a person is considered a resident of both Contracting
States, Article 4 provides rules for determining a State of
residence (or no State of residence). This determination
governs for all purposes of the Convention.
Certain provisions are applicable to persons who may not be
residents of either Contracting State. For example, paragraph 1
of Article 24 (Non-Discrimination) applies to nationals of the
Contracting States. Under Article 26 (Exchange of Information),
information may be exchanged with respect to residents of third
states.
Paragraph 2
Paragraph 2 states the generally accepted relationship both
between the Convention and domestic law and between the
Convention and other agreements between the Contracting States.
That is, no provision in the Convention may restrict any
exclusion, exemption, deduction, credit or other benefit
accorded by the tax laws of the Contracting States, or by any
other agreement between the Contracting States. The
relationship between the non-discrimination provisions of the
Convention and other agreements is addressed not in paragraph 2
but in paragraph 3.
Under paragraph 2, for example, if a deduction would be
allowed under the U.S. Internal Revenue Code (the ``Code'') in
computing the U.S. taxable income of a resident of Finland, the
deduction also is allowed to that person in computing taxable
income under the Convention. Paragraph 2 also means that the
Convention may not increase the tax burden on a resident of a
Contracting States beyond the burden determined under domestic
law. Thus, a right to tax given by the Convention cannot be
exercised unless that right also exists under internal law.
It follows that under the principle of paragraph 2 a
taxpayer's U.S. tax liability need not be determined under the
Convention if the Code would produce a more favorable result. A
taxpayer may not, however, choose among the provisions of the
Code and the Convention in an inconsistent manner in order to
minimize tax. For example, assume that a resident of Finland
has three separate businesses in the United States. One is a
profitable permanent establishment and the other two are trades
or businesses that would earn taxable income under the Code but
that do not meet the permanent establishment threshold tests of
the Convention. One is profitable and the other incurs a loss.
Under the Convention, the income of the permanent establishment
is taxable in the United States, and both the profit and loss
of the other two businesses are ignored. Under the Code, all
three would be subject to tax, but the loss would offset the
profits of the two profitable ventures. The taxpayer may not
invoke the Convention to exclude the profits of the profitable
trade or business and invoke the Code to claim the loss of the
loss trade or business against the profit of the permanent
establishment. (See Rev. Rul. 84-17, 1984-1 C.B. 308.) If,
however, the taxpayer invokes the Code for the taxation of all
three ventures, he would not be precluded from invoking the
Convention with respect, for example, to any dividend income he
may receive from the United States that is not effectively
connected with any of his business activities in the United
States.
Similarly, nothing in the Convention can be used to deny
any benefit granted by any other agreement between the United
States and Finland.
Paragraph 3
Paragraph 3 specifically relates to non-discrimination
obligations of the Contracting States under the General
Agreement on Trade in Services (the ``GATS''). The provisions
of paragraph 3 are an exception to the rule provided in
paragraph 2 of this Article under which the Convention shall
not restrict in any manner any benefit now or hereafter
accorded by any other agreement between the Contracting States.
Subparagraph (a) of paragraph 3 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 24 (Non-
Discrimination) of the Convention.
The term ``measure'' for these purposes is defined broadly
in subparagraph (b) of paragraph 3. It would include, for
example, a law, regulation, rule, procedure, decision,
administrative action or guidance, or any other form of
measure.
Paragraph 4
Paragraph 4 contains the traditional saving clause found in
U.S. tax treaties. The Contracting States reserve their rights,
except as provided in paragraph 5, to tax their residents and
citizens as provided in their internal laws, notwithstanding
any provisions of the Convention to the contrary. For example,
if a resident of Finland 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 Finland 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 5(a) of Article 1 preserves the
benefits of special foreign tax credit rules applicable to the
U.S. taxation of certain U.S. income of its citizens resident
in Finland.
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 Finland
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 4, each Contracting State also reserves its
right to tax former citizens and former long-term residents for
a period of ten years following the loss of such status. Thus,
paragraph 4 allows the United States to tax former U.S.
citizens and former U.S. long-term residents in accordance with
Section 877 of the Code. Section 877 generally applies to a
former citizen or long-term resident of the United States who
relinquishes citizenship or terminates long-term residency 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 average annual net income
tax threshold is 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 5
Paragraph 5 sets forth certain exceptions to the
application of the saving clause. The referenced provisions are
intended to provide benefits to citizens and residents even if
such benefits do not exist under internal law. Paragraph 5 thus
preserves these benefits for citizens and residents of the
Contracting States.
Subparagraph (a) lists certain provisions of the Convention
that are applicable to all citizens and residents of a
Contracting State, despite the general saving clause rule of
paragraph 4:
(1) Paragraph 2 of Article 9 (Associated Enterprises)
grants the right to a correlative adjustment with
respect to income tax due on profits reallocated under
Article 9.
(2) Paragraphs 1(b) and 4 of Article 18 (Pensions,
Annuities, Alimony, and Child Support) provide
exemptions from source or residence State taxation for
certain pension distributions, social security payments
and child support.
(3) Article 23 (Elimination of Double Taxation)
confirms to citizens and residents of one Contracting
State the benefit of a credit for income taxes paid to
the other or an exemption for income earned in the
other State.
(4) Article 24 (Non-Discrimination) protects
residents and nationals of one Contracting State
against the adoption of certain discriminatory
practices in the other Contracting State.
(5) Article 25 (Mutual Agreement Procedure) confers
certain benefits on citizens and residents of the
Contracting States in order to reach and implement
solutions to disputes between the two Contracting
States. For example, the competent authorities are
permitted to use a definition of a term that differs
from an internal law definition. The statute of
limitations may be waived for refunds, so that the
benefits of an agreement may be implemented.
Subparagraph (b) of paragraph 5 provides a different set of
exceptions to the saving clause. The benefits referred to are
all intended to be granted to temporary residents of a
Contracting State (for example, in the case of the United
States, holders of non-immigrant visas), but not to citizens or
to persons who have acquired permanent residence in that State.
If beneficiaries of these provisions travel from one of the
Contracting States to the other, and remain in the other long
enough to become residents under its internal law, but do not
acquire permanent residence status (i.e., in the U.S. context,
they do not become ``green card'' holders) and are not citizens
of that State, the host State will continue to grant these
benefits even if they conflict with the statutory rules. The
benefits preserved by this paragraph are the host country
exemptions for government service salaries and pensions under
Article 19 (Government Service), certain income of visiting
students and trainees under Article 20 (Students and Trainees),
and the income of diplomatic agents and consular officers under
Article 27 (Members of Diplomatic Missions and Consular Posts).
