[DOCID: f:er007.105]
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105th Congress                                               Exec. Rpt.
                                 SENATE

 1st Session                                                      105-7
_______________________________________________________________________


 
                    TAXATION CONVENTION WITH AUSTRIA

                                _______
                                

                October 30, 1997.--Ordered to be printed

_______________________________________________________________________


          Mr. Helms, from the Committee on Foreign Relations,

                        submitted the following

                              R E P O R T

                   [To accompany Treaty Doc. 104-31]

    The Committee on Foreign Relations, to which was referred 
the Convention between the United States of America and the 
Republic of Austria for the Avoidance of Double Taxation and 
the Prevention of Fiscal Evasion with Respect to Taxes on 
Income, signed at Vienna on May 31, 1996, having considered the 
same, reports favorably thereon, with one understanding, two 
declarations, and one proviso, and recommends that the Senate 
give its advice and consent to ratification thereof, as set 
forth in this report and the accompanying resolution of 
ratification.

                                CONTENTS

                                                                   Page

  I. Purpose..........................................................1
 II. Background.......................................................2
III. Summary..........................................................2
 IV. Entry Into Force and Termination.................................3
  V. Committee Action.................................................3
 VI. Committee Comments...............................................4
VII. Budget Impact...................................................19
VIII.Explanation of Proposed Treaty..................................19

 IX. Text of of the Resolution of Ratification.......................67

                               I. Purpose

    The principal purposes of the proposed income tax treaty 
between the United States and Austria are to reduce or 
eliminate double taxation of income earned by residents of 
either country from sources within the other country and to 
prevent avoidance or evasion of the income taxes of the two 
countries. The proposed treaty is intended to continue to 
promote close economic cooperation and facilitate trade and 
investment between the two countries. It also is intended to 
enable the two countries to cooperate in preventing avoidance 
and evasion of taxes.

                             II. Background

    The proposed treaty was signed on May 31, 1996. The United 
States and Austria also exchanged notes, with an attached 
Memorandum of Understanding (the ``MOU''), on May 31, 1996. The 
proposed treaty would replace the existing income tax treaty 
between the two countries that was signed in 1956.
    The proposed treaty was transmitted to the Senate for 
advice and consent to its ratification on September 4, 1996 
(see Treaty Doc. 104-31). The Committee on Foreign Relations 
held a public hearing on the proposed treaty on October 7, 
1997.

                              III. Summary

    The proposed treaty is similar to other recent U.S. income 
tax treaties, the 1996 U.S. model income tax treaty (``U.S. 
model''), <SUP>1</SUP> and the model income tax treaty of the 
Organization for Economic Cooperation and Development (``OECD 
model''). However, the proposed treaty contains certain 
substantive deviations from those documents.
---------------------------------------------------------------------------
    \1\ The Treasury Department released the U.S. model on September 
20, 1996. A 1981 U.S. model treaty was withdrawn by the Treasury 
Department on July 17, 1992.
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    As in other U.S. tax treaties, the proposed treaty's 
objective of reducing or eliminating taxation principally is 
achieved by each country agreeing to limit, in certain 
specified situations, its right to tax income derived from its 
territory by residents of the other country. For example, the 
proposed treaty contains provisions under which neither country 
generally will tax business income derived from sources within 
that country by residents of the other country unless the 
business activities in the taxing country are substantial 
enough to constitute a permanent establishment or fixed base 
(Articles 7 and 14). Similarly, the proposed treaty contains 
``commercial visitor'' exemptions under which residents of one 
country performing personal services in the other country will 
not be required to pay tax in the other country unless their 
contact with the other country exceeds specified minimums 
(Articles 14, 15, and 17). The proposed treaty provides that 
dividends and certain capital gains derived by a resident of 
either country from sources within the other country may be 
taxed by both countries (Articles 10 and 13); however, the rate 
of tax that the source country may impose on a resident of the 
other country on dividends generally will be limited by the 
proposed treaty (Article 10). The proposed treaty also provides 
that interest and royalties derived by a resident of either 
country generally will be exempt from tax in the other country 
(Articles 11 and 12).
    In situations where the country of source retains the right 
under the proposed treaty to tax income derived by residents of 
the other country, the proposed treaty generally provides for 
relief from the potential double taxation through the allowance 
by the country of residence of a tax credit for certain foreign 
taxes paid to the other country (Article 22).
    The proposed treaty contains the standard provision (the 
``saving clause'') contained in U.S. tax treaties pursuant to 
which each country retains the right to tax its citizens and 
residents as if the proposed treaty had not come into effect 
(Article 1). In addition, the proposed treaty contains the 
standard provision that it may not be applied to deny any 
taxpayer any benefits the taxpayer would be entitled to under 
the domestic law of a country or under any other agreement 
between the two countries (Article 1).
    The proposed treaty also contains a detailed limitation on 
benefits provision to prevent the inappropriate use of the 
proposed treaty (Article 16).

                  IV. Entry Into Force and Termination

                          A. Entry into Force

    The proposed treaty provides that the instruments of 
ratification are to be exchanged as soon as possible. The 
proposed treaty will enter into force on the first day of the 
second month following the exchange of instruments of 
ratification. The present treaty generally ceases to have 
effect once the provisions of the proposed treaty take effect.
    In the case of taxes payable at source, the proposed treaty 
takes effect for payments made on or after the first day of the 
second month following the entry into force (i.e., the first 
day of the fourth month following the exchange of instruments 
of ratification). In the case of other taxes, the proposed 
treaty takes effect for taxable years and periods beginning on 
or after the first of January following the entry into force.
    Taxpayers may elect temporarily to continue to claim 
benefits under the present treaty with respect to a period 
after the proposed treaty takes effect. For such a taxpayer, 
the present treaty continues to have effect in its entirety for 
the first assessment period or taxable year from the date on 
which the provisions of the proposed treaty would otherwise 
take effect.

                             B. Termination

    The proposed treaty will continue in force until terminated 
by a treaty country. Either country may terminate it at any 
time after five years from the date of its entry into force by 
giving at least six months prior written notice through 
diplomatic channels. With respect to taxes payable at source, a 
termination will be effective for payments made after the end 
of the calendar year in which such notice has been given. With 
respect to other taxes, a termination will be effective for 
taxable years and periods beginning after the end of the 
calendar year in which the notice has been given.

                          V. Committee Action

    The Committee on Foreign Relations held a public hearing on 
the proposed treaty with Austria (Treaty Doc. 104-31), as well 
as on other proposed tax treaties and protocols, on October 7, 
1997. The hearing was chaired by Senator Hagel. The Committee 
considered these proposed treaties and protocols on October 8, 
1997, and ordered the proposed treaty with Austria favorably 
reported by a voice vote, with the recommendation that the 
Senate give its advice and consent to ratification of the 
proposed treaty, subject to an understanding, two declarations 
and a proviso.

                         VI. Committee Comments

    On balance, the Committee on Foreign Relations believes 
that the proposed treaty with Austria is in the interest of the 
United States and urges that the Senate act promptly to give 
advice and consent to ratification. The Committee has taken 
note of certain issues raised by the proposed treaty, and 
believes that the following comments may be useful to Treasury 
Department officials in providing guidance on these matters 
should they arise in the course of future treaty negotiations.

                     A. Treatment of REIT Dividends

REITs in general

    Real Estate Investment Trusts (``REITs'') essentially are 
treated as conduits for U.S. tax purposes. The income of a REIT 
generally is not taxed at the entity level but is distributed 
and taxed only at the investor level. This single level of tax 
on REIT income is in contrast to other corporations, the income 
of which is subject to tax at the corporate level and is taxed 
again at the shareholder level upon distribution as a dividend. 
Hence, a REIT is like a mutual fund that invests in qualified 
real estate assets.
    An entity that qualifies as a REIT is taxable as a 
corporation. However, unlike other corporations, a REIT is 
allowed a deduction for dividends paid to its shareholders. 
Accordingly, income that is distributed by a REIT to its 
shareholders is not subject to corporate tax at the REIT level. 
A REIT is subject to corporate tax only on any income that it 
does not distribute currently to its shareholders. As discussed 
below, a REIT is required to distribute on a current basis the 
bulk of its income each year.
    In order to qualify as a REIT, an entity must satisfy, on a 
year-by-year basis, specific requirements with respect to its 
organizational structure, the nature of its assets, the source 
of its income, and the distribution of its income. These 
requirements are intended to ensure that the benefits of REIT 
status are accorded only to pooling of investment arrangements, 
the income of which is derived from passive investments in real 
estate and is distributed to the investors on a current basis.
    In order to satisfy the organizational structure 
requirements for REIT status, a REIT must have at least 100 
shareholders and not more than 50 percent (by value) of its 
shares may be owned by five or fewer individuals. In addition, 
shares of a REIT must be transferrable.
    In order to satisfy the asset requirements for REIT status, 
a REIT must have at least 75 percent of the value of its assets 
invested in real estate, cash and cash items, and government 
securities. In addition, diversification rules apply to the 
REIT's investment in assets other than the foregoing qualifying 
assets. Under these rules, not more than 5 percent of the value 
of its assets may be invested in securities of a single issuer 
and any such securities held may not represent more than 10 
percent of the voting securities of the issuer.
    In order to satisfy the source of income requirements, at 
least 95 percent of the gross income of the REIT generally must 
be from certain passive sources (e.g., dividends, interest, and 
rents). In addition, at least 75 percent of its gross income 
generally must be from certain real estate sources (e.g., real 
property rents, mortgage interest, and real property gains).
    Finally, in order to satisfy the distribution of income 
requirement, the REIT generally is required to distribute to 
its shareholders each year at least 95 percent of its taxable 
income for the year (excluding net capital gains). A REIT may 
retain 5 percent or less of its taxable income and all or part 
of its net capital gain.
    A REIT is subject to corporate-level tax only on any 
taxable income and net capital gains that the REIT retains. 
Under an available election, shareholders may be taxed 
currently on the undistributed capital gains of a REIT, with 
the shareholder entitled to a credit for the tax paid by the 
REIT with respect to the undistributed capital gains such that 
the gains are subject only to a single level of tax. 
Distributions from a REIT of ordinary income are taxable to the 
shareholders as a dividend, in the same manner as dividends 
from an ordinary corporation. Accordingly, such dividends are 
subject to tax at a maximum rate of 39.6 percent in the case of 
individuals and 35 percent in the case of corporations. In 
addition, capital gains of a REIT distributed as a capital gain 
dividend are taxable to the shareholders as capital gain. 
Capital gain dividends received by an individual will be 
eligible for preferential capital gain tax rates if the 
relevant holding period requirements are satisfied.

