[Senate Executive Report 110-3]
[From the U.S. Government Publishing Office]



110th Congress                                              Exec. Rept.
                                 SENATE
 1st Session                                                      110-3

======================================================================



 
                   PROTOCOL AMENDING TAX CONVENTION 
                              WITH DENMARK

                                _______
                                

                November 14, 2007.--Ordered to be printed

                                _______
                                

          Mr. Biden, from the Committee on Foreign Relations,
                        submitted the following

                                 REPORT

                   [To accompany Treaty Doc. 109-19]

    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 Kingdom 
of Denmark for the Avoidance of Double Taxation and the 
Prevention of Fiscal Evasion with Respect to Taxes on Income, 
signed at Copenhagen on May 2, 2006 (the ``Protocol'') (Treaty 
Doc. 109-19), 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................................3
  V. Implementing Legislation.........................................4
 VI. Committee Action.................................................4
VII. Committee Reccommendation and Comments...........................4
VIII.Resolution of Advice and Consent to Ratification.................4

 IX. Annex.--Technical Explanation....................................5

                               I. Purpose

    The proposed Protocol to the existing income tax treaty 
between the United States and Denmark is intended to promote 
closer cooperation and further facilitate trade and investment 
between the United States and Denmark. The Protocol's principal 
objectives are to eliminate the withholding tax on 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 Denmark to bring it into closer conformity with 
U.S. tax treaty law and policy.

                             II. Background

    The Protocol was signed on May 2, 2006. On the same day, 
the United States and the Kingdom of Denmark exchanged notes to 
confirm certain understandings with respect to the application 
of the Protocol. The Protocol, accompanied by an exchange of 
notes, amends the Convention between the Government of the 
United States of America and the Government of the Kingdom of 
Denmark for the Avoidance of Double Taxation and the Prevention 
of Fiscal Evasion with Respect to Taxes on Income, signed at 
Washington on August 19, 1999, together with a Protocol (the 
``1999 Convention'') (Treaty Doc. 106-12; Exec. Rept. 106-9). 
The 1999 Convention replaced an older income tax treaty 
concluded in 1948 between the United States and Denmark.

                         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-46-
07 (July 17, 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 1999 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 share capital 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 of the subsidiary for the 
12-month period ending on the date entitlement to the dividend 
is determined. By contrast, the 1999 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 22(2)(e) 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 1999 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. These rules will also apply with respect to dividends 
from Danish corporations determined by agreement of the 
competent authorities to be similar to U.S. RICs and REITs.

2. Limitation on Benefits

    The 1999 Convention already contains a ``Limitation on 
Benefits'' provision (Article 22), 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 includes a requirement to determine whether a 
company's public trading or management constitutes an adequate 
connection to its country of residence in either the United 
States or Denmark, in order to prevent certain companies that 
are not adequately connected from qualifying for treaty 
benefits.

3. Scope

    The Protocol updates Article 1 of the 1999 Convention 
(General Scope) in order to reflect subsequent changes in U.S. 
tax law. Paragraph 4 of Article 1 of the 1999 Convention 
provides that, with the exception of certain benefits listed 
under paragraph 5 of Article 1, 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.

                 IV. Entry Into Force; Effective Dates

    The United States and Denmark shall notify each other when 
the requirements for entry into force have been complied with 
and in accordance with Article V, the Protocol will enter into 
force upon the date of the receipt of the later of such 
notifications. The Protocol's provisions shall have effect with 
respect to taxes withheld at source, on 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 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.

                      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 Recommendation and Comments

    The Committee on Foreign Relations believes that the 
Protocol will stimulate increased investment, further 
strengthen the provision in the 1999 Convention that prevents 
treaty shopping, and promote closer cooperation and facilitate 
trade and investment between the United States and Denmark. 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 Protocol was considered by the committee on October 31, 
2007, along with three other tax treaties: (1) The Protocol 
Amending Tax Convention with Finland (Treaty Doc. 109-18); (2) 
The Protocol Amending Tax Convention with Germany (Treaty Doc. 
109-20); and (3) The Tax Convention with Belgium (Treaty Doc. 
110-3). In the committee's report regarding the Protocol 
Amending Tax Convention with Finland, also filed this day, the 
committee set forth comments on two issues, which are also 
relevant here.
    First, the committee suggested that the Treasury Department 
consider sharing the Technical Explanation it develops with its 
treaty partners, prior to its public release. Second, the 
committee encouraged the Treasury Department to further 
strengthen anti-treaty-shopping provisions in tax treaties 
whenever possible, with a particular focus on closing the 
loophole created by those U.S. tax treaties currently in force 
that do not have an anti-treaty-shopping provision. A detailed 
discussion regarding these issues can be found in Section VII 
of the committee's report regarding the Protocol Amending Tax 
Convention with Finland (Exec. Rept. 110-4).