Paragraph 6
Paragraph 6 addresses special issues presented by fiscally
transparent entities such as partnerships and certain estates
and trusts. Because different countries frequently take
different views as to when an entity is fiscally transparent,
the risk of both double taxation and double non-taxation are
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 through 21, 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 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 Finnish company 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 U.S. only to the extent that the taxation laws of the
United States treat one or more U.S. residents (whose status as
U.S. residents is determined, for this purpose, under U.S. tax
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 a
benefit for the interest paid to the entity under the
Convention, because they are not residents of the United States
for purposes of claiming this treaty benefit. (If, however, the
country in which they are treated as resident for tax purposes,
as determined under the laws of that country, has an income tax
convention with Finland, 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 Finnish
company 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 the other Contracting State
(e.g., as not fiscally transparent in Finland 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 Finnish tax
purposes. These results also obtain regardless of where the
entity is organized (i.e., in the United States, in Finland,
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 Finnish tax purposes as a corporation and is owned by a
shareholder who is a resident of Finland for Finnish 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 Finland, 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 Finland
only to the extent that the laws of Finland treat X as deriving
the income for tax purposes, perhaps through application of
rules similar to the U.S. ``grantor trust'' rules.
Paragraph 6 is not an exception to the saving clause of
paragraph 4. Accordingly, paragraph 6 does not prevent a
Contracting State from taxing an entity that is treated as a
resident of that State under its tax law. For example, if a
U.S. LLC with members who are residents of Finland 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 Finland views the LLC as fiscally
transparent.
ARTICLE II
Paragraph (a) of Article II of the Protocol replaces
paragraph 1 of Article 4 (Residence) of the Convention. The
term ``resident of a Contracting State'' is defined in
subparagraph (a) of paragraph 1. In general, this definition
incorporates the definitions of residence in U.S. and Finnish
law by referring to a resident as a person who, under the laws
of a Contracting State, is subject to tax therein by reason of
his domicile, residence, 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). Subparagraph (a) of
paragraph 1 also specifically includes the two Contracting
States, and political subdivisions, statutory bodies and local
authorities of the two States, as residents for purposes of the
Convention.
Certain entities that are nominally subject to tax but that
in practice are rarely required to pay tax also would generally
be treated as residents and therefore accorded treaty benefits.
For example, a U.S. Regulated Investment Company (RIC) and a
U.S. Real Estate Investment Trust (REIT) are residents of the
United States for purposes of the treaty. Although the income
earned by these entities normally is not subject to U.S. tax in
the hands of the entity, they are taxable to the extent that
they do not currently distribute their profits, and therefore
may be regarded as ``liable to tax.'' They also must satisfy a
number of requirements under the Code in order to be entitled
to special tax treatment.
A person who is liable to tax in a Contracting State only
in respect of income from sources within that State or capital
situated therein or of profits attributable to a permanent
establishment in that State will not be treated as a resident
of that Contracting State for purposes of the Convention. Thus,
a consular official of Finland 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 Finland 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.
Subparagraph (b) of paragraph 1 contains an exception to
the general rule of paragraph 1(a) that residence under
internal law also determines residence under the Convention.
The exception applies with respect to a U.S. citizen or alien
lawfully admitted for permanent residence (i.e., a ``green
card'' holder). Under paragraph 1(a), a person is considered a
resident of the United States for purposes of the Convention if
he is liable to tax in the United States by reason of
citizenship. In addition, aliens admitted to the United States
for permanent residence (``green card'' holders) qualify as
U.S. residents under the first sentence of paragraph 1 because
they are taxed by the United States as residents, regardless of
where they physically reside.
Paragraph 1(b) provides that a U.S. citizen or green card
holder will be treated as a resident of the United States for
purposes of the Convention, and, thereby entitled to treaty
benefits, only if he has a substantial presence (see section
770 1(b)(3)), permanent home or habitual abode in the United
States. This rule requires that the U.S. citizen or green card
holder have a reasonably strong nexus with the United States.
Thus, for example, an individual resident of Mexico who is
a U.S. citizen by birth, or who is a Mexican citizen and holds
a U.S. green card, but who, in either case, has never lived in
the United States, would not be entitled to benefits under the
Convention. However, a U.S. citizen who is transferred to
Mexico for two years would be entitled to benefits under the
Convention if he maintains a permanent home or habitual abode
in the United States.
The fact that a U.S. citizen who does not have close ties
to the United States may not be treated as a U.S. resident
under the Convention does not alter the application of the
saving clause of paragraph 4 of Article 1 (Personal Scope) to
that citizen. For example, a U.S. citizen who pursuant to the
``citizen/green card holder'' rule is not considered to be a
resident of the United States still is taxable on his worldwide
income under the generally applicable rules of the Code.
Subparagraph (c) of paragraph 1 of Article 4 of the
Convention provides that certain tax-exempt entities such as
pension funds and charitable organizations will be regarded as
residents of a Contracting State regardless of whether they are
generally liable to income tax in the State where they are
established. Subparagraph (c) applies to legal persons
organized under the laws of a Contracting State and established
and maintained in that State to provide pensions or other
similar benefits pursuant to a plan, or exclusively for
religious, charitable, scientific, artistic, cultural, or
educational purposes. Thus, a section 501(c) organization (such
as a U.S. charity) that is generally exempt from tax under U.S.
law is a resident of the United States for all purposes of the
Convention.
Paragraph (b) of Article II of the Protocol, which replaces
paragraph 3 of Article 4 (Residence) of the Convention,
addresses dual-residence issues for persons other than
individuals. This provision applies to persons such as trusts,
estates, and corporations. If such a person is, under paragraph
1 of Article 4 of the Convention, resident in both Contracting
States, the competent authorities shall seek to determine a
single State of residence for such person for purposes of the
Convention.
If the competent authorities do not reach an agreement on a
single State of residence, that person may not claim any
benefit accorded to residents of a Contracting State by the
Convention. The person may, however, claim any benefits that
are not limited to residents, such as those provided by
paragraph 1 of Article 24 (Non-Discrimination). Thus, for
example, a State cannot discriminate against a dual-resident
company.
Dual resident persons 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 the other Contracting
State, 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 the other Contracting State,
not by the dual resident company. The dual resident company
that paid the dividend would, for this purpose, be treated as a
resident of the United States under the Convention. In
addition, information relating to dual resident companies can
be exchanged under the Convention because, by its terms,
Article 26 (Exchange of Information) is not limited to
residents of the Contracting States.
ARTICLE III
Article III of the Protocol replaces Article 10 (Dividends)
of the 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 also provides rules for
the imposition of a tax on branch profits by the State of
source.
Paragraph 1
The right of a shareholder's country of residence to tax
dividends arising in the source country is preserved by
paragraph 1, which permits a Contracting State to tax its
residents on dividends paid to them by a company that is a
resident of the other Contracting State. For dividends from any
other source paid to a resident, Article 21 (Other Income)
grants the residence country exclusive taxing jurisdiction
(other than for dividends attributable to a permanent
establishment in the other State).
Paragraph 2
The State of source also may tax dividends beneficially
owned by a resident of the other State, subject to the
limitations of paragraphs 2 and 3. Paragraph 2 generally limits
the rate of withholding tax in the State of source on dividends
paid by a company resident in that State to 15 percent of the
gross amount of the dividend. If, however, the beneficial owner
of the dividend is a company resident in the other State and
owns directly shares representing at least 10 percent of the
voting power of the company paying the dividend, then the rate
of withholding tax in the State of source is limited to 5
percent of the gross amount of the dividend. Shares are
considered voting shares if they provide the power to elect,
appoint or replace any person vested with the powers ordinarily
exercised by the board of directors of a U.S. corporation.