Foreign investors in REITs

    Nonresident alien individuals and foreign corporations 
(collectively, foreign persons) are subject to U.S. tax on 
income that is effectively connected with the foreign person's 
conduct of a trade or business in the United States, in the 
same manner and at the same graduated tax rates as U.S. 
persons. In addition, foreign persons generally are subject to 
U.S. tax at a flat 30-percent rate on certain gross income that 
is derived from U.S. sources and that is not effectively 
connected with a U.S. trade or business. The 30-percent tax 
applies on a gross basis to U.S.-source interest, dividends, 
rents, royalties, and other similar types of income. This tax 
generally is collected by means of withholding by the person 
making the payment of such amounts to a foreign person.
    Capital gains of a nonresident alien individual that are 
not connected with a U.S. business generally are subject to the 
30-percent withholding tax only if the individual is present in 
the United States for 183 days or more during the year. The 
United States generally does not tax foreign corporations on 
capital gains that are not connected with a U.S. trade or 
business. However, foreign persons generally are subject to 
U.S. tax on any gain from a disposition of an interest in U.S. 
real property at the same rates that apply to similar income 
received by U.S. persons. Therefore, a foreign person that has 
capital gains with respect to U.S. real estate is subject to 
U.S. tax on such gains in the same manner as a U.S. person. For 
this purpose, a distribution by a REIT to a foreign shareholder 
that is attributable to gain from a disposition of U.S. real 
property by the REIT is treated as gain recognized by such 
shareholder from the disposition of U.S. real property.
    U.S. income tax treaties contain provisions limiting the 
amount of income tax that may be imposed by one country on 
residents of the other country. Many treaties, like the 
proposed treaty, generally allow the source country to impose 
not more than a 15-percent withholding tax on dividends paid to 
a resident of the other treaty country. In the case of real 
estate income, most treaties, like the proposed treaty, specify 
that income derived from, and gain from dispositions of, real 
property in one country may be taxed by the country in which 
the real property is situated without limitation. <SUP>2</SUP> 
Accordingly, U.S. real property rental income derived by a 
resident of a treaty partner generally is subject to the U.S. 
withholding tax at the full 30-percent rate (unless the net-
basis taxation election is made), and U.S. real property gains 
of a treaty partner resident are subject to U.S. tax in the 
manner and at the rates applicable to U.S. persons.
---------------------------------------------------------------------------
    \2\ The proposed treaty, like many treaties, allows the foreign 
person to elect to be taxed in the source country on income derived 
from real property on a net basis under the source country's domestic 
laws.
---------------------------------------------------------------------------
    Although REITs are not subject to corporate-level taxation 
like other corporations, distributions of a REIT's income to 
its shareholders generally are treated as dividends in the same 
manner as distributions from other corporations. Accordingly, 
in cases where no treaty is applicable, a foreign shareholder 
of a REIT is subject to the U.S. 30-percent withholding tax on 
ordinary income distributions from the REIT. In addition, such 
shareholders are subject to U.S. tax on U.S. real estate 
capital gain distributions from a REIT in the same manner as a 
U.S. person.
    In cases where a treaty is applicable, this U.S. tax on 
capital gain distributions from a REIT still applies. However, 
absent special rules applicable to REIT dividends, treaty 
provisions specifying reduced rates of tax on dividends apply 
to ordinary income dividends from REITs as well as to dividends 
from taxable corporations. As discussed above, the proposed 
treaty, like many U.S. treaties, reduces the U.S. 30-percent 
withholding tax to 15 percent in the case of dividends 
generally. Prior to 1989, U.S. tax treaties contained no 
special rules excluding dividends from REITs from these reduced 
rates. Therefore, under pre-1989 treaties such as the present 
treaty with Austria, REIT dividends are eligible for the same 
reductions in the U.S. withholding tax that apply to other 
corporate dividends.
    Beginning in 1989, U.S. treaty negotiators began including 
in treaties provisions excluding REIT dividends from the 
reduced rates of withholding tax generally applicable to 
dividends. Under treaties with these provisions such as the 
proposed treaty, REIT dividends generally are subject to the 
full U.S. 30-percent withholding tax. <SUP>3</SUP>
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    \3\  Many treaties, like the proposed treaty, provide a maximum tax 
rate of 15 percent in the case of REIT dividends beneficially owned by 
an individual who holds a less than 10 percent interest in the REIT.
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Analysis of treaty treatment of REIT dividends

    The specific treaty provisions governing REIT dividends 
were introduced beginning in 1989 because of concerns that the 
reductions in withholding tax generally applicable to dividends 
were inappropriate in the case of dividends from REITs. The 
reductions in the rates of source-country tax on dividends 
reflect the view that the full 30-percent withholding tax rate 
may represent an excessive rate of source-country taxation 
where the source country already has imposed a corporate-level 
tax on the income prior to its distribution to the shareholders 
in the form of a dividend. In the case of dividends from a 
REIT, however, the income generally is not subject to 
corporate-level taxation.
    REITs are required to distribute their income to their 
shareholders on a current basis. The assets of a REIT consist 
primarily of passive real estate investments and the REIT's 
income may consist principally of rentals from such real estate 
holdings. U.S.-source rental income generally is subject to the 
U.S. 30-percent withholding tax. Moreover, the United States' 
treaty policy is to preserve its right to tax real property 
income derived from the United States. Accordingly, the U.S. 
30-percent tax on rental income from U.S. real property is not 
reduced in U.S. tax treaties.
    If a foreign investor in a REIT were instead to invest in 
U.S. real estate directly, the foreign investor would be 
subject to the full 30-percent withholding tax on rental income 
earned on such property (unless the net-basis taxation election 
is made). However, when the investor makes such investment 
through a REIT instead of directly, the income earned by the 
investor is treated as dividend income. If the reduced rates of 
withholding tax for dividends apply to REIT dividends, the 
foreign investor in the REIT is accorded a reduction in U.S. 
withholding tax that is not available for direct investments in 
real estate.
    On the other hand, some argue that it is important to 
encourage foreign investment in U.S. real estate through REITs. 
In this regard, a higher withholding tax on REIT dividends 
(i.e., 30 percent instead of 15 percent) may not be fully 
creditable in the foreign investor's home country and the cost 
of the higher withholding tax therefore may discourage foreign 
investment in REITs. For this reason, some oppose the inclusion 
in U.S. treaties of the special provisions governing REIT 
dividends, arguing that dividends from REITs should be given 
the same treatment as dividends from other corporate entities. 
Accordingly, under this view, the 15-percent withholding tax 
rate generally applicable under treaties to dividends should 
apply to REIT dividends as well.
    This argument is premised on the view that investment in a 
REIT is not equivalent to direct investment in real property. 
From this perspective, an investment in a REIT should be viewed 
as comparable to other investments in corporate stock. In this 
regard, like other corporate shareholders, REIT investors are 
investing in the management of the REIT and not just its 
underlying assets. Moreover, because the interests in a REIT 
are widely held and the REIT itself typically holds a large and 
diversified asset portfolio, an investment in a REIT represents 
a very small investment in each of a large number of 
properties. Thus, the REIT investment provides diversification 
and risk reduction that are not easily replicated through 
direct investment in real estate.
    At the October 7, 1997 hearing on the proposed treaty (as 
well as other proposed treaties and protocols), the Treasury 
Department announced that it has modified its policy with 
respect to the exclusion of REIT dividends from the reduced 
withholding tax rates applicable to other dividends under 
treaties. The Treasury Department worked extensively with the 
staff of the Committee on Foreign Relations, the staff of the 
Joint Committee on Taxation, and representatives of the REIT 
industry in order to address the concern that the current 
treaty policy with respect to REIT dividends may discourage 
some foreign investment in REITs while maintaining a treaty 
policy that properly preserves the U.S. taxing jurisdiction 
over foreign direct investment in U.S. real property. The new 
policy is a result of significant cooperation among all parties 
to balance these competing considerations.
    Under this policy, REIT dividends paid to a resident of a 
treaty country will be eligible for the reduced rate of 
withholding tax applicable to portfolio dividends (typically, 
15 percent) in two cases. First, the reduced withholding tax 
rate will apply to REIT dividends if the treaty country 
resident beneficially holds an interest of 5 percent or less in 
each class of the REIT's stock and such dividends are paid with 
respect to a class of the REIT's stock that is publicly traded. 
Second, the reduced withholding tax rate will apply to REIT 
dividends if the treaty country resident beneficially holds an 
interest of 10 percent or less in the REIT and the REIT is 
diversified, regardless of whether the REIT's stock is publicly 
traded. In addition, the current treaty policy with respect to 
the application of the reduced withholding tax rate to REIT 
dividends paid to individuals holding less than a specified 
interest in the REIT will remain unchanged.
    For purposes of these rules, a REIT will be considered 
diversified if the value of no single interest in real property 
held by the REIT exceeds 10 percent of the value of the REIT's 
total interests in real property. An interest in real property 
will not include a mortgage, unless the mortgage has 
substantial equity components. An interest in real property 
also will not include foreclosure property. Accordingly, a REIT 
that holds exclusively mortgages will be considered to be 
diversified. The diversification rule will be applied by 
looking through a partnership interest held by a REIT to the 
underlying interests in real property held by the partnership. 
Finally, the reduced withholding tax rate will apply to a REIT 
dividend if the REIT's trustees or directors make a good faith 
determination that the diversification requirement is satisfied 
as of the date the dividend is declared.
    The Treasury Department will incorporate this new policy 
with respect to the treatment of REIT dividends in the U.S. 
model treaty and in future treaty negotiations. In addition, 
the Treasury Department has committed to use its best efforts 
to negotiate a protocol with Austria to amend the proposed 
treaty to incorporate this policy.
    The Committee believes that the new policy with respect to 
the applicability of reduced withholding tax rates to REIT 
dividends appropriately reflects economic changes since the 
establishment of the current policy. The Committee further 
believes that the new policy fairly balances competing 
considerations by extending the reduced rate of withholding tax 
on dividends generally to dividends paid by REITs that are 
relatively widely-held and diversified. The Committee 
encourages the Treasury Department to act expeditiously in 
meeting its commitment to negotiate a protocol with Austria 
that incorporates this new policy, and the Committee believes 
that negotiating such a protocol with Austria should take 
priority over negotiating similar protocols with other 
countries.