     VIII. Text of 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 
Kingdom of Denmark for the Avoidance of Double Taxation and the 
Prevention of Fiscal Evasion with Respect to Taxes on Income, 
signed at Copenhagen on May 2, 2006 (Treaty Doc. 109-19).

                   IX. Annex.--Technical Explanation


DEPARTMENT OF THE TREASURY TECHNICAL EXPLANATION OF THE PROTOCOL SIGNED 
   AT COPENHAGEN ON MAY 2, 2006 AMENDING THE CONVENTION BETWEEN THE 
 GOVERNMENT OF THE UNITED STATES OF AMERICA AND THE GOVERNMENT OF THE 
    KINGDOM OF DENMARK FOR THE AVOIDANCE OF DOUBLE TAXATION AND THE 
PREVENTION OF FISCAL EVASION WITH RESPECT TO TAXES ON INCOME SIGNED AT 
                     WASHINGTON ON AUGUST 19, 1999

    This is a technical explanation of the Protocol signed at 
Copenhagen on May 2, 2006 (the ``Protocol''), amending the 
Convention between the United States of America and the 
Government of Denmark for the avoidance of double taxation and 
the prevention of fiscal evasion with respect to taxes on 
income, signed at Washington on August 19, 1999 (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 paragraph 4 of Article 1 
(General Scope) of the Convention, which 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 
Denmark 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 Denmark 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 
Denmark.
    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 Denmark 
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.