The benefits of paragraph 2 may be granted at the time of
payment by means of a 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 (a) of paragraph 2 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 24 (Non-Discrimination).
The term ``beneficial owner'' is not defined in the
Convention, and is, therefore, defined as under the internal
law of the country imposing tax (i.e., the source country). The
beneficial owner of the dividend for purposes of Article 10 is
the person to which the dividend income is attributable for tax
purposes under the laws of the source State. Thus, if a
dividend paid by a corporation that is a resident of one of the
States (as determined under Article 4 (Residence)) 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 interpretations are confirmed by paragraph 12 of the
Commentary to Article 10 of the OECD Model.
Companies holding shares through fiscally transparent
entities such as partnerships are considered for purposes of
this paragraph to hold their proportionate interest in the
shares held by the intermediate entity. 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 exclusive residence-country taxation
(i.e., an elimination of withholding tax) with respect to
certain dividends distributed by a company that is a resident
of one Contracting State to a resident of the other Contracting
State. As described further below, this elimination of
withholding tax is available with respect to certain inter-
company dividends and with respect to pension funds.
Subparagraph (a) of paragraph 3 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 both stock
owned directly and stock owned 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, but supplementing, the rules of Article 16 (Limitation on
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 (Limitation on
Benefits), (2) meets the ``ownership-base erosion'' and
``active trade or business'' tests described in subparagraph
2(f) and paragraph 4 of Article 16 (Limitation on Benefits),
(3) meets the ``derivative benefits'' test of paragraph 3 of
Article 16 (Limitation on Benefits), or (4) is granted the
benefits of subparagraph 3(a) of Article 10 by the competent
authority of the source State pursuant to paragraph 6 of
Article 16 (Limitation on Benefits).
These restrictions are necessary because of the increased
pressure on the Limitation on 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 re-organizing in order to become
eligible for the elimination of withholding tax in
circumstances where the Limitation on 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
inter-company dividends. ThirdCo owns directly 100 percent of
the issued and outstanding voting stock of USCo, a U.S.
company, and of FCo, a Finnish company. FCo is a substantial
company that manufactures widgets; USCo distributes those
widgets in the United States. If ThirdCo contributes to FCo all
the stock of USCo, dividends paid by USCo to FCo would qualify
for treaty benefits under the active trade or business test of
paragraph 4 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 requires FCo to meet the ownership-base erosion requirements
of subparagraph 2(f) of Article 16 in addition to the active
trade or business test of paragraph 4 of Article 16. Thus, FCo
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 Finland and eligible for treaty benefits under
certain specified tests and (ii) less than 50 percent of FCo'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 FCo is wholly owned by a
third country resident, FCo 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, FCo would need to qualify under another
test or obtain discretionary relief from the competent
authority under Article 16(6). For purposes of Article
10(3)(a)(ii), 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. Thus, a company
that is a resident of Finland and that meets the requirements
of Article 16(2)(c) (i) or (ii) will be entitled to the
elimination of withholding tax, subject to the 12-month holding
period requirement of Article 10(3)(a).
In addition, under Article 10(3)(a)(iii), a company that is
a resident of a Contracting State may also qualify for the
elimination of withholding tax on dividends if it satisfies the
derivative benefits test of paragraph 3 of Article 16. Thus, a
Finnish company that owns all of the stock of a U.S.
corporation may qualify for the elimination of withholding tax
if it is wholly-owned, for example, by a U.K., Dutch, Swedish,
or Mexican publicly-traded company and the other requirements
of the derivative benefits test are met. At this time,
ownership by companies that are residents of other European
Union, European Economic Area or North American Free Trade
Agreement countries would not qualify the Finnish company for
benefits under this provision, as the United States does not
have treaties that eliminate the withholding tax on inter-
company dividends with any other of those countries. If the
United States were to enter into such treaties with more of
those countries, residents of those countries could then
qualify as equivalent beneficiaries for purposes of this
provision.
The derivative benefits test may also provide benefits to
U.S. companies receiving dividends from Finnish subsidiaries,
because of the effect of the Parent-Subsidiary Directive in the
European Union. Under that directive, inter-company dividends
paid within the European Union are free of withholding tax.
Under subparagraph (h) of paragraph 7 of Article 16, that
directive will also be taken into account in determining
whether the owner of a U.S. company receiving dividends from a
Finnish company is an ``equivalent beneficiary.'' Thus, a
company that is a resident of a member state of the European
Union will, by definition, meet the requirements regarding
equivalent benefits with respect to any dividends received by
its U.S. subsidiary from a Finnish company. For example, assume
USCo is a wholly-owned subsidiary of ICo, an Italian publicly-
traded company. USCo owns all of the shares of FCo, a Finnish
company. If FCo were to pay dividends directly to ICo, those
dividends would be exempt from withholding tax in Finland by
reason of the Parent-Subsidiary Directive. If ICo meets the
other conditions of subparagraph 7(g) of Article 16, it will be
treated as an equivalent beneficiary by reason of subparagraph
7(h) of that article.
A company also may qualify for the elimination of
withholding tax pursuant to Article 10(3)(a)(iii) if it is
owned by seven or fewer U.S. or Finnish residents who qualify
as an ``equivalent beneficiary'' and meet the other
requirements of the derivative benefits provision. This rule
may apply, for example, to certain Finnish corporate joint
venture vehicles that are closely-held by a few Finnish
resident individuals.
Subparagraph (g) of paragraph 7 of Article 16 contains a
specific rule of application intended to ensure that for
purposes of applying Article 10(3) certain joint ventures, not
just wholly-owned subsidiaries, can qualify for benefits. For
example, assume that the United States were to enter into a
treaty with Country X, a member of the European Union, that
includes a provision identical to Article 10(3). USCo is 100
percent owned by FCo, a Finnish company, which in turn is owned
49 percent by PCo, a Finnish publicly-traded company, and 51
percent by XCo, a publicly-traded company that is resident in
Country X. In the absence of a special rule for interpreting
the derivative benefits provision, each of the shareholders
would be treated as owning only its proportionate share of the
shares held by FCo. If that rule were applied in this
situation, neither shareholder would be an equivalent
beneficiary, because neither would meet the 80 percent
ownership test with respect to USCo. However, since both PCo
and XCo are residents of countries that have treaties with the
United States that provide for elimination of withholding tax
on inter-company dividends, it is appropriate to provide
benefits to FCo in this case.
Consequently, when determining whether a person is an
equivalent beneficiary under paragraph 7 of Article 16, each of
the shareholders is treated as owning shares with the same
percentage of voting power as the shares held by FCo for
purposes of determining whether it would be entitled to an
equivalent rate of withholding tax. This rule is necessary
because of the high ownership threshold for qualification for
the elimination of withholding tax on inter-company dividends.
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 6 of Article 16. Benefits will
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.