                             B. Stock Gains

    Under U.S. internal law, gains realized by a nonresident 
alien or a foreign corporation from the disposition of a 
capital asset, other than a U.S. real property interest, 
generally are not subject to U.S. tax unless the gain is 
effectively connected with a U.S. trade or business. The U.S. 
model and the OECD model reflect this policy. Under these model 
treaties, such gains derived by a resident of a treaty country 
from sources within the other country generally are taxed only 
by the recipient's country of residence (except gains connected 
with a real estate interest or a permanent establishment or a 
fixed base). In other words, a U.S. investor who realizes 
capital gain in a treaty country generally is taxable only by 
the United States.
    The proposed treaty provides an exception to the above 
general rule. Under the proposed treaty, if a U.S. resident 
transfers property to an Austrian company as a capital 
contribution and, pursuant to the Austrian Reorganization Act 
(``Umgrundungssteuergesetz''), the transfer is not subject to 
Austrian tax, a subsequent ``alienation'' of the shares in the 
Austrian company will be taxable in Austria if such alienation 
occurs through the year 2010. According to the Treasury 
Department's Technical Explanation of the proposed treaty 
(hereinafter referred to as the ``Technical Explanation''), 
this rule applies to the disposition of stock of an Austrian 
company that was received upon the incorporation of a permanent 
establishment in Austria if the capital gains inherent in the 
property transferred to the Austrian company were not taxed at 
the time of the incorporation.
    The term ``alienation'' is defined broadly for this purpose 
to include any transfer of property. <SUP>4</SUP> For example, 
a subsequent contribution of the stock of the Austrian company 
that is the transferee of the property (from the U.S. 
transferor) to the capital of another company would constitute 
an alienation, and the appreciation in the stock of the 
Austrian company would be subject to Austrian tax under the 
proposed treaty.
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    \4\ Thus, a transfer may qualify as an alienation for Austrian tax 
purposes even though such transfer qualifies as a nonrecognition 
transaction for U.S. tax purposes.
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    This provision could be viewed as a one-sided concession by 
the United States that is inconsistent with the preferred U.S. 
tax treaty position which, as stated above, generally grants 
the residence country the exclusive right to tax non-business 
capital gains derived by its residents from the other country.
    In addition, the provision also creates a potential double 
taxation problem for the U.S. taxpayer that transferred 
property to an Austrian company as a capital contribution. In 
the event that a subsequent transfer of the stock of such an 
Austrian company is treated as an ``alienation'' for Austrian 
tax purposes, the transfer would be taxable in Austria. 
However, if the subsequent transfer qualifies as a tax-free 
transaction in the United States, it would not be taxable in 
the year of the transfer and the U.S. tax on the appreciation 
in the stock of the Austrian company would be deferred until a 
later year. Consequently, the Austrian tax paid with respect to 
this transfer may not be available to offset the U.S. tax on 
the gain in the stock of the Austrian company (imposed in a 
subsequent year when the gain on such stock is recognized in a 
taxable transaction for U.S. tax purposes). <SUP>5</SUP>
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    \5\ However, the Austrian tax paid may be carried back two years or 
carried forward five years to offset U.S. tax imposed on a similar type 
of foreign-source income under U.S. internal law.
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    In the event that the transfer is treated as an 
``alienation'' for Austrian tax purposes, and if the transfer 
is taxable in the United States and Austria in the same year, 
double taxation still may occur because the gain generally is 
treated as U.S.-source income. <SUP>6</SUP> Under the U.S. 
foreign tax credit rules, foreign taxes paid or accrued by a 
taxpayer are allowed to reduce only U.S. taxes on foreign-
source income. Consequently, the Austrian taxes paid on the 
transfer of the stock of the Austrian subsidiary would not be 
allowed to reduce the U.S. gain from the same transaction, 
resulting in double taxation of the same gain, unless other 
relief is available. <SUP>7</SUP>
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    \6\ Under certain circumstances, such gain may, however, qualify as 
foreign-source income.
    \7\ The Technical Explanation states that it is expected that any 
such double taxation would be addressed by the competent authorities.
---------------------------------------------------------------------------
    As part of its consideration of the proposed treaty, the 
Committee asked the Treasury Department whether the provision 
in the proposed treaty is appropriate as a matter of U.S. 
treaty policy. The relevant portion of the Treasury 
Department's October 8, 1997 letter <SUP>8</SUP> responding to 
this inquiry is reproduced below:
---------------------------------------------------------------------------
    \8\ Letter from Joseph H. Guttentag, International Tax Counsel, 
Treasury Department, to Senator Paul Sarbanes, Committee on Foreign 
Relations, October 8, 1997 (``October 8, 1997 Treasury Department 
letter'').

    [O]ur current tax convention with Austria (which dates from 
1957) has no provision reserving to the residence country the 
right to source gain from the disposition of shares. Therefore, 
Austria now has the right to tax such gain. In the proposed 
treaty, Austria was willing to adopt a provision that gives up 
its right to tax stock gains at source. In securing this 
concession from Austria, we agreed to a transition rule in the 
pending convention preserving Austria's right to tax gain 
through the year 2010--a rule covering a very limited number of 
cases. This transition rule is limited to the disposition of 
stock that was received on the incorporation of a permanent 
establishment in Austria if the capital gains were not taxed on 
the incorporation of the subsidiary.
    We do not consider this provision to be a one-sided 
concession. Rather we believe that accepting the limited 
transition rule in the treaty was necessary in order to move 
over the long run to a provision that is fully consistent with 
U.S. tax treaty policy. We believe that our acceptance of such 
a transition rule in this case will not be misconstrued as a 
retreat from our support for the position we take in the U.S. 
Model.

    Although the proposed treaty represents a limited departure 
from U.S. tax treaty policy, the Committee believes that the 
provision represents a substantial improvement from the present 
treaty. This provision should not stand as a model for other 
treaty negotiations, however. In negotiating future treaties, 
the Treasury Department should continue to seek provisions that 
conform more closely to the U.S. model in generally providing 
for exclusive residence-country taxation of stock gains.