                               ARTICLE II

    Article II 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 shares 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 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 
4(1)(d) (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, with respect to qualified governmental 
entities, 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 stock 
owned both 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 22 (Limitation of 
Benefits). Accordingly, a company that meets the holding 
requirements described above will qualify for the benefits of 
paragraph 3 only if it also: (1) meets the ``publicly traded'' 
test of subparagraph 2(c) of Article 22 (Limitation of 
Benefits), (2) meets the ``ownership-base erosion'' and 
``active trade or business'' tests described in subparagraph 
2(f) and paragraph 4 of Article 22 (Limitation of Benefits), 
(3) meets the ``derivative benefits'' test of paragraph 3 of 
Article 22 (Limitation of 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 7 of 
Article 22 (Limitation of Benefits).
    These restrictions are necessary because of the increased 
pressure on the Limitation of Benefits tests resulting from the 
fact that the United States has relatively few treaties that 
provide for such elimination of withholding tax on inter-
company dividends. The additional restrictions are intended to 
prevent companies from re-organizing in order to become 
eligible for the elimination of withholding tax in 
circumstances where the Limitation of Benefits provision does 
not provide sufficient protection against treaty-shopping.
    For example, assume that ThirdCo is a company resident in a 
third country that does not have a tax treaty with the United 
States providing for the elimination of withholding tax on 
inter-company dividends. ThirdCo owns directly 100 percent of 
the issued and outstanding voting stock of USCo, a U.S. 
company, and of DCo, a Danish company. DCo is a substantial 
company that manufactures widgets; USCo distributes those 
widgets in the United States. If ThirdCo contributes to DCo all 
the stock of USCo, dividends paid by USCo to DCo would qualify 
for treaty benefits under the active trade or business test of 
paragraph 4 of Article 22. 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 DCo to meet the ownership-base erosion requirements 
of subparagraph 2(f) of Article 22 in addition to the active 
trade or business test of paragraph 4 of Article 22. Thus, DCo 
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 Denmark and eligible for treaty benefits under 
certain specified tests and (ii) less than 50 percent of DCo'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 DCo is wholly owned by a 
third country resident, DCo 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, DCo would need to qualify under another 
test or obtain discretionary relief from the competent 
authority under Article 22(7). 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. In the case of 
companies resident in Denmark, this includes companies that are 
more than 50 percent owned by one or more taxable nonstock 
corporations entitled to benefits under Article 22(2)(g). Thus, 
a company that is a resident of Denmark and that meets the 
requirements of Article 22(2) (i), (ii) or (iii) 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 22. Thus, a 
Danish 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 Danish 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 Danish 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 (i) of paragraph 8 of Article 22, that 
directive will also be taken into account in determining 
whether the owner of a U.S. company receiving dividends from a 
Danish 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 Danish company. For example, assume 
USCo is a wholly-owned subsidiary of ICo, an Italian publicly-
traded company. USCo owns all of the shares of DCo, a Danish 
company. If DCo were to pay dividends directly to ICo, those 
dividends would be exempt from withholding tax in Denmark by 
reason of the Parent-Subsidiary Directive. If ICo meets the 
other conditions of subparagraph 8(h) of Article 22, it will be 
treated as an equivalent beneficiary by reason of subparagraph 
8(i) 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 Danish 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 Danish corporate joint venture vehicles 
that are closely-held by a few Danish resident individuals.
    Subparagraph (h) of paragraph 8 of Article 22 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 DCo, a Danish company, which in turn is owned 
49 percent by PCo, a Danish 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 DCo. 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 DCo in this case.
    Consequently, when determining whether a person is an 
equivalent beneficiary under paragraph 8 of Article 22, each of 
the shareholders is treated as owning shares with the same 
percentage of voting power as the shares held by DCo 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 7 of Article 22. 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. The Notes provide that the U.S. competent 
authority generally will exercise its discretion to grant 
benefits under this paragraph to a company that is a resident 
of Denmark if (1) the company meets the requirements of 
paragraph 4 of Article 22 (Limitation of Benefits) regarding 
the active conduct of a trade or business in Denmark, (2) the 
company meets the base erosion test of clause (f)(ii) of 
paragraph 2 of Article 22, and (3) more than 80 percent of the 
voting power and the value of the shares in the company is 
owned by one or more taxable nonstock corporations that meet 
the requirements of subparagraph (g) of paragraph 2 of Article 
22. However, the competent authority may choose not to grant 
benefits under this paragraph if it determines that a 
significant percentage or amount of the income qualifying for 
benefits under this paragraph will inure to the benefit of a 
private person who is not a resident of Denmark.
    Subparagraph (b) of paragraph 3 of Article 10 of the 
Convention provides for exemption from tax in the state of 
source for dividends paid to qualified governmental entities. 
This exemption is analogous to that provided to foreign 
governments under section 892 of the Code. Subparagraph (b) of 
paragraph 3 makes that exemption reciprocal. A qualified 
governmental entity is defined in paragraph 1(i) of Article 3 
(General Definitions) of the Convention. The definition does 
not include a governmental entity that carries on commercial 
activity. Further, a dividend paid by a company engaged in 
commercial activity that is controlled (within the meaning of 
Treas. Reg. section 1.892-5T) by a qualified governmental 
entity that is the beneficial owner of the dividend is not 
exempt at source under paragraph 4 because ownership of a 
controlled company is viewed as a substitute for carrying on a 
business activity.
    Subparagraph (c) of paragraph 3 of Article 10 of the 
Convention provides that dividends beneficially owned by a 
pension fund described in subparagraph (e) of paragraph 2 of 
Article 22 (Limitation of Benefits) 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 subparagraphs 3 (b) and (c) 
applies to dividends paid by RICs and beneficially owned by a 
qualified governmental entity or 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 subparagraphs 3 (b) and (c) applies to 
dividends paid by REITs and beneficially owned by a qualified 
governmental entity or 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 Denmark 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 Denmark 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.
    The final sentence of paragraph 4(a) provides that the 
rules of paragraph 4 apply also to dividends paid by companies 
resident in Denmark that are similar to U.S. RICs and REITs. 
Whether a Danish company is similar to a U.S. RIC or REIT will 
be determined by mutual agreement of the competent authorities. 
The Notes provide that for purposes of paragraph 4, a Danish 
undertaking for collective investment in transferable 
securities that is required to currently distribute its income 
will be treated as a company similar to a U.S. RIC, while such 
an undertaking that is permitted to accumulate its income will 
not be so treated.