Subparagraph (b) of paragraph 3 of Article 10 of the
Convention provides that dividends beneficially owned by a
pension fund (as defined in subparagraph (j) of paragraph 7 of
Article 16) may not be taxed in the Contracting State of which
the company paying the dividends is a resident, unless such
dividends are derived from the carrying on of a business,
directly by the pension fund or indirectly through an
associated enterprise.
This rule is necessary because pension funds normally do
not pay tax (either through a general exemption or because
reserves for future pension liabilities effectively offset all
of the fund's income), and therefore cannot benefit from a
foreign tax credit. Moreover, distributions from a pension fund
generally do not maintain the character of the underlying
income, so the beneficiaries of the pension are not in a
position to claim a foreign tax credit when they finally
receive the pension, in many cases years after the withholding
tax has been paid. Accordingly, in the absence of this rule,
the dividends would almost certainly be subject to unrelieved
double taxation.
Paragraph 4
Article 10 generally applies to distributions made by a RIC
or a REIT. However, distributions made by a REIT or certain
RICs that are attributable to gains derived from the alienation
of U.S. real property interests and treated as gain recognized
under section 897(h)(1) are taxable under paragraph 1 of
Article 13 instead of Article 10. In the case of RIC or REIT
distributions to which Article 10 applies, 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 REIT are not eligible for the 5
percent rate of withholding tax of subparagraph 2(a) or the
elimination of source-country withholding tax of subparagraph
3(a).
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 and that the elimination of
source-country withholding tax of subparagraph 3(b) applies to
dividends paid by RICs and beneficially owned by a pension
fund.
The third sentence of subparagraph 4(a) provides that the
15 percent rate of withholding tax also applies to dividends
paid by a REIT and that the elimination of source-country
withholding tax of subparagraph 3(b) applies to dividends paid
by REITs and beneficially owned by a pension fund, 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 (b) provides a definition of the term
``diversified,'' which is necessary because the term is not
defined in the Code. 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 Finland that wishes to hold
a diversified portfolio of U.S. corporate shares could hold the
portfolio directly and would bear a U.S. withholding tax of 15
percent on all of the dividends that it receives.
Alternatively, it could hold the same diversified portfolio by
purchasing 10 percent or more of the interests in a RIC. If the
RIC is a pure conduit, there may be no U.S. tax cost to
interposing the RIC in the chain of ownership. Absent the
special rule in paragraph 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.
Similarly, a resident of Finland directly holding U.S. real
property would pay U.S. tax on rental income 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 rental income 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
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, including
types of 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
dividends 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 subsidiary's and
sister's earnings and profits). Further, a distribution from a
U.S. publicly traded limited partnership, which is taxed as a
corporation under U.S. law, is a dividend for purposes of
Article 10. However, a distribution by a limited liability
company is not taxable by the United States under Article 10,
provided the limited liability company is not characterized as
an association taxable as a corporation under U.S. law.
Finally, a payment denominated as interest that is made by
a thinly capitalized corporation may be treated as a dividend
to the extent that the debt is recharacterized as equity under
the laws of the source State.
Paragraph 6
Paragraph 6 provides that the general source country
limitations under paragraph 2 and 3 on dividends do not apply
if the beneficial owner of the dividends carries on business
through a permanent establishment situated in the source
country, or performs in the source country independent personal
services from a fixed base situated therein, and the dividends
are attributable to such permanent establishment or fixed base.
In such case, the rules of Article 7 (Business Profits) or
Article 14 (Independent Personal Services) shall apply, as the
case may be. Accordingly, such dividends will be taxed on a net
basis using the rates and rules of taxation generally
applicable to residents of the Contracting State in which the
permanent establishment or fixed base is located, as such rules
may be modified by the Convention. An example of dividends
attributable to a permanent establishment would be dividends
derived by a dealer in stock or securities from stock or
securities that the dealer held for sale to customers.
Paragraph 7
The right of a Contracting State to tax dividends paid by a
company that is a resident of the other Contracting State is
restricted by paragraph 7 to cases in which the dividends are
paid to a resident of that Contracting State or are
attributable to a permanent establishment or fixed base in that
Contracting State. Thus, a Contracting State may not impose a
``secondary'' withholding tax on dividends paid by a
nonresident company out of earnings and profits from that
Contracting State. In the case of the United States, the
secondary withholding tax was eliminated for payments made
after December 31, 2004 in the American Jobs Creation Act of
2004.
Paragraphs 8 and 9
Paragraph 8 permits a Contracting State to impose a branch
profits tax on a company resident in the other Contracting
State. The tax is in addition to other taxes permitted by the
Convention. The term ``company'' is defined in subparagraph
1(d) of Article 3 (General Definitions).
A Contracting State may impose a branch profits tax on a
company if the company has income attributable to a permanent
establishment in that Contracting State, derives income from
real property in that Contracting State that is taxed on a net
basis under Article 6 (Income from Immovable (Real) Property),
or realizes gains taxable in that State under paragraph 1 of
Article 13 (Gains). In the case of the United States, the
imposition of such tax is limited, however, to the portion of
the aforementioned items of income that represents the amount
of such income that is the ``dividend equivalent amount.'' This
is consistent with the relevant rules under the U.S. branch
profits tax, and the term dividend equivalent amount is defined
under U.S. law. Section 884 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 Articles 6
(Income from Immovable (Real) Property), 7 (Business Profits)
or 13 (Gains), 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.
In Finland, similarly, the imposition of a branch profits
tax on business profits attributable to a permanent
establishment in Finland, as well as income that is subject to
tax under Article 6 (Income from Immovable (Real) Property) or
paragraph 1 of Article 13, is limited to amounts, as defined
under the laws of Finland, that would be distributed as a
dividend if the operation were carried on by a Finnish
subsidiary. Although Finland currently does not have statutory
provisions for imposition of a branch tax, subparagraph (b) of
paragraph 8 preserves Finland's right to impose such a tax if
one is subsequently enacted, provided that the base of that tax
is limited to an amount that is analogous to the dividend
equivalent amount.
Paragraph 9 limits the rate of the branch profits tax
allowed under paragraph 8 to 5 percent. Paragraph 9 also
provides, however, that the branch profits tax will not be
imposed if certain requirements are met. In general, these
requirements provide rules for a branch that parallel the rules
for when a dividend paid by a subsidiary will be subject to
exclusive residence-country taxation (i.e., the elimination of
source-country withholding tax). Accordingly, the branch
profits tax may not be imposed in the case of a company that:
(1) meets the ``publicly traded'' test of subparagraph 2(c) of
Article 16 (Limitation of Benefits), (2) meets the ``ownership-
base erosion'' and ``active trade or business'' tests described
in subparagraph 2(f) and subparagraph 4 of Article 16, (3)
meets the ``derivative benefits'' test of paragraph 3 of
Article 16, or (4) is granted benefits with respect to the
elimination of the branch profits tax by the competent
authority pursuant to paragraph 6 of Article 16.