                              C. Royalties

    The present treaty contains a two-tier limitation on 
source-country taxation of royalties: (1) royalty payments for 
motion picture film rentals may be taxed by the source country 
at a rate of 10 percent; and (2) all other royalty payments are 
exempt from source-country taxation. The proposed treaty 
maintains the two-tier limitation of the present treaty, but 
modifies the treatment of royalties in two ways.
    First, the proposed treaty modifies the definition of the 
term ``royalties'' to exclude rentals and like payments for the 
use of industrial, commercial or scientific equipment. Such 
payments generally are treated as business profits under the 
proposed treaty. <SUP>9</SUP> Consequently, a U.S. resident 
would not be subject to Austrian income tax on amounts paid for 
the use of industrial, commercial or scientific equipment in 
Austria unless such amounts are attributable to a permanent 
establishment that the U.S. resident has in Austria. If the 
amounts are attributable to an Austrian permanent 
establishment, then the U.S. resident would be subject to 
Austrian tax on such amounts in the same manner that an 
Austrian resident that derives the same income would be taxed.
---------------------------------------------------------------------------
    \9\ See 1992 OECD Commentary on Article 12, paragraph 9.
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    Second, the proposed treaty expands the class of royalty 
payments that are subject to the 10-percent source-country 
taxation. Under the present treaty, only motion picture film 
rentals are subject to source-country taxation. Under the 
proposed treaty, source-country taxation also applies to 
payments for the use of, or the right to use, tapes or other 
means of reproduction used for radio or television 
broadcasting. Consequently, a significantly expanded class of 
Austrian-source royalties beneficially owned by U.S. residents 
will be subject to a 10-percent Austrian withholding tax under 
the proposed treaty. Such withholding taxes generally may be 
allowed to reduce the U.S. income tax imposed on the same or 
similar income. Accordingly, this increased class of Austrian 
royalty payments that are subject to a creditable 10-percent 
Austrian tax represents an expansion of the instances in which 
the United States cedes its taxing jurisdiction to Austria.
    By contrast, U.S. treaty policy, as reflected in the U.S. 
model and in many U.S. treaties with developed nations, 
generally would eliminate the source-country tax on royalties. 
The Committee noted during its consideration of the present 
treaty in 1957 that the treaty ``differs from a number of other 
tax treaties which provide a complete exemption for film 
rentals.''
    As part of its consideration of the proposed treaty, the 
Committee asked the Treasury Department whether the expansion 
under the proposed treaty of the 10-percent source-country tax 
on royalties is appropriate as a matter of U.S. treaty policy. 
The relevant portion of the October 8, 1997 Treasury Department 
letter responding to the inquiry is reproduced below:

    Because we had accepted the 10-percent rate at source on 
movie royalties under the current U.S.-Austria tax convention 
and because we wanted to improve the current tax treaty in 
several other respects, we concluded that the best approach 
under the circumstances was to continue to accept the provision 
on film royalties. Realistically, because of technological and 
economic developments, this meant extending the rule to include 
radio and television broadcasting royalties. For example, it 
would be administratively difficult to distinguish between 
royalties relating to different broadcasting rights. In 
addition, distinguishing among these sectors would have created 
an uneven playing field within the entertainment industry. In 
negotiating the provision, we not only took into account the 
royalty income flows between our two countries but recognized 
that many of Austria's treaties, including several with OECD 
member countries, retain some source-country tax rights for 
royalties.

Although the Committee understands the reasons for expanding 
source-country taxation for royalties in this case, the 
Committee remains concerned that this provision represents a 
significant step backward from the present treaty. Its effect 
will be to cede taxing jurisdiction from the United States to 
Austria. The Committee believes that in updating existing tax 
treaties the Treasury Department should reject changes that 
would lessen the treaty's overall benefit to the United States. 
The Committee also is concerned by the precedent this provision 
may present for future treaty partners that may seek provisions 
allowing source-country taxation of royalties. Although the 
Committee does not believe that the treatment of such royalties 
warrants a reservation to, or rejection of, the proposed 
treaty, such a provision could be cause for such action in 
future treaties, particularly treaties with OECD member 
countries. The Treasury Department should continue to seek 
provisions that conform more closely to the U.S. model in 
exempting royalties from source-country taxation.

                       D. Exchange of Information

    One of the principal purposes of the proposed income tax 
treaty between the United States and Austria is to prevent 
avoidance or evasion of income taxes of the two countries. The 
exchange of information article of the proposed treaty is one 
of the primary vehicles used to achieve that purpose.
    The exchange of information article contained in the 
proposed treaty generally conforms to the corresponding 
articles of the U.S. and OECD models. As is true under these 
model treaties and the present treaty, under the proposed 
treaty a country is not required to carry out administrative 
measures at variance with the laws and administrative practices 
of either country, to supply information which is not 
obtainable under the laws or in the normal course of the 
administration of either country, or to supply information 
which discloses any trade, business, industrial, commercial, or 
professional secret or trade process, or information the 
disclosure of which is contrary to public policy. The MOU 
provides that provisions on bank secrecy do not constitute a 
professional, trade, business, industrial, or commercial 
secret.
    The Technical Explanation states that Austrian bank secrecy 
laws prohibit Austrian tax authorities from obtaining 
information from Austrian banks for their own non-penal tax 
investigations and proceedings. Consequently, the Austrian 
competent authority generally would not be able to provide such 
information upon the request of the U.S. competent authority in 
connection with a non-penal tax investigation or proceeding in 
the United States. However, the proposed treaty provides that 
the Austrian competent authority may obtain Austrian bank 
information in connection with a U.S. penal investigation. 
According to the MOU, the term ``penal investigations'' applies 
to proceedings carried out by either judicial or administrative 
bodies, such as the commencement of a criminal investigation by 
the Criminal Investigation Division of the Internal Revenue 
Service (the ``IRS''). Therefore, this special provision 
enables the United States to obtain Austrian bank information 
in connection with criminal investigations without violating 
Austrian internal law. However, as under the present treaty, 
because of Austrian internal law, the United States may not 
obtain Austrian bank information in situations that are not in 
connection with a criminal investigation.
    As part of its consideration of the proposed treaty, the 
Committee asked the Treasury Department about the adequacy of 
the exchange of information provisions in the proposed treaty. 
The relevant portion of the October 8, 1997 Treasury Department 
letter is reproduced below:

    [T]he proposed treaty improves the ability of the United 
States to obtain information for the enforcement of U.S. tax 
laws and the prevention of tax avoidance and evasion. We were 
able to obtain assurance from Austria that the commencement of 
a criminal investigation by the Criminal Investigation Division 
of the Internal Revenue Service constitutes a penal 
investigation under Austrian domestic law. The establishment of 
a clear point for obtaining account information at a stage that 
is early enough to be useful in key cases is a major step 
forward under our pending treaty. Further, under our pending 
treaty, Austria is undertaking to do something else that it has 
not done for any other treaty partner. Austria will use its 
power of search and seizure in connection with a penal 
proceeding to obtain information under our pending treaty in 
connection with a penal proceeding in the United States.

    Although broader exchange of information provisions are 
desirable, the Committee understands the difficulty in 
achieving broader provisions given the current constraints of 
Austrian law and practices. Moreover, the Committee understands 
that the information exchange provisions of the proposed treaty 
represent a significant improvement over those of the present 
treaty. However, the Committee does not believe that the 
proposed Austrian treaty should be construed in any way as a 
precedent for other negotiations. The exchange of information 
provisions in treaties are central to the purposes for which 
tax treaties are entered into, and significant limitations on 
their effect, relative to the preferred U.S. tax treaty 
position, should not be accepted in negotiations with other 
countries that seek to have or to maintain the benefits of a 
tax treaty relationship with the United States.

                           E. OECD Commentary

    The MOU includes a special provision with respect to the 
interpretation of the proposed treaty. Under this provision, 
the OECD Commentary is to apply in interpreting any provision 
of the proposed treaty that corresponds to a provision of the 
OECD model. However, this general rule does not apply if either 
the United States or Austria has entered into a reservation or 
has included an observation with respect to the OECD model or 
its Commentary. In addition, this rule also does not apply if a 
contrary interpretation is included in the MOU, or a published 
interpretation of the proposed treaty (e.g., the Technical 
Explanation) has been provided by one country to the competent 
authority of the other country before the proposed treaty 
enters into force, or has been agreed to by the competent 
authorities after the proposed treaty has entered into force. 
In other words, unless specifically stipulated by either or 
both countries, the relevant OECD Commentary generally is 
controlling in the interpretation of provisions of the proposed 
treaty.
    The proposed treaty contains the standard provision that 
unless the context otherwise requires or the competent 
authorities of the two countries establish a common meaning, 
all terms not defined in the treaty are to have the meanings 
which they have under the laws of the country applying the 
treaty (Article 3, paragraph 2 (General Definitions)). Because 
this standard provision is part of the text of the proposed 
treaty, it overrides the provisions of the MOU in the event of 
a conflict. Thus, for example, if a term of the proposed treaty 
is not defined in the treaty, but is defined in U.S. internal 
law, and the same term also is defined in the OECD Commentary, 
and the United States and Austria have not stipulated 
otherwise, the definition provided by U.S. internal law would 
control.
    Other U.S. income tax treaties and protocols occasionally 
have required that a specific provision of an income tax treaty 
be interpreted in accordance with the OECD Commentary to the 
corresponding provision of the OECD model. <SUP>10</SUP> 
However, no U.S. treaty has ever required the treaty countries 
to interpret the provisions of the treaty broadly in accordance 
with the OECD Commentary.
---------------------------------------------------------------------------
    \10\ For example, Provision 19 of the Protocol to the 1990 U.S.-
Spain income tax treaty requires the two countries to interpret Article 
27 (Exchange of Information and Administrative Assistance) of that 
treaty in a manner consistent with the Commentary to the corresponding 
provision of the 1977 OECD model treaty.
---------------------------------------------------------------------------
    As part of its consideration of the proposed treaty, the 
Committee asked the Treasury Department whether the self-
executing nature of this provision could have the effect of 
modifying the substantive rules of the proposed treaty without 
the usual ratification procedures of either country. The 
relevant portion of the October 8, 1997 Treasury Department 
letter responding to this inquiry is reproduced below:

    This provision cannot create a substantive amendment to the 
proposed convention as adopted by both countries under their 
usual ratification procedures. Rather the provision utilizes an 
additional tool (the OECD Commentary) in interpreting the 
provisions of the Convention. The OECD Commentary would be 
useful in interpreting most of the provisions of the proposed 
Convention to a greater or lesser extent. Of course, the MOU 
and the Treasury Technical Explanation have precedence over the 
OECD commentaries, now and in the future.
    Neither country is bound by OECD Commentary to the extent 
that its disagreement with the Commentary is indicated at any 
time by observation or reservation. Therefore, the United 
States is not required to interpret a provision in a manner 
inconsistent with U.S. law or U.S. tax treaty policy. However, 
the ability to enter a reservation or observation to the OECD 
Commentary does not give either party a unilateral right to 
override the treaty because one country's reservation or 
observation does not bind the other. If the OECD Commentary, 
because of observations, and other interpretive sources do not 
resolve an issue, the competent authorities may attempt to do 
so.

    The Committee understands that the proposed treaty, as 
interpreted by the MOU, does not permit either country to make 
substantive amendments to the proposed treaty without 
ratification. The Committee also understands that the provision 
does not permit the OECD Commentary to override U.S. law or 
U.S. tax treaty policy. In order to make this point clear, the 
Committee has included in its recommended resolution of 
ratification an understanding regarding the ability of the 
United States to enter a reservation or observation to the OECD 
model or its Commentary at any time.

       F. Income from Sleeping Partnerships (Stille Gesellschaft)

    The proposed treaty contains a special rule which treats 
income derived from an Austrian ``sleeping partnership'' 
(Stille Gesellschaft) by a U.S. ``sleeping partner'' as 
business profits attributable to the permanent establishment of 
the partnership in Austria. According to the Technical 
Explanation, there are two types of sleeping partnerships under 
Austrian tax law: the ``typical'' form and the ``non-typical'' 
form. The profits of a sleeping partner in a typical sleeping 
partnership generally are treated as income from investment 
activities for Austrian tax purposes. On the other hand, the 
profits of a sleeping partner of a non-typical sleeping 
partnership are treated as income from commercial activities 
for Austrian tax purposes. Whether a particular sleeping 
partnership should be characterized as typical or non-typical 
under Austrian tax law may not be clear.
    German internal law also provides for sleeping 
partnerships. The 1989 U.S.-Germany income tax treaty provides 
that income from a sleeping partnership may be taxed in 
accordance with internal German tax law, without regard to the 
reduction in the tax rate otherwise applicable to dividends 
provided by that treaty, if such amount is deductible in 
computing the profits of the sleeping partnership. 
<SUP>11</SUP>
---------------------------------------------------------------------------
    \11\ See Article 10(5) of the 1989 U.S.-Germany income tax treaty.
---------------------------------------------------------------------------
    As part of its consideration of the proposed treaty, the 
Committee asked the Treasury Department whether the proposed 
treaty's characterization of the profits from an Austrian 
sleeping partnership as business profits is appropriate, given 
that the U.S.-Germany treaty provides for different treatment 
of profits from similar entities under German law. The relevant 
portion of the October 8, 1997 Treasury Department letter 
responding to this inquiry is reproduced below:

    The domestic laws of Germany and Austria differ in how they 
tax income from one form of silent or sleeping partnership--the 
typical sleeping partnership. Austria requires a nonresident 
sleeping partner to declare the income and imposes tax on the 
income on a net basis. Germany imposes a withholding tax in 
full and final settlement of the sleeping partner's tax 
liability. The German and the pending Austrian treaty reflect 
this difference in their treatment of income from a typical 
sleeping partnership.
    Under the proposed Austrian treaty, in the case of either 
type of sleeping partnership arrangement (typical or non-
typical), there is only one level of tax imposed on the income. 
In the typical sleeping partnership arrangement, the income of 
the silent partner is deductible to the other partner; and, in 
the non-typical sleeping partnership arrangement, the other 
partner is entitled to exclude from income the amounts 
allocable to the silent partner.

As described above, profits from Austrian sleeping partnerships 
generally are taxed on a net basis under Austrian law, similar 
to the treatment of business profits under the proposed treaty. 
Accordingly, the Committee believes that the treatment of 
profits from Austrian sleeping partnerships under the proposed 
treaty as business profits is appropriate.

                           G. Treaty Shopping

In general

    The proposed treaty, like a number of U.S. income tax 
treaties, generally limits treaty benefits for treaty country 
residents so that only those residents with a sufficient nexus 
to a treaty country will receive treaty benefits. Although the 
proposed treaty generally is intended to benefit residents of 
Austria and the United States only, residents of third 
countries sometimes attempt to use a treaty to obtain treaty 
benefits. This is known as treaty shopping. Investors from 
countries that do not have tax treaties with the United States, 
or from countries that have not agreed in their tax treaties 
with the United States to limit source-country taxation to the 
same extent that it is limited in another treaty may, for 
example, attempt to reduce the tax on interest on a loan to a 
U.S. person by lending money to the U.S. person indirectly 
through a country whose treaty with the United States provides 
for a lower rate of withholding tax on interest. The third-
country investor may attempt to do this by establishing in that 
treaty country a subsidiary, trust, or other entity which then 
makes the loan to the U.S. person and claims the treaty 
reduction for the interest it receives.
    The anti-treaty-shopping provision of the proposed treaty 
is similar to anti-treaty-shopping provisions in the Internal 
Revenue Code (the ``Code''), as interpreted by Treasury 
regulations, and in several recent treaties. Some aspects of 
the provision, however, differ from the anti-treaty-shopping 
provision in the U.S. model. In its details, the proposed 
treaty resembles the 1993 U.S. treaty with the Netherlands and 
the 1995 U.S. treaty with France. The degree of detail included 
in this provision is notable in itself. The proliferation of 
detail may reflect, in part, a diminution in the scope afforded 
the IRS and the courts in the anti-treaty-shopping provisions 
of most previous U.S. treaties to resolve interpretive issues 
adversely to a person attempting to claim the benefits of the 
treaty; this diminution represents a bilateral commitment, not 
alterable by developing internal U.S. tax policies, rules, and 
procedures, unless enacted as legislation that would override 
the treaty. (To the same extent as is provided under other 
treaties, the IRS generally is not limited under the proposed 
treaty in its discretion to allow treaty benefits under the 
anti-treaty-shopping rules.) The detail in the proposed treaty 
does represent added guidance and certainty for taxpayers that 
may be absent under other treaties, although in many other U.S. 
treaties the negotiators have chosen to forego such additional 
guidance in favor of somewhat simpler and more flexible 
provisions.