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, 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.
    The paragraph also restricts the right of a Contracting 
State to impose corporate level taxes on undistributed profits, 
other than a branch profits tax. The paragraph does not 
restrict a State's right to tax its resident shareholders on 
undistributed earnings of a corporation resident in the other 
State. Thus, the authority of the United States to impose taxes 
on subpart F income and on earnings deemed invested in U.S. 
property, and its tax on income of a passive foreign investment 
company that is a qualified electing fund is in no way 
restricted by this provision.

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(b) 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 Real Property), or realizes 
gains taxable in that State under paragraph 1 of Article 13 
(Capital Gains). In the case of the United States, the 
imposition of such tax is limited, however, to the portion of 
the aforementioned items of income that represents the amount 
of such income that is the ``dividend equivalent amount.'' This 
is consistent with the relevant rules under the U.S. branch 
profits tax, and the term dividend equivalent amount is defined 
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 Real Property), 7 (Business Profits) or 13 
(Capital 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. Denmark currently does not impose a branch 
profits tax. If in the future Denmark were to impose a branch 
profits tax, paragraph 8 provides that the base of its tax must 
be 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 22 (Limitation of Benefits), (2) meets the ``ownership-
base erosion'' and ``active trade or business'' tests described 
subparagraph 2(f) and subparagraph 4 of Article 22, (3) meets 
the ``derivative benefits'' test of paragraph 3 of Article 22, 
or (4) is granted benefits with respect to the elimination of 
the branch profits tax by the competent authority pursuant to 
paragraph 7 of Article 22.
    Thus, for example, if a Danish 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 
Danish 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 Danish company is granted 
benefits with respect to the elimination of the branch profits 
tax by the competent authority pursuant to paragraph 7 of 
Article 22.

Relation to Other Articles

    Notwithstanding the foregoing limitations on source country 
taxation of dividends, the saving clause of paragraph 4 of 
Article 1 (General Scope) permits the United States to tax 
dividends received by its residents and citizens, subject to 
the special foreign tax credit rules of paragraph 2 of Article 
23 (Relief From Double Taxation), as if the Convention had not 
come into effect.
    The benefits of this Article are also subject to the 
provisions of Article 22 (Limitation of Benefits). Thus, if a 
resident of Denmark 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 22 in order 
to receive the benefits of this Article.

                              ARTICLE III

    Article III of the Protocol amends subparagraph (b) of 
paragraph 2 of Article 19 (Government Service) of the 
Convention to correct a drafting error. Paragraph 2(a) provides 
a general rule that a pension paid from public funds of a 
Contracting State or a political subdivision or local authority 
thereof to an individual in respect of services rendered to 
that State or subdivision or authority in the discharge of 
governmental functions is taxable only in that State. Paragraph 
2(b) provides an exception under which the pension is taxable 
only in the other State if the individual is a resident of and 
a national of that other State. Before this amendment, 
paragraph 2(b) incorrectly referred to pensions paid to ``a 
resident or a national'' rather than pensions paid to ``a 
resident and a national.''

                               ARTICLE IV

    Article IV of the Protocol replaces Article 22 (Limitation 
of Benefits) of the Convention. Article 22 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 for limited derivative benefits for 
shipping and air transport income. Paragraph 6 provides special 
rules for so-called ``triangular cases'' notwithstanding 
paragraphs 1 through 5 of Article 22. Paragraph 7 provides that 
benefits may also be granted if the competent authority of the 
State from which the benefits are claimed determines that it is 
appropriate to grant benefits in that case. Paragraph 8 defines 
certain terms used in the Article.