Thus, for example, if a Finnish company would be subject to
the branch profits tax with respect to profits attributable to
a U.S. branch and not reinvested in that branch, paragraph 9
may apply to eliminate the branch profits tax if the company
either met the ``publicly traded'' test, met the combined
``ownership-base erosion'' and ``active trade or business''
test, or met the derivative benefits test. If, by contrast, a
Finnish company did not meet those tests, but met the
ownership-base erosion test (and thus qualified for treaty
benefits under subparagraph 2(a)), then the branch profits tax
would apply at a rate of 5 percent, unless the Finnish company
is granted benefits with respect to the elimination of the
branch profits tax by the competent authority pursuant to
paragraph 6 of Article 16.
Relation to Other Articles
Notwithstanding the foregoing limitations on source country
taxation of dividends, the saving clause of paragraph 4 of
Article 1 (Personal Scope) permits the United States to tax
dividends received by its residents and citizens as if the
Convention had not come into effect.
The benefits of this Article are also subject to the
provisions of Article 16 (Limitation on Benefits). Thus, if a
resident of Finland 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.
Paragraph 2 of Article III of the Protocol makes a
conforming change to the cross-reference in paragraph 5 of
Article 24 (Non-Discrimination) of the Convention.
ARTICLE IV
Article IV of the Protocol modifies Article 11 (Interest)
of the Convention by adding a new paragraph 6, providing anti-
abuse exceptions to the source-country exemption in paragraph 1
for two classes of interest payments.
The first class of interest, dealt with in subparagraph (a)
of paragraph 6, is so-called ``contingent interest.'' Such
interest is defined in subparagraph (a) as any interest paid by
a resident of a Contracting State that is determined by
reference to the receipts, sales, income, profits or other cash
flow of the debtor or a related person, to any change in the
value of any property of the debtor or a related person or to
any dividend, partnership distribution or similar payment made
by the debtor or a related person and paid to a resident of the
other Contracting State. Any such interest may be taxed in the
Contracting State in which it arises according to the laws of
that State. If the beneficial owner is a resident of the other
Contracting State, however, the gross amount of the interest
may be taxed at a rate not exceeding 15 percent.
The second class of interest is dealt with in subparagraph
(b) of paragraph 6. 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.
ARTICLE V
Article V of the Protocol deletes paragraph 2 of Article 12
(Royalties) of the Convention, which allowed taxation in the
Contracting State in which they arise of royalties beneficially
owned by a resident of the other Contracting State, in the case
of payments with respect to certain types of intellectual
property. Thus, the change eliminates withholding on cross-
border royalty payments regardless of the type of intellectual
property involved, bringing the Convention in line with the
U.S. Model.
ARTICLE VI
Article VI of the Protocol replaces Article 16 (Limitation
on Benefits) of the 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 a so-called ``derivative
benefits'' test under which certain categories of income may
qualify for benefits. Paragraph 4 provides that regardless of
whether a person qualifies for benefits under paragraph 2 or 3,
benefits may be granted to that person with regard to certain
income earned in the conduct of an active trade or business.
Paragraph 5 provides special rules for so-called ``triangular
cases'' notwithstanding paragraphs 1 through 4 of Article 16.
Paragraph 6 provides that benefits may also be granted if the
competent authority of the State from which benefits are
claimed determines that it is appropriate to grant benefits in
that case. Paragraph 7 defines certain terms used in the
Article.
Paragraph 1
Paragraph 1 provides that a resident of a Contracting State
will be entitled to the benefits of the Convention otherwise
accorded to residents of a Contracting State only to the extent
provided in this Article. The benefits otherwise accorded to
residents under the Convention include all limitations on
source-based taxation under Articles 6 through 22, the treaty-
based relief from double taxation provided by Article 23
(Elimination of Double Taxation), and the protection afforded
to residents of a Contracting State under Article 24 (Non-
Discrimination). Some provisions do not require that a person
be a resident in order to enjoy the benefits of those
provisions. For example, Article 25 (Mutual Agreement
Procedure) is not limited to residents of the Contracting
States, and Article 27 (Members of Diplomatic Missions and
Consular Posts) applies to diplomatic agents or consular
officials regardless of residence. Article 16 accordingly does
not limit the availability of treaty benefits under such
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 a 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
Paragraph 2 has six 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 6, 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 applicable 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,
statutory body or local authority thereof will be entitled to
all the benefits of the Convention. Subparagraph (i) of
paragraph 7 defines the term ``statutory body'' to mean any
legal entity of a public character created by the laws of a
Contracting State in which no person other than the State
itself, or a political subdivision or local authority thereof,
has an interest. The term ``statutory body'' was added at
Finland's request because under Finnish laws there exist
governmental bodies that cannot be properly described as
political subdivisions or local authorities. These include,
among others, the National Social Insurance Institution, the
Bank of Finland (Finland's central bank), and the University of
Helsinki.
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 a recognized stock exchange located in the
Contracting State of which the company is a resident, or, in
the case of a company resident in Finland, on a recognized
stock exchange located within the European Union, any other
European Economic Area country, or, in the case of a company
resident in the United States, on a recognized stock exchange
located in another state that is a party to the North American
Free Trade Agreement; 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 (d) of paragraph 7. It includes 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 and the
Helsinki Stock Exchange. The term also includes the Irish Stock
Exchange and the stock exchanges of Amsterdam, Brussels,
Copenhagen, Frankfurt, London, Oslo, Paris, Reykjavik, Riga,
Stockholm, Tallinn, Vilnius, Vienna and Zurich, and 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 (a) of paragraph 7 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. Subparagraph (c) of paragraph 7
defines the term ``shares'' to include depository receipts for
shares. 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 percent 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 (c) of paragraph 2 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
(b) of paragraph 7. 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 Finland meets the test of
subparagraph (b) of paragraph 7 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.--FCo is a corporation resident in Finland. FCo has
two classes of shares: Common and Preferred. The Common shares
are listed and regularly traded on the Helsinki Stock Exchange.
The Preferred shares have no voting rights and are entitled to
receive dividends equal in amount to interest payments that FCo
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 FCo 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 FCo, the Preferred shares are a
disproportionate class of shares. Because the Preferred shares
are not regularly traded on a recognized stock exchange, FCo
will not qualify for benefits under subparagraph (c) of
paragraph 2.
A class of shares will be ``regularly traded'' in a taxable
year, under subparagraph (e) of paragraph 7, if the aggregate
number of shares of that class traded on one or more recognized
exchanges during the twelve months ending on the day before the
beginning of that taxable year is at least six percent of the
average number of shares outstanding in that class during that
twelve-month period. For this purpose, if a class of shares was
not listed on a recognized stock exchange during this twelve-
month period, the class of shares will be treated as regularly
traded only if the class meets the aggregate trading
requirements for the taxable period in which the income arises.
Trading on one or more recognized stock exchanges may be
aggregated for purposes of meeting the ``regularly traded''
standard of subparagraph (e). For example, a U.S. company could
satisfy the definition of ``regularly traded'' through trading,
in whole or in part, on a recognized stock exchange located in
Finland or certain third countries. Authorized but unissued
shares are not considered for purposes of subparagraph (e).