Analysis of provisions

    One provision of the anti-treaty-shopping article differs 
from the comparable rule of some earlier U.S. treaties, but the 
effect of the change is not completely clear. The general test 
applied by those earlier treaties for the allowance of benefits 
to an entity that does not meet the bright-line ownership and 
base erosion tests is a broadly subjective one, turning on 
whether the acquisition, maintenance, or operation of an entity 
did not have ``as a principal purpose obtaining benefits 
under'' the treaty. By contrast, the proposed treaty contains a 
more precise test that denies the benefits of the treaty only 
in cases where the income is not derived in connection with, or 
incidental to, the active conduct of a trade or business. 
<SUP>12</SUP> In addition, the proposed treaty gives the 
competent authority of the source country the ability to 
override this standard and to allow benefits if it so 
determines in its discretion.
---------------------------------------------------------------------------
    \12\ However, this active trade or business test does not apply 
with respect to a business of making or managing investments carried on 
by a person other than a bank or insurance company, so that treaty 
benefits may be denied with respect to such a business regardless of 
whether it is an active trade or business.
---------------------------------------------------------------------------
    Although the proposed treaty's active business test is 
similar to that of other U.S. tax treaties, the proposed treaty 
provides greater detail than other treaties. In some cases, the 
proposed treaty mirror provisions in the branch tax 
regulations, but may be more generous to taxpayers. In 
addition, like some recent U.S. treaties, the proposed treaty 
attributes to the treaty resident active trades or businesses 
conducted by other entities. The attribution rules in the 
proposed treaty may result in more taxpayers being eligible for 
treaty benefits, and permit certain third-country business 
operations to be treated as if they were carried on in Austria. 
These rules are similar to those in the U.S.-Netherlands treaty 
and the U.S.-France treaty.
    The proposed treaty includes a special rule designed to 
prevent the proposed treaty from reducing or eliminating U.S. 
tax on income of an Austrian resident in a case where no other 
substantial tax is imposed on that income (the so-called 
``triangular case''). This is necessary because an Austrian 
resident in some cases may be wholly or partially exempt from 
Austrian tax on foreign (i.e., non-Austrian) income. The 
special rule applies generally if the combined Austrian and 
third-country taxation of third-country income earned by an 
Austrian enterprise with a permanent establishment in the third 
country is less than 60 percent of the tax that would be 
imposed if the income were subject to tax in Austria.
    Under the special rule, the United States is permitted to 
tax U.S.-source interest and royalties paid to the third-
country permanent establishment in accordance with its internal 
law without regard to the treaty. There are several exceptions 
to this special rule. Under one of the exceptions, the special 
rule does not apply if the income is subject to U.S. taxation 
under the controlled foreign corporation rules. <SUP>13</SUP> 
The special rule for triangular cases is not included in the 
U.S. model.
---------------------------------------------------------------------------
    \13\ These provisions are contained in sections 951-964 of the Code 
(referred to as the ``subpart F'' rules).
---------------------------------------------------------------------------
    The practical difference between the proposed treaty tests 
and the earlier tests will depend upon how they are interpreted 
and applied. The principal purpose test may be applied 
leniently (so that any colorable business purpose suffices to 
preserve treaty benefits), or it may be applied strictly (so 
that any significant intent to obtain treaty benefits suffices 
to deny them). Similarly, the standards in the proposed treaty 
could be interpreted to require, for example, a more active or 
a less active trade or business (though the range of 
interpretation is far narrower). Thus, a narrow reading of the 
principal purpose test could theoretically be stricter than a 
broad reading of the proposed treaty test (i.e., would operate 
to deny benefits in potentially abusive situations more often).
    As part of its consideration of the proposed treaty, the 
Committee asked the Treasury Department about the adequacy of 
the anti-treaty-shopping provision in the proposed treaty. The 
relevant portion of the October 8, 1997 Treasury Department 
letter responding to this inquiry is reproduced below:

    Unlike the existing Convention, the proposed Convention 
with Austria contains a comprehensive anti-treaty-shopping 
provision. A Memorandum of Understanding provides an 
interpretation of key terms. Austria's recent membership in the 
European Union and the special United States ties to Canada and 
Mexico under the North American Free Trade Agreement are an 
element in the determination by the competent authority of 
eligibility for benefits of certain Austrian and United States 
companies. Recognized headquarters companies of multinational 
corporate groups are entitled to benefits of the Convention 
under rules that are substantively identical to the parallel 
rule in the U.S.-France treaty reviewed by the Committee in 
1995.
    The proposed Convention also provides for the elimination 
of another potential abuse relating to the granting of United 
States treaty benefits in the so-called triangular cases to 
income of an Austrian resident attributable to third-country 
permanent establishments of Austrian corporations that are 
exempt from tax in Austria by operation of Austria's law or 
treaties. Under the proposed rule, full United States treaty 
benefits will be granted in these triangular cases only when 
the United States-source income is subject to a sufficient 
level of tax in Austria and in the third country. As in the 
U.S.-France treaty, this anti-abuse rule does not apply in 
certain circumstances, including when the United States taxes 
the profits of the Austrian enterprise under subpart F of the 
Internal Revenue Code.

Committee Conclusions

    The Committee believes that limitation on benefits 
provisions are important to protect against ``treaty shopping'' 
by limiting benefits of a treaty to bona fide residents of the 
treaty partner. The Committee further believes that the United 
States should maintain its policy of limiting treaty shopping 
opportunities whenever possible. The Committee continues to 
believe further that, in exercising any latitude Treasury has 
to adjust the operation of the proposed treaty, the rules as 
applied should adequately deter treaty shopping abuses. The 
anti-treaty-shopping provision in the proposed treaty may be 
effective in preventing third-country investors from obtaining 
treaty benefits by establishing investing entities in Austria 
since third-country investors may be unwilling to share 
ownership of such investing entities on a less-than-50-percent 
basis with U.S. or Austrian residents or other qualified owners 
to meet the ownership test of the anti-treaty-shopping 
provision. In addition, the base erosion test provides 
protection from certain potential abuses of an Austrian 
conduit. Finally, Austria imposes significant taxes of its own; 
these taxes may deter third-country investors from seeking to 
use Austrian entities to make U.S. investments. On the other 
hand, implementation of the detailed tests for treaty shopping 
set forth in the proposed treaty may raise factual, 
administrative, or other issues that cannot currently be 
foreseen. The Committee emphasizes that the proposed anti-
treaty-shopping provision must be implemented so as to serve as 
an adequate tool for preventing possible treaty-shopping abuses 
in the future.

                           VII. Budget Impact

    The Committee has been informed by the staff of the Joint 
Committee on Taxation that the proposed treaty is estimated to 
cause a negligible change in fiscal year Federal budget 
receipts during the 1998-2007 period.

                  VIII. Explanation of Proposed Treaty

    A detailed, article-by-article explanation of the proposed 
income tax treaty between the United States and Austria is 
presented below. The MOU agreed to by the negotiators, and 
other matters set forth in diplomatic notes exchanged at the 
time the proposed treaty was signed, are covered together with 
the relevant articles of the proposed treaty.

Article 1. Personal Scope

    The personal scope article describes the persons who may 
claim the benefits of the proposed treaty.
            Overview
    The proposed treaty generally applies to residents of the 
United States and to residents of Austria, with specific 
modifications to such scope in other articles (e.g., Articles 
23 (Non-discrimination) and Article 25 (Exchange of Information 
and Administrative Assistance)).
    The proposed treaty provides that it generally does not 
restrict any exclusion, exemption, deduction, credit or other 
allowance accorded by internal law or by any other agreement 
between the United States and Austria. Thus, the proposed 
treaty will apply only where it benefits taxpayers. As 
discussed below in the Technical Explanation, the fact that the 
proposed treaty only applies to a taxpayer's benefit does not 
mean that a taxpayer could inconsistently select among treaty 
and internal law provisions in order to minimize its overall 
tax burden. The Technical Explanation sets forth the following 
example. Assume a resident of Austria has three separate 
businesses in the United States. One business is profitable, 
and constitutes a U.S. permanent establishment. The other two 
are trades or businesses that would generate effectively 
connected income as determined under the Code, but that do not 
constitute permanent establishments as determined under the 
proposed treaty; one trade or business is profitable and the 
other incurs a net loss. Under the Code, all three operations 
would be subject to U.S. income tax, in which case the losses 
from the unprofitable line of business could offset the taxable 
income from the other lines of business. On the other hand, 
only the income of the operation which gives rise to a 
permanent establishment would be taxable by the United States 
under the proposed treaty. The Technical Explanation makes 
clear that the taxpayer could not invoke the proposed treaty to 
exclude the profits of the profitable trade or business that 
does not constitute a permanent establishment and invoke U.S. 
internal law to claim the loss of the unprofitable trade or 
business that does not constitute a permanent establishment 
against the taxable income of the permanent establishment. 
<SUP>14</SUP>
---------------------------------------------------------------------------
    \14\ See Rev. Rul. 84-17, 1984-1 C.B. 308.
---------------------------------------------------------------------------
            Coordination with dispute resolution procedures of other 
                    agreements
    The proposed treaty provides that its dispute resolution 
procedures under the mutual agreement article take precedence 
over the corresponding provisions of any other agreement 
between the United States and Austria in determining whether a 
law or other measure is within the scope of the proposed 
treaty. Unless the competent authorities agree that the law or 
other measure is outside the scope of the proposed treaty, only 
the proposed treaty's nondiscrimination rules, and not the 
nondiscrimination rules of any other agreement in effect 
between the United States and Austria, generally apply to that 
law or other measure. The only exception to this general rule 
is that the national treatment or most-favored nation treatment 
of the General Agreement on Tariffs and Trade would continue to 
apply with respect to trade in goods. For purposes of this 
provision, the term ``measure'' means a law, regulation, rule, 
procedure, decision, administrative action, or any other form 
of measure.
            Saving clause
    Like all U.S. income tax treaties, the proposed treaty is 
subject to a ``saving clause.'' Under this clause, with 
specific exceptions described below, the proposed treaty is not 
to affect the taxation by either treaty country of its 
residents or its citizens. By reason of this saving clause, 
unless otherwise specifically provided in the proposed treaty, 
the United States will continue to tax its citizens who are 
residents of Austria as if the proposed treaty were not in 
force. ``Residents'' for purposes of the proposed treaty (and, 
thus, for purposes of the saving clause) include corporations 
and other entities as well as individuals who are not treated 
as residents of the other country under the proposed treaty 
tie-breaker provisions governing dual residents (as defined in 
Article 4 (Resident)).
    Like the U.S. model, the proposed treaty contains a 
provision under which the saving clause (and therefore the U.S. 
jurisdiction to tax) applies to a former U.S. citizen whose 
loss of citizenship had as one of its principal purposes the 
avoidance of tax; such application is limited to the ten-year 
period following the loss of citizenship. Prior to the 
enactment of the Health Insurance Portability and 
Accountability Act of 1996, section 877 of the Code provided 
special rules for the imposition of U.S. income tax on former 
U.S. citizens for a period of ten years following the loss of 
citizenship; these special tax rules applied to a former 
citizen only if his or her loss of U.S. citizenship had as one 
of its principal purposes the avoidance of U.S. income, estate 
or gift taxes. The Health Insurance Portability and 
Accountability Act of 1996 expanded section 877 in several 
respects. Under these amendments, the special income tax rules 
of section 877 were extended to apply also to certain former 
long-term residents of the United States. For purposes of 
applying the special tax rules to former citizens and long-term 
residents, individuals who meet a specified income tax 
liability threshold or a specified net worth threshold 
generally are considered to have lost citizenship or resident 
status for a principal purpose of U.S. tax avoidance. In 
addition, an expanded foreign tax credit is provided with 
respect to the U.S. tax imposed under these rules. The 
amendments to section 877 generally are applicable to 
individuals whose loss of U.S. citizenship or U.S. resident 
status occurred on or after February 6, 1995. The proposed 
treaty provision reflects the reach of the U.S. tax 
jurisdiction pursuant to section 877 prior to its expansion by 
the Health Insurance Portability and Accountability Act of 
1996. Accordingly, the saving clause in the proposed treaty 
does not permit the United States to impose tax on former U.S. 
long-term residents who otherwise would be subject to the 
special income tax rules contained in the Code.
    Exceptions to the saving clause are provided for the 
following benefits conferred by the proposed treaty: 
correlative adjustments to the income of enterprises associated 
with other enterprises the profits of which were adjusted by 
the other country (Article 9, paragraph 2); exemption from 
residence-country tax (or in the case of the United States, 
citizenship country tax) on gain accrued from the disposition 
of certain business assets (Article 13, paragraph 4); exemption 
from residence-country tax (or in the case of the United 
States, citizenship country tax) on social security benefits 
and alimony (Article 18, paragraphs 1(b) and 3); relief from 
double taxation (Article 22); nondiscrimination (Article 23); 
and mutual agreement procedures (Article 24).
    In addition, the saving clause does not apply to certain 
benefits conferred by one of the countries with respect to an 
individual who is neither a citizen of the conferring country 
nor, in the case of the United States, someone who has 
``immigrant status.'' Under this rule, for example, such treaty 
benefits are available to an Austrian citizen who spends enough 
time in the United States to be taxed as a U.S. resident under 
Code section 7701(b) (see discussion below in connection with 
Article 4 (Resident)), provided that the individual has not 
acquired U.S. immigrant status. The benefits that are subject 
to this rule are exemption from tax on compensation from 
government service to the other country (Article 19), exemption 
from host-country tax on certain income received by temporary 
visitors who are students and trainees (Article 20), and 
certain fiscal privileges of diplomatic agents and consular 
officers referred to in the proposed treaty (Article 26). An 
individual who has been admitted to the United States as a 
permanent resident under U.S. immigration laws (i.e., a ``green 
card'' holder) is considered to have ``immigrant status'' under 
the proposed treaty.
    The exceptions to the saving clause in the proposed treaty 
generally are consistent with the U.S. model and recent U.S. 
treaties. By contrast, although the double taxation provisions 
in paragraph 1 of Article XV of the present treaty afford 
protection to citizens, residents and corporations with respect 
to tax imposed by their home country, the saving clause in the 
present treaty sets forth only three exceptions. The first 
exception applies to governmental employment income derived by 
a resident of the other country (Article XI, paragraph (1)). 
The second exception applies to remuneration for teachers 
(Article XII). The third exception applies to remittances and 
maintenance for students and trainees (Article XIII).