Paragraph 1

    Paragraph 1 provides that a resident of a Contracting State 
will be entitled to 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 21, the treaty-
based relief from double taxation provided by Article 23 
(Relief From 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 (Diplomatic Agents and Consular 
Officers) applies to diplomatic agents or consular officials 
regardless of residence. Article 22 accordingly does not limit 
the availability of treaty benefits under such provisions.
    Article 22 and the anti-abuse provisions of domestic law 
complement each other, as Article 22 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 22 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 seven subparagraphs, each of which 
describes a category of residents that are entitled to all 
benefits of the Convention.
    It is intended that the provisions of paragraph 2 will be 
self-executing. Unlike the provisions of paragraph 7, discussed 
below, claiming benefits under paragraph 2 does not require 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 or 
local authority thereof, or an agency or instrumentality of 
that State, subdivision, or authority will be entitled to all 
the benefits of the Convention.
    Publicly-Traded Corporations--Subparagraph 2(c)(i).--
Subparagraph (c) applies to two categories of companies: 
publicly traded companies and subsidiaries of publicly traded 
companies. A company resident in a Contracting State is 
entitled to all the benefits of the Convention under clause (i) 
of subparagraph (c) if the principal class of its shares, and 
any disproportionate class of shares, is regularly traded on 
one or more recognized stock exchanges and the company 
satisfies at least one of the following additional 
requirements: first, the company's principal class of shares is 
primarily traded on 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 Denmark, 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 8. It includes the NASDAQ System, 
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 Copenhagen Stock 
Exchange. The term also includes the stock exchanges of 
Amsterdam, Brussels, Frankfurt, Hamburg, Helsinki, London, 
Oslo, Paris, Stockholm, Sydney, Tokyo, and Toronto, 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 8 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 8 
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 8. 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 Denmark meets the test of 
subparagraph (b) of paragraph 8 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.--DCo is a corporation resident in Denmark. DCo has 
two classes of shares: Common and Preferred. The Common shares 
are listed and regularly traded on the Stockholm Stock 
Exchange. The Preferred shares have no voting rights and are 
entitled to receive dividends equal in amount to interest 
payments that DCo 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 DCo 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 DCo, the Preferred 
shares are a disproportionate class of shares. Because the 
Preferred shares are not regularly traded on a recognized stock 
exchange, DCo will not qualify for benefits under subparagraph 
(c) of paragraph 2.
    A class of shares will be ``regularly traded'' on one or 
more recognized stock exchanges in a taxable year, under 
subparagraph (f)(i) of paragraph 8, if two requirements are 
met: (1) trades in the class of shares are effected on one or 
more such exchanges in other than de minimis quantities during 
every quarter, and (2) the aggregate number of shares of that 
class traded on one or more such 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 (including shares held by taxable 
nonstock corporations) 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 (f). 
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 Denmark or certain third 
countries. Authorized but unissued shares are not considered 
for purposes of subparagraph (f).
    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 Danish Taxable Nonstock Corporations--
Subparagraph 2(c)(ii).--Clause (ii) of subparagraph 2(c) 
provides a test under which certain companies that are 
controlled by one or more taxable nonstock corporations 
(``TNCs'') entitled to benefits under subparagraph (g) may meet 
the publicly-traded test. This test is necessary because it is 
common for a TNC to hold 100% of the ``Class A'' shares of 
another company. The Class A shares have a disproportionate 
amount of the voting power but have little or no rights to 
dividends. The subsidiary company also issues ``Class B'' 
shares, which have preferential treatment as to dividends. 
Class A shares held by TNCs are listed but not traded on the 
Copenhagen stock exchange. Any class A shares that are not held 
by TNCs and all Class B shares are both listed and traded on 
the Copenhagen stock exchange. This rule is included to ensure 
that a corporation whose voting shares are substantially owned 
by a Danish TNC is not precluded from qualifying as a publicly-
traded company, so long as the rest of its shares satisfy a 
public trading test.
    A company will qualify under this test if one or more such 
TNCs own shares representing more than 50 percent of the voting 
power of the company and all other shares are listed on a 
recognized stock exchange and are primarily traded on a 
recognized stock exchange located within the European Union or 
in any other European Economic Area state. Thus, all shares not 
owned by TNCs, taken as a single class, must be traded more on 
a recognized stock exchange located in a state within the 
European Union or in any other European Economic Area state 
than on established securities markets in any other single 
foreign state.
    Subsidiaries of Publicly-Traded Corporations--Subparagraph 
2(c)(iii).--A company resident in a Contracting State is 
entitled to all the benefits of the Convention under clause 
(iii) of subparagraph (c) of paragraph 2 if five or fewer 