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 staffs 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 CEO 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 (c) of paragraph 2 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 Finnish company, all the shares of
which are owned by another Finnish company, would qualify for
benefits under the Convention if the principal class of shares
(and any disproportionate classes of shares) of the Finnish
parent company are regularly and primarily traded on the London
stock exchange. However, a Finnish subsidiary would not qualify
for benefits under clause (ii) if the publicly traded parent
company were a resident of Ireland, for example, and not a
resident of the United States or Finland. Furthermore, if a
Finnish parent company indirectly owned a Finnish 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 Finland for the Finnish subsidiary to meet the
test in clause (ii).
Tax-Exempt Organizations--Subparagraph 2(d).--Subparagraphs
2(d) and 2(e) provide rules by which tax-exempt organizations
described in Article 4(1)(c)(i) and pension funds described in
paragraph 7(j) of Article 16 will be entitled to all of the
benefits of the Convention. A tax-exempt organization other
than a tax-exempt pension fund automatically qualifies for
benefits, without regard to the residence of its beneficiaries
or members. Entities qualifying under this subparagraph are
those that are generally exempt from tax in their Contracting
State of residence and that are established and maintained
exclusively to fulfill religious, charitable, scientific,
artistic, cultural, or educational purposes.
Pension Funds--Subparagraph 2(e).--A pension fund will
qualify for benefits if, as of the close of the end of the
prior taxable year, more than 50 percent of the beneficiaries,
members or participants of the pension 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 pension fund. ``Pension
fund'' is defined in subparagraph (j) of paragraph 7 to
include, in the case of the United States, a tax-exempt pension
fund. In the case of Finland, the term ``pension fund''
includes a pension institution, but if such an institution is
organized as a company, only a mutual pension insurance
company.
Ownership/Base Erosion--Subparagraph 2(f).--Subparagraph
2(f) 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 (f), 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(f).
The ownership prong of the test, under clause (i), requires
that 50 percent or more of each class of shares or other
beneficial interests in the person is owned, directly or
indirectly, on at least half the days of the person's taxable
year by persons who are residents of the Contracting State of
which that person is a resident and that are themselves
entitled to treaty benefits under subparagraphs (a), (b), (d),
(e) or clause (i) of subparagraph (c) of paragraph 2. In the
case of indirect owners, however, each of the intermediate
owners must be a resident of that Contracting State.
Trusts may be entitled to benefits under this provision if
they are treated as residents under Article 4 (Residence) 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 the other subparagraphs of
paragraph 2.
The base erosion prong of clause (ii) of subparagraph (f)
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), (d), (e) or
clause (i) of subparagraph (c) of paragraph 2, in the form of
payments deductible for tax purposes in the payer's State of
residence. These amounts do not include arm's-length payments
in the ordinary course of business for services or tangible
property or payments in respect of financial obligations to a
bank that 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
Paragraph 3 sets forth a derivative benefits test that is
potentially applicable to all treaty benefits, although the
test is applied to individual items of income. In general, a
derivative benefits test entitles the resident of a Contracting
State to treaty benefits if the owner of the resident would
have been entitled to the same benefit had the income in
question flowed directly to that owner. To qualify under this
paragraph, the company must meet an ownership test and a base
erosion test.
Subparagraph (a) sets forth the ownership test. Under this
test, seven or fewer equivalent beneficiaries must own shares
representing at least 95 percent of the aggregate voting power
and value of the company and at least 50 percent of any
disproportionate class of shares. Ownership may be direct or
indirect. The term ``equivalent beneficiary'' is defined in
subparagraph (g) of paragraph 7. This definition may be met in
two alternative ways, the first of which has two requirements.
Under the first alternative, a person may be an equivalent
beneficiary because it is entitled to equivalent benefits under
a treaty between the country of source and the country in which
the person is a resident. This alternative has two
requirements.
The first requirement is that the person must be a resident
of a member state of the European Union, a European Economic
Area state, a party to the North American Free Trade Agreement,
or Switzerland (collectively, ``qualifying States'').
The second requirement of the definition of ``equivalent
beneficiary'' is that the person must be entitled to equivalent
benefits under an applicable treaty. To satisfy the second
requirement, the person must be entitled to all the benefits of
a comprehensive treaty between the Contracting State from which
benefits of the Convention are claimed and a qualifying State
under provisions that are analogous to the rules in paragraph 2
of this Article regarding individuals, governmental entities,
publicly-traded companies, and tax-exempt organizations and
pensions. If the treaty in question does not have a
comprehensive limitation on benefits article, this requirement
is met only if the person would be entitled to treaty benefits
under the tests in paragraph 2 of this Article applicable to
individuals, governmental entities, publicly-traded companies,
and tax-exempt organizations and pensions if the person were a
resident of one of the Contracting States.
In order to satisfy the second requirement necessary to
qualify as an ``equivalent beneficiary'' under paragraph
7(g)(i)(B) with respect to insurance premiums, dividends,
interest, royalties or branch tax, the person must be entitled
to a rate of excise, withholding or branch tax that is at least
as low as the excise, withholding or branch tax rate that would
apply under the Convention to such income. Thus, the rates to
be compared are: (1) the rate of tax that the source State
would have imposed if a qualified resident of the other
Contracting State was the beneficial owner of the income; and
(2) the rate of tax that the source State would have imposed if
the third State resident received the income directly from the
source State. For example, USCo is a wholly owned subsidiary of
FCo, a company resident in Finland. FCo is wholly owned by ICo,
a corporation resident in Italy. Assuming FCo satisfies the
requirements of paragraph 3 of Article 10 (Dividends), FCo
would be eligible for the elimination of dividend withholding
tax. The dividend withholding tax rate in the treaty between
the United States and Italy is 5 percent. Thus, if ICo received
the dividend directly from USCo, ICo would have been subject to
a 5 percent rate of withholding tax on the dividend. Because
ICo would not be entitled to a rate of withholding tax that is
at least as low as the rate that would apply under the
Convention to such income (i.e., zero), ICo is not an
equivalent beneficiary within the meaning of paragraph 7(g)(i)
of Article 16 with respect to the elimination of withholding
tax on dividends.
Subparagraph 7(h) provides a special rule to take account
of the fact that withholding taxes on many inter-company
dividends, interest and royalties are exempt within the
European Union by reason of various EU directives, rather than
by tax treaty. If a U.S. company receives such payments from a
Finnish company, and that U.S. company is owned by a company
resident in a member state of the European Union that would
have qualified for an exemption from withholding tax if it had
received the income directly, the parent company will be
treated as an equivalent beneficiary. This rule is necessary
because many European Union member countries have not re-
negotiated their tax treaties to reflect the exemptions
available under the directives.
The requirement that a person be entitled to ``all the
benefits'' of a comprehensive tax treaty eliminates those
persons that qualify for benefits with respect to only certain
types of income. Accordingly, the fact that a French parent of
a Finnish company is engaged in the active conduct of a trade
or business in France and therefore would be entitled to the
benefits of the U.S.-France treaty if it received dividends
directly from a U.S. subsidiary of the Finnish company is not
sufficient for purposes of this paragraph. Further, the French
company cannot be an equivalent beneficiary if it qualifies for
benefits only with respect to certain income as a result of a
``derivative benefits'' provision in the U.S.-France treaty.