Article 2. Taxes Covered

    The proposed treaty generally applies to the income taxes 
of the United States and Austria.
    In the case of the United States, the proposed treaty 
applies to the Federal income taxes imposed by the Code, but 
excluding social security taxes. Unlike many U.S. income tax 
treaties in force, but like the present treaty, the proposed 
treaty applies to the accumulated earnings tax and the personal 
holding company tax. In the case of Austria, the proposed 
treaty applies to the income tax (die Einkommensteuer) and the 
corporation tax (die Koerperschaftsteuer).
    For purposes of the non-discrimination article (Article 
23), the proposed treaty applies to taxes of all kinds imposed 
by the countries, including any taxes imposed by their 
political subdivisions or local authorities. In addition, for 
purposes of paragraphs 1 to 5 of the exchange of information 
and administrative assistance article (Article 25), the 
proposed treaty applies to taxes of all kinds imposed by the 
countries at the federal level.
    The proposed treaty also contains a provision generally 
found in U.S. income tax treaties (including the present 
treaty) to the effect that it will apply to any identical or 
substantially similar taxes that either country may 
subsequently impose. The proposed treaty obligates the 
competent authority of each country to notify the competent 
authority of the other country of any significant changes in 
its internal tax laws. The competent authorities also are to 
notify each other of any official published material concerning 
the application of the treaty. This clause is similar to the 
U.S. model.

Article 3. General Definitions

    Certain of the standard definitions found in most U.S. 
income tax treaties are contained in the proposed treaty.
    The term ``Austria'' comprises the Republic of Austria.
    The term ``United States'' means the United States of 
America, but does not include Puerto Rico, the Virgin Islands, 
Guam or any other U.S. possession or territory. When used in a 
geographical sense, it means the States and the District of 
Columbia. It also includes the territorial waters of the United 
States and the seabed and subsoil of the submarine areas 
adjacent to the territorial waters and over which the United 
States has exclusive rights, in accordance with international 
law, with respect to the exploration and exploitation of 
natural resources. Under the proposed treaty, these same areas 
are considered part of the United States for treaty purposes, 
but only to the extent that the person, property, or activity 
to which the proposed treaty is being applied is connected with 
such exploration or exploitation.
    The term ``person'' includes an individual, an estate, a 
trust, a company, and any other body of persons. A ``company'' 
is any body corporate or any entity which is treated as a body 
corporate for tax purposes.
    An enterprise of a country is defined as an enterprise 
carried on by a resident of that country. The proposed treaty 
does not define the term ``enterprise.''
    Under the proposed treaty, a person is considered a 
national of one of the treaty countries if the person is an 
individual possessing nationality of that country, or a legal 
person, partnership, or association deriving its status as such 
from the law in force in that country.
    The Austrian competent authority is the Federal Minister of 
Finance or his delegate. The U.S. competent authority is the 
Secretary of the Treasury or his delegate. The U.S. competent 
authority function has been delegated to the Commissioner of 
Internal Revenue, who has redelegated the authority to the 
Assistant Commissioner (International) of the IRS. On 
interpretative issues, the latter acts with the concurrence of 
the Associate Chief Counsel (International) of the IRS.
    The proposed treaty also contains the standard provision 
that, unless the context otherwise requires or the competent 
authorities of the two countries establish a common meaning, 
all terms not defined in the treaty are to have the meanings 
which they have under the laws of the country applying the 
treaty. The MOU includes a special provision with respect to 
the interpretation of the proposed treaty. Generally, the OECD 
Commentary is to apply in interpreting any provision of the 
proposed treaty that corresponds to a provision of the OECD 
model. <SUP>15</SUP> However, this general rule does not apply 
if either the United States or Austria has entered a 
reservation or has included an observation with respect to the 
OECD model or its Commentary. In addition, this rule also does 
not apply if a contrary interpretation is included in the MOU 
or a published interpretation of the proposed treaty (e.g., the 
Technical Explanation) that has been provided to the competent 
authorities of both countries or has been agreed to by the 
competent authorities. The Technical Explanation clarifies that 
the Technical Explanation overrides a different interpretation 
in the OECD Commentary, even where the OECD Commentary is 
adopted subsequent to the issuance of the Technical 
Explanation.
---------------------------------------------------------------------------
    \15\ The applicability of the OECD Commentary to the proposed 
treaty is consistent with the Vienna Convention on the Law of Treaties 
of May 23, 1969 (the ``Vienna Convention''). The United States has not 
yet ratified the Vienna Convention.
---------------------------------------------------------------------------