companies entitled to benefits under clause (i) or (ii) (or any 
combination thereof) 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 companies are 
indirect owners, however, each of the intermediate companies 
must be a resident of one of the Contracting States.
    Thus, for example, a Danish company, all the shares of 
which are owned by another Danish company, would qualify for 
benefits under the Convention if the principal class of shares 
(and any disproportionate classes of shares) of the Danish 
parent company are regularly and primarily traded on the London 
stock exchange. However, a Danish subsidiary would not qualify 
for benefits under clause (iii) if the publicly traded parent 
company were a resident of Ireland, for example, and not a 
resident of the United States or Denmark. Furthermore, if a 
Danish parent company indirectly owned a Danish 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 Denmark for the Danish subsidiary to meet the test in clause 
(iii).
    Tax-Exempt Organizations--Subparagraph 2(d).--Subparagraphs 
2(d) and 2(e) provide rules by which tax-exempt organizations 
described in Article 4(1)(b)(i) and pension funds will be 
entitled to all of the benefits of the Convention. A tax-exempt 
organization other than a pension fund automatically qualifies 
for benefits, without regard to the residence of its 
beneficiaries or members. Entities qualifying under this 
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, 
educational, scientific, or other similar purposes.
    Pensions--Subparagraph 2(e).--A legal person, whether tax-
exempt or not, that is organized under the laws of either 
Contracting State to provide pension or similar benefits to 
employees (including self-employed individuals) pursuant to a 
plan will qualify for benefits if, as of the close of the end 
of the prior taxable year, more than 50 percent of the 
pension's beneficiaries, members or participants 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.
    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.
    Danish Taxable Nonstock Corporations--Subparagraph 2(g).--
Paragraph 2(g) provides a special rule for a Danish Taxable 
Nonstock Corporation (``TNC''), which is a vehicle to preserve 
control of operating companies by the TNC through its control 
of voting shares, with public shareholders receiving most 
rights to dividends of the operating company. A TNC may qualify 
for the benefits of the Convention if it meets specific 
requirements under a two-part test.
    Under subparagraph 8(e), the term ``taxable nonstock 
corporation'' as used in paragraph 2 means a foundation that is 
taxable in accordance with paragraph 1 of Article 1 of the 
Danish Act on Taxable Nonstock Corporations (fonde der 
beskattes efter fondsbeskatningsloven). A TNC is a legal person 
that is controlled by a professional board of directors, the 
majority of which must be unrelated to the persons that founded 
the TNC. As a foundation, a TNC must have a charter governing 
the corporation's operations and identifying any TNC 
beneficiaries and their entitlement to distributions from the 
TNC. One TNC cannot own another. A TNC's capital is irrevocably 
separated from the control of any person (``founder'') 
contributing assets to the TNC at the time the TNC is 
established. A TNC's assets can never be inherited nor can such 
assets be paid out in liquidation except to creditors. TNCs are 
subject to income tax at the same rate (32%) and in exactly the 
same way as Danish corporations, except that a TNC can deduct 
charitable contributions, whereas a regular Danish corporation 
cannot deduct them, and a TNC, like any other foundation, can 
deduct distributions to members of the founder's family 
provided that these family members are resident in Denmark and 
are taxable in Denmark at the full rate, which is from 45% to 
59%. Distributions to other persons, e.g., Danish nonresidents, 
are not deductible.
    The two-part test in subparagraph (g) is a modification of 
the ownership-base erosion test that is necessary because TNCs 
do not have owners and thus cannot be subject to any ownership 
test. This test was included for TNCs in order to treat them as 
similarly as possible to other Danish corporations.
    The first part of the test under subparagraph (g)(i) is 
satisfied if no more than 50 percent of the amount of the TNC's 
gross income (excluding its tax-exempt income) is paid or 
accrued in the form of deductible payments (but not including 
arms-length payments in the ordinary course of its activities 
of a charitable nature and authorized by the Danish laws on 
taxable non-stock companies for services or tangible property) 
in the taxable year and in each of the preceding three taxable 
years, directly or indirectly, to persons who are not entitled 
to benefits under subparagraphs (a), (b), (d), (e), or clause 
(i) of subparagraph (c). This means that no more than 50 
percent of the amount of the TNC's gross income (excluding its 
tax-exempt income) can be paid to persons other than residents 
of either Contracting State that qualify for treaty benefits as 
an individual (subparagraph (a)), a Contracting State, etc. 
(subparagraph (b)), a company that is publicly traded 
(subparagraph (c)(i)), a charitable organization, etc. 
(subparagraph (d)), or a pension plan (subparagraph e).
    The second part of the test under subparagraph (g)(ii) is 
satisfied if no more than 50% of the amount of the total income 
of the TNC (including its tax-exempt income) is paid or 
accrued, in the form of deductible payments (but not including 
arm's length payments in the ordinary course of its activities 
of a charitable nature and authorized by the Danish laws on 
taxable non-stock companies for services or tangible 
properties) and non-deductible distributions, in the taxable 
year and in each of the preceding three taxable years, directly 
or indirectly, to persons who are not entitled to benefits 
under subparagraphs (a), (b), (d), (e), or clause (i) of 
subparagraph (c).