However, it would be possible to look through the French
company to its parent company to determine whether the parent
company is an equivalent beneficiary.
The second alternative for satisfying the ``equivalent
beneficiary'' test is available only to residents of one of the
two Contracting States. U.S. or Finnish residents who are
eligible for treaty benefits by reason of subparagraphs (a),
(b), (c)(i), (d), or (e) of paragraph 2 are equivalent
beneficiaries under the second alternative. Thus, a Finnish
individual will be an equivalent beneficiary without regard to
whether the individual would have been entitled to receive the
same benefits if it received the income directly. A resident of
a third country cannot qualify for treaty benefits under any of
those subparagraphs or any other rule of the treaty, and
therefore does not qualify as an equivalent beneficiary under
this alternative. Thus, a resident of a third country can be an
equivalent beneficiary only if it would have been entitled to
equivalent benefits had it received the income directly.
The second alternative was included in order to clarify
that ownership by certain residents of a Contracting State
would not disqualify a U.S. or Finnish company under this
paragraph. Thus, for example, if 90 percent of a Finnish
company is owned by five companies that are resident in member
states of the European Union who satisfy the requirements of
clause (i), and 10 percent of the Finnish company is owned by a
U.S. or Finnish individual, then the Finnish company still can
satisfy the requirements of subparagraph (a) of paragraph 3.
Subparagraph (b) of paragraph 3 sets forth the base erosion
test. A company meets this base erosion test if less than 50
percent of its gross income (as determined in the company's
State of residence) for the taxable period is paid or accrued,
directly or indirectly, to a person or persons who are not
equivalent beneficiaries in the form of payments deductible for
tax purposes in company's State of residence. These amounts do
not include arm's-length payments in the ordinary course of
business for services or tangible property and payments in
respect of financial obligations to a bank that is not related
to the payor. This test is the same as the base erosion test in
clause (ii) of subparagraph (f) of paragraph 2, except that the
test in subparagraph 3(b) focuses on base-eroding payments to
persons who are not equivalent beneficiaries.
Paragraph 4
Paragraph 4 sets forth an alternative test under which a
resident of a Contracting State may receive treaty benefits
with respect to certain items of income that are connected to
an active trade or business conducted in its State of
residence. A resident of a Contracting State may qualify for
benefits under paragraph 4 whether or not it also qualifies
under paragraphs 2 or 3.
Subparagraph (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 from
the other Contracting State. The item of income, however, must
be derived in connection with or incidental to that trade or
business.
The term ``trade or business'' is not defined in the
Convention. Pursuant to paragraph 2 of Article 3 (General
Definitions), when determining whether a resident of Finland is
entitled to the benefits of the Convention under paragraph 4 of
this Article with respect to an item of income derived from
sources within the United States, the United States will
ascribe to this term the meaning that it has under the law of
the United States. Accordingly, the U.S. competent authority
will refer to the regulations issued under section 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 4.
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 FCo,
a company resident in Finland. FCo distributes USCo products in
Finland. Because the business activities conducted by the two
corporations involve the same products, FCo'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 FCo. FCo and other USCo affiliates then manufacture
and market the USCo-designed products in their respective
markets. Because the activities conducted by FCo 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. FSub is a
wholly-owned subsidiary of Americair resident in Finland. FSub
operates a chain of hotels in Finland that are located near
airports served by Americair flights. Americair frequently
sells tour packages that include air travel to Finland and
lodging at FSub 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 FSub's business does
not form a part of Americair's business. However, FSub'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 FSub owns an office building in Finland instead of a hotel
chain. No part of Americair's business is conducted through the
office building. FSub'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 company resident in the United
States. USFlower produces and sells flowers in the United
States and other countries. USFlower owns all the shares of
FHolding, a corporation resident in Finland. FHolding is a
holding company that is not engaged in a trade or business.
FHolding owns all the shares of three corporations that are
resident in Finland: FFlower, FLawn, and FFish. FFlower
distributes USFlower flowers under the USFlower trademark in
Finland. FLawn markets a line of lawn care products in Finland
under the USFlower trademark. In addition to being sold under
the same trademark, FLawn and FFlower products are sold in the
same stores and sales of each company's products tend to
generate increased sales of the other's products. FFish imports
fish from the United States and distributes it to fish
wholesalers in Finland. For purposes of paragraph 4, the
business of FFlower forms a part of the business of USFlower,
the business of FLawn is complementary to the business of
USFlower, and the business of FFish 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 (b) of paragraph 4 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. In any case,
in making each determination or comparison, due regard will be
given to the relative sizes of the U.S. and Finnish economies.
The determination in subparagraph (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 4, 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, Finnish pharmaceutical
manufacturer, the size of the U.S. research firm would not have
to be tested against the size of the Finnish manufacturer.
Similarly, a small U.S. bank that makes a loan to a very large
unrelated Finnish business would not have to pass a
substantiality test to receive treaty benefits under Paragraph
4.
Subparagraph (c) of paragraph 4 provides special
attribution rules for purposes of applying the substantive
rules of subparagraphs (a) and (b). Thus, 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
fifty percent or more of the beneficial interest in both X and
Y. For this purpose, if X or Y is a company, the threshold
relationship with respect to such company or companies is fifty
percent or more of the aggregate voting power and value or
fifty percent or more of the beneficial equity interest.
Finally, X is connected to Y if, based upon all the facts and
circumstances, X controls Y, Y controls X, or X and Y are
controlled by the same person or persons.
Paragraph 5
Paragraph 5 deals with the treatment of insurance premiums,
royalties and interest in the context of a so-called
``triangular case.''
The term ``triangular case'' refers to the use of the
following structure by a resident of Finland to earn, in this
case, interest income from the United States. The resident of
Finland, who is assumed to qualify for benefits under one or
more of the provisions of Article 16 (Limitation on Benefits),
sets up a permanent establishment in a third jurisdiction that
imposes only a low rate of tax on the income of the permanent
establishment. The Finnish 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 Finnish 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 Finnish income tax treaty with the
host jurisdiction of the permanent establishment, the income of
the permanent establishment is exempt from Finnish tax. Thus,
the interest income is exempt from U.S. tax, is subject to
little tax in the host jurisdiction of the permanent
establishment, and is exempt from Finnish tax.
Because 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, the paragraph
only applies with respect to U.S. source insurance premiums,
interest, or royalties that are attributable to a third-
jurisdiction permanent establishment of a Finnish resident.
Paragraph 5 replaces the otherwise applicable rules in the
Convention for insurance premiums, interest and royalties with
a 15 percent withholding taxfor interest and royalties and U.S.
domestic law rules for insurance premiums if the actual tax
paid on the income in the third state is less than 60 percent
of the tax that would have been payable in Finland if the
income were earned in Finland by the enterprise and were not
attributable to the permanent establishment in the third state.