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 (h) of paragraph 8. 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, 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, 
tax-exempt organizations, and pensions if the person were a 
resident of one of the Contracting States.
    In order to satisfy the second requirement to qualify as an 
``equivalent beneficiary'' under paragraph 8(h)(i)(B) with 
respect to dividends, interest, royalties, or branch tax, the 
person must also be entitled to a rate of withholding or branch 
tax that is at least as low as the 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 DCo, a company resident in Denmark. DCo is 
wholly owned by ICo, a corporation resident in Italy. Assuming 
DCo satisfies the requirements of paragraph 3 of Article 10 
(Dividends), DCo 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 
8(h)(i) of Article 22 with respect to the elimination of 
withholding tax on dividends.
    Subparagraph 8(i) 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 
Danish 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 Danish 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 Danish 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 Danish 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 Danish 
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 Danish company under this 
paragraph. Thus, for example, if 90 percent of a Danish 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 Danish company is owned by a U.S. or 
Danish individual, then the Danish 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 Denmark 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 DCo, 
a company resident in Denmark. DCo distributes USCo products in 
Denmark. Because the business activities conducted by the two 
corporations involve the same products, DCo'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 DCo. DCo and other USCo affiliates then manufacture 
and market the USCo-designed products in their respective 
markets. Because the activities conducted by DCo 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. DSub is a 
wholly-owned subsidiary of Americair resident in Denmark. DSub 
operates a chain of hotels in Denmark that are located near 
airports served by Americair flights. Americair frequently 
sells tour packages that include air travel to Denmark and 
lodging at DSub 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 DSub's business does 
not form a part of Americair's business. However, DSub'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 DSub owns an office building in Denmark instead of a hotel 
chain. No part of Americair's business is conducted through the 
office building. DSub'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 
DHolding, a corporation resident in Denmark. DHolding is a 
holding company that is not engaged in a trade or business. 
DHolding owns all the shares of three corporations that are 
resident in Denmark: DFlower, DLawn, and DFish. DFlower 
distributes USFlower flowers under the USFlower trademark in 
Denmark. DLawn markets a line of lawn care products in Denmark 
under the USFlower trademark. In addition to being sold under 
the same trademark, DLawn and DFlower products are sold in the 
same stores and sales of each company's products tend to 
generate increased sales of the other's products. DFish imports 
fish from the United States and distributes it to fish 
wholesalers in Denmark. For purposes of paragraph 4, the 
business of DFlower forms a part of the business of USFlower, 
the business of DLawn is complementary to the business of 
USFlower, and the business of DFish 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 Danish 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, Danish pharmaceutical 
manufacturer, the size of the U.S. research firm would not have 
to be tested against the size of the Danish manufacturer. 
Similarly, a small U.S. bank that makes a loan to a very large 
unrelated Danish 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 provides that a resident of one of the States 
that derives income from the other State described in Article 8 
(Shipping and Air Transport) and that is not entitled to the 
benefits of the Convention under paragraphs 1 through 4, shall 
nonetheless be entitled to the benefits of the Convention with 
respect to income described in Article 8 if it meets one of two 
tests. These tests in substance duplicate the rules set forth 
under Code section 883 and therefore afford little additional 
benefit beyond those provided by the Code. These tests are 
described below.
    First, a resident of one of the States that derives income 
from the other State will be entitled to the benefits of the 
Convention with respect to income described in Article 8 if at 
least 50 percent of the beneficial interest in the person (in 
the case of a company, at least 50 percent of the aggregate 
vote and value of the stock of the company) is owned, directly 
or indirectly, by persons entitled to benefits under 
subparagraphs (a), (b), (c)(i), (d), or (e), paragraph 2, 
citizens of the United States or individuals who are residents 
of a third state that grants by law, common agreement, or 
convention an exemption under similar terms for profits as 
mentioned in Article 8 to citizens and corporations of the 
other State. This provision is analogous to the relief provided 
under Code section 883(c)(1).
    Alternatively, a resident of one of the States that derives 
income from the other State will be entitled to the benefits of 
the Convention with respect to income described in Article 8 if 
at least 50 percent of the beneficial interest in the person 
(in the case of a company, at least 50 percent of the aggregate 
vote and value of the stock of the company) is owned directly 
or indirectly by a company or combination of companies the 
stock of which is primarily and regularly traded on an 
established securities market in a third state, provided that 
the third state grants by law, common agreement or convention 
an exemption under similar terms for profits as mentioned in 
Article 8 to citizens and corporations of the other State. This 
provision is analogous to the relief provided under Code 
section 883(c)(3).
    The provisions of paragraph 5 are intended to be self 
executing. Unlike the provisions of paragraph 7, discussed 
below, claiming benefits under paragraph 5 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.