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 interest (as
defined in Article 11 (Interest)), paragraph 5 will not apply
if the interest 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. 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.
Paragraph 6
Paragraph 6 provides that a resident of one of the States
that is not entitled to the benefits of the Convention as a
result of paragraphs 1 through 5 still may be granted benefits
under the Convention at the discretion of the competent
authority of the State from which benefits are claimed. In
making determinations under paragraph 6, that competent
authority will take into account as its guideline 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 the Convention
or the 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 Convention. 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 6.
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 4.
Further, the competent authority may establish conditions, such
as setting time limits on the duration of any relief granted.
For purposes of implementing paragraph 6, 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.
A competent authority is required by paragraph 6 to consult
the other competent authority before denying benefits under
this paragraph.
Paragraph 7
Paragraph 7 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 VII
Paragraph (a) amends Article 23 of the convention by
deleting paragraph (1)(c), which provided that, regardless of
any other provision of the Treaty, Finland could tax an
individual Finnish national who is a resident of the United
States, and who, under Finnish taxation laws, is also a
resident of Finland. Due to changes in Finland's domestic tax
laws, such a provision is no longer required.
Paragraph (b) makes conforming changes to Article 23 to
reflect the amendments made to the saving clause of paragraph 4
Article 1 (Personal Scope) and to reflect amendments to section
877 of the Code in 1996.
Paragraph (c) amends paragraph 4, which sets forth the
source of income rules applicable for purposes of allowing
relief under Article 23. Prior to amendment, the source rules
of paragraph 4 were subject to such source rules in the
domestic laws of the Contracting States as applied for the
purpose of limiting the foreign tax credit. Paragraph (c) of
Article VII of the Protocol removes this limitation in order to
ensure that the source rules set out in paragraph 4 of Article
23 have their intended effect.
ARTICLE VIII
Article VIII replaces Article 26 (Exchange of Information)
of the Convention. This Article provides for the exchange of
information and administrative assistance between the competent
authorities of the Contracting States.
Paragraph 1
The obligation to obtain and provide information to the
other Contracting State is set out in Paragraph 1. The
information to be exchanged is that which may be relevant for
carrying out the provisions of the Convention or the domestic
laws of the United States or Finland 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.'' 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
admissibility.'' 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 tax law is authorized to the extent that taxation
under domestic tax 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
Contracting 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 Finland 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
Finland, value added taxes.
Information exchange is not restricted by Article 1
(Personal 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 Finland,
which 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 Finland, 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 Finland 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 26. 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
Paragraph 2 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 unedited
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 3
Paragraph 3 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 Contracting 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 4
Paragraph 4 provides that the obligations undertaken in
paragraphs 1 and 3 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
Contracting State. Nor is a Contracting State required to
supply information not obtainable under the laws or
administrative practice of either Contracting State, or to
disclose trade secrets or other information, the disclosure of
which would be contrary to public policy.
Thus, a requesting Contracting State may be denied
information from the other Contracting State if the information
would be obtained pursuant to procedures or measures that are
broader than those available in the requesting Contracting
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 4 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 5
Paragraph 5 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 other 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 4(a) prevents the requested State from obtaining
information from a bank or fiduciary that the requested State
does not need for its own tax purposes. This paragraph
clarifies that paragraph 4 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 6
Paragraph 6 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 6 would
effectively prevent a Contracting State from relying on
paragraph 4 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 exception does not include information that would
reveal confidential communications between a client and an
attorney, solicitor, or other legal representative, where the
client seeks legal advice. In the case of the United States,
the scope of the privilege for such confidential communications
is coextensive with the attorney-client privilege under U.S.
law. Paragraph 6 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 7
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 Finland 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.
Efective dates and termination in relation to exchange of information
Once the Protocol is in force, the competent authority may
seek information under Article 26 as amended by the Protocol
with respect to a year prior to the entry into force of the
Protocol, even if Article 26 of the Convention prior to its
amendment by the Protocol was in effect during the years in
which the transaction at issue occurred.
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 VIII
Article VIII of the Protocol contains the rules for
bringing the Protocol into force and giving effect to its
provisions.
Paragraph 1 provides for the ratification of the Convention
by both Contracting States and the exchange of instruments of
ratification as soon as possible thereafter. The Protocol shall
enter into force upon the exchange of instruments of
ratification.
In the United States, the process leading to ratification
and entry into force is as follows: Once a protocol or treaty
has been signed by authorized representatives of the two
Contracting States, the Department of State sends the protocol
or 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 of the Senate Committee on Foreign Relations to hold
hearings on the protocol or 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
protocol or treaty, an instrument of ratification is drafted
for the President's signature. The President's signature
completes the process in the United States.
The date on which a treaty enters into force is not
necessarily the date on which its provisions take effect.
Paragraph 2 contains rules that determine when the provisions
of the treaty will have effect.
Under subparagraphs (a)(i) and (b)(i), the provisions of
the Protocol relating to taxes withheld at source will have
effect with respect to amounts paid or credited (or in the case
of Finland, income derived) on or after the first day of the
second month next following the date on which the Protocol
enters into force. For example, if instruments of ratification
are exchanged on April 25 of a given year, the withholding
rates specified in paragraph 2 of Article 10 (Dividends) would
be applicable to any dividends paid or credited on or after
June 1 of that year. Similarly, the revised Limitation on
Benefits provisions of Article VI of the Protocol would apply
with respect to any payments of interest, royalties or other
amounts on which withholding would apply under the Code if
those amounts are paid or credited on or after June 1.
This rule allows the benefits of the withholding reductions
to be put into effect as soon as possible, without waiting
until the following year. The delay of one to two months is
required to allow sufficient time for withholding agents to be
informed about the change in withholding rates. If for some
reason a withholding agent withholds at a higher rate than that
provided by the Convention (perhaps because it was not able to
re-program its computers before the payment is made), a
beneficial owner of the income that is a resident of Finland
may make a claim for refund pursuant to section 1464 of the
Code.
For all other taxes, subparagraphs (a)(ii) and (b)(ii)
specify that the Protocol will have effect for any taxable
period beginning on or after January 1 of the year next
following entry into force.
In both Contracting States, provisions of the Protocol
relating to taxes withheld at source covered by paragraph 3 of
Article 10 (Dividends) will have effect with respect to income
derived on or after January 1, 2007, provided that the Protocol
enters into force before December 31, 2007. The relevant date
for this purpose is the date on which income from the dividend
is derived by the beneficial owner, rather than to the date on
which the income was originally derived by the company paying
the dividend. The phrase ``income derived'' was used because it
is compatible with the standard for inclusion of income under
Finnish tax law. It is intended to have a meaning similar to
the phrase ``income paid or credited,'' a standard more
commonly used in U.S. tax treaties. Thus, provided the Protocol
enters into force prior to December 31, 2007, the provisions of
the Protocol eliminating withholding on companies and pension
funds meeting the requirement of paragraph 3 of Article 10
(Dividends) will have effect with respect to income derived
from dividends paid or accrued on or after January 1, 2007.