Paragraph 6

    Paragraph 6 deals with the treatment of 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 Denmark to earn, in this 
case, interest income from the United States. The resident of 
Denmark, who is assumed to qualify for benefits under one or 
more of the provisions of Article 22 (Limitation of 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 Danish 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 Danish resident. Therefore the income that 
it earns on those loans, absent the provisions of paragraph 6, 
is entitled to exemption from U.S. withholding tax under the 
Convention. Under a current Danish income tax treaty with the 
host jurisdiction of the permanent establishment, the income of 
the permanent establishment is exempt from Danish 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 Danish 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 interest or royalties 
that are attributable to a third-jurisdiction permanent 
establishment of a Danish resident.
    Paragraph 6 replaces the otherwise applicable rules in the 
Convention for interest and royalties with a 15 percent 
withholding tax for interest and royalties 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 Denmark if the 
income were earned in Denmark 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 6 will not 
apply under certain circumstances. In the case of interest (as 
defined in Article 11 (Interest)), paragraph 6 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 6 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 7

    Paragraph 7 provides that a resident of one of the States 
that is not entitled to the benefits of the Convention as a 
result of paragraphs 1 through 6 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 7, 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 7.
    The competent authority's discretion is quite broad. It may 
grant all of the benefits of the Convention to the taxpayer 
making the request, or it may grant only certain benefits. For 
instance, it may grant benefits only with respect to a 
particular item of income in a manner similar to paragraph 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 7, a taxpayer will 
be permitted to present his case to the relevant competent 
authority for an advance determination based on the facts. In 
these circumstances, it is also expected that if the competent 
authority determines that benefits are to be allowed, they will 
be allowed retroactively to the time of entry into force of the 
relevant treaty provision or the establishment of the structure 
in question, whichever is later.
    A competent authority is required by paragraph 7 to consult 
the other competent authority before denying benefits under 
this paragraph.

Paragraph 8

    Paragraph 8 defines several key terms for purposes of 
Article 22. Each of the defined terms is discussed in the 
context in which it is used.

                               ARTICLE V

    Article V of the Protocol contains the rules for bringing 
the Protocol into force and giving effect to its provisions.
    Paragraph 1 provides that each State must notify the other 
as soon as its requirements for ratification have been complied 
with. The Protocol will enter into force upon the date of 
receipt of the later of such notifications.
    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), the provisions of the Protocol 
relating to taxes withheld at source will have effect with 
respect to 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 paragraphs 2 and 3 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 of 
Benefits provisions of Article 5 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 Denmark 
may make a claim for refund pursuant to section 1464 of the 
Code.
    For all other taxes, subparagraph (b) specifies that the 
Protocol will have effect for any taxable period beginning on 
or after January 1 of the year next following entry into force.