Article 4. Resident

            In general
    The assignment of a country of residence is important 
because the benefits of the proposed treaty generally are 
available only to a resident of one of the treaty countries as 
that term is defined in the treaty. Furthermore, double 
taxation is often avoided by the assignment of a single treaty 
country as the country of residence when, under the internal 
laws of the treaty countries, a person is a resident of both.
    Under U.S. law, residence of an individual is important 
because a resident alien is taxed on worldwide income, while a 
nonresident alien is taxed only on certain U.S.-source income 
and on income that is effectively connected with a U.S. trade 
or business. An individual who spends substantial time in the 
United States in any year or over a three-year period generally 
is treated as a U.S. resident (Code sec. 7701(b)). A permanent 
resident for immigration purposes (i.e., a green-card holder) 
also is treated as a U.S. resident. The standards for 
determining residence provided in the Code do not alone 
determine the residence of a U.S. citizen for the purpose of 
any U.S. tax treaty (such as a treaty that benefits residents, 
rather than citizens, of the United States.) Under the Code, a 
company is domestic, and therefore taxable on its worldwide 
income, if it is organized in the United States or under the 
laws of the United States, a State, or the District of 
Columbia.
    The proposed treaty generally defines ``resident of a 
Contracting State'' to mean any person who, under the laws of 
that country, is liable to tax in that country by reason of his 
or her domicile, residence, citizenship, place of management, 
place of incorporation, or any other criterion of a similar 
nature. A U.S. citizen or a green-card holder who is not a 
resident of Austria is treated as a U.S. resident under the 
proposed treaty only if the individual has a substantial 
presence, permanent home, or habitual abode in the United 
States. Consistent with most U.S. income tax treaties, 
citizenship alone does not establish residence. As a result, 
U.S. citizens residing overseas are not necessarily entitled to 
the benefits of the proposed treaty as U.S. residents. The 
Technical Explanation provides that the term ``substantial 
presence'' under the proposed treaty is a similar concept to 
``substantial presence'' under Code section 7701(b); 
``permanent home'' and ``habitual abode'' are terms frequently 
used in treaty ``tie-breaker'' rules, as described below.
    The term ``resident of a Contracting State'' does not 
include any person who is liable to tax in that country in 
respect only of income from sources in that country. In the 
case of income derived by, or paid by, a partnership, estate or 
trust, the term applies only to the extent that the income it 
derives is subject to that country's tax as the income of a 
resident, either in its hands or in the hands of its partners, 
beneficiaries or grantors. For example, if the U.S. 
beneficiaries' share in the income of a U.S. trust is only one-
half, Austria would have to reduce its withholding tax pursuant 
to the proposed treaty on only one-half of the Austrian-source 
income paid to the trust. The MOU provides that a similar test 
applies in determining the residence of other pass-through 
entities, such as limited liability companies.
    According to the Technical Explanation, it is understood 
that a tax-exempt organization, including a pension trust, that 
is established under the laws of the United States or Austria 
is treated as a resident of the country under the laws of which 
it is established for purposes of the proposed treaty.
    These provisions of the proposed treaty generally are based 
on the provisions of the U.S. and OECD models and are similar 
to the provisions found in other U.S. tax treaties.
            Dual residents

Individuals

    A set of ``tie-breaker'' rules is provided to determine 
residence in the case of an individual who, under the basic 
residence rules, would be considered to be a resident of both 
countries. Such a dual resident individual will be deemed to be 
a resident of the country in which he or she has a permanent 
home available. If this permanent home test is inconclusive 
because the individual has a permanent home in both countries 
or in neither country, the individual's residence is deemed to 
be the country with which his or her personal and economic 
relations are closer (i.e., the ``center of vital interests''). 
The MOU provides that the center of vital interests may not be 
determinable solely by reviewing the circumstances prevailing 
in one single year; a longer period may have to be taken into 
consideration. If the country in which the individual has his 
or her center of vital interests cannot be determined, such 
individual is deemed to be a resident of the country in which 
he or she has an habitual abode. If the individual has an 
habitual abode in both countries or in neither country, the 
individual is deemed to be a resident of the country of which 
he or she is a national. If the individual is a national of 
both countries or neither of them, the competent authorities of 
the countries are to settle the question of residence by mutual 
agreement.

Entities

    In the case of a company that is resident in both countries 
under the basic residence rules, the proposed treaty provides 
that the company is treated as a resident of the country under 
the laws of which the company was created. This rule conforms 
with U.S. internal law.
    In the case of a person other than an individual or a 
company that is resident in both countries under the basic 
residence rules, the proposed treaty, like the U.S. model, 
requires the competent authorities of the two countries to 
determine by mutual agreement the residence of such person and 
the mode of application of the treaty to such person.

Article 5. Permanent Establishment

    The proposed treaty contains a definition of the term 
``permanent establishment'' that generally follows the pattern 
of other recent U.S. income tax treaties, the U.S. model and 
the OECD model.
    The permanent establishment concept is one of the basic 
devices used in income tax treaties to limit the taxing 
jurisdiction of the host country and thus to mitigate double 
taxation. Generally, an enterprise that is a resident of one 
country is not taxable by the other country on its business 
profits unless those profits are attributable to a permanent 
establishment of the resident in the other country. In 
addition, the permanent establishment concept is used to 
determine whether the reduced rates of, or exemptions from, tax 
provided for dividends, interest, and royalties apply, or 
whether those amounts are taxed as business profits.
    In general, under the proposed treaty, a permanent 
establishment is a fixed place of business through which an 
enterprise engages in business. A permanent establishment 
includes a place of management, a branch, an office, a factory, 
a workshop, a mine, an oil or gas well, a quarry, or any other 
place of extraction of natural resources. It also includes any 
building site or construction or installation project or an 
installation or drilling rig or ship used for the exploration 
or development of natural resources if the site or project 
lasts for more than 12 months. The Technical Explanation states 
that projects that are commercially and geographically 
interdependent are to be treated as a single project for 
purposes of the 12-month test. The 12-month period for 
establishing a permanent establishment in connection with a 
site or project corresponds to the rule of the U.S. model.
    The general definition of a permanent establishment is 
modified to provide that a fixed place of business that is used 
for any of a number of specified activities will not constitute 
a permanent establishment. These activities include the use of 
facilities solely for storing, displaying, or delivering goods 
or merchandise belonging to the enterprise and the maintenance 
of a stock of goods or merchandise belonging to the enterprise 
solely for storage, display, or delivery or solely for 
processing by another enterprise. These activities also include 
the maintenance of a fixed place of business solely for the 
purchase of goods or merchandise or the collection of 
information for the enterprise. These activities further 
include the maintenance of a fixed place of business solely for 
the purpose of carrying on, for the enterprise, any other 
activity of a preparatory or auxiliary character. The Technical 
Explanation refers to advertising and supplying information as 
examples of activities that are of a preparatory or auxiliary 
character. The proposed treaty, like the U.S. model, provides 
that the maintenance of a fixed place of business solely for 
any combination of these activities will not constitute a 
permanent establishment.
    If a person has, and habitually exercises, the authority to 
conclude contracts in a country on behalf of an enterprise of 
the other country, the enterprise generally is deemed to have a 
permanent establishment in the first country in respect of any 
activities that person undertakes for the enterprise. 
Consistent with the U.S. and OECD models, this rule does not 
apply where the contracting authority is limited to those 
activities described above, such as storage, display, or 
delivery of merchandise, which are excluded from the definition 
of a permanent establishment. The proposed treaty contains the 
usual provision that no permanent establishment is deemed to 
arise based on an agent's activities if the agent is a broker, 
general commission agent, or any other agent of independent 
status acting in the ordinary course of its business.
    The fact that a company that is resident in one country is 
related to a company that is a resident of the other country or 
to a company that engages in business in that other country 
does not of itself cause either company to be a permanent 
establishment of the other.

Article 6. Income from Real Property

    This article covers income, but not gains, from real 
property. The rules covering gains from the sale of real 
property are contained in Article 13 (Capital Gains).
    Under the proposed treaty, income derived by a resident of 
one country from real property situated in the other country 
may be taxed in the country where the real property is located. 
Income from real property includes income from agriculture or 
forestry.
    The term ``real property'' generally has the meaning that 
it has under the law of the country in which the property in 
question is situated. The term in any case includes property 
accessory to real property; livestock and equipment used in 
agriculture and forestry; rights to which the provisions of 
general law respecting landed property apply; usufruct of real 
property; and rights to variable or fixed payments as 
consideration for the working of, or the right to work, mineral 
deposits, sources, and other natural resources. Thus, income 
from real property includes royalties and other payments in 
respect of the exploitation of natural resources (e.g., oil). 
Ships, boats and aircraft are not real property. This 
definition corresponds to the definition of real property in 
the OECD model.
    The proposed treaty specifies that the source country may 
tax income derived from the direct use, letting, or use in any 
other form of real property. The rules of this article allowing 
source-country taxation also apply to income from real property 
of an enterprise and to income from real property used for the 
performance of independent personal services.
    The MOU clarifies that the source country may tax the 
income derived from the exploitation of rights in real 
property. For example, a U.S. person that is a lessee of real 
property situated in Austria is subject to Austrian tax on the 
income derived from any sublease of the same property, even 
though the U.S. person is not the owner of the real property.
    The present treaty permits the source country to tax 
interest on mortgages secured by real property under this 
article. The proposed treaty eliminates this rule and treats 
such interest in the same way as other types of interest, which 
generally is free from source-country tax (see Article 11).
    Like the U.S. model and certain other U.S. income tax 
treaties, the proposed treaty provides residents of one country 
with an election to be taxed on a net basis by the other 
country on income from real property in that other country. 
U.S. internal law provides such a net-basis election in the 
case of income of a foreign person from U.S. real property 
income (Code secs. 871(d) and 882(d)). The proposed treaty 
provides that any such election shall be binding for the 
taxable year of the election and all subsequent taxable years, 
unless the competent authorities of the treaty countries agree 
to terminate the election pursuant to a request by the taxpayer 
made to the competent authority of the country in which the 
taxpayer is resident.

Article 7. Business Profits

            U.S. internal law
    U.S. law distinguishes between the U.S. business income and 
other U.S. income of a nonresident alien or foreign 
corporation. A nonresident alien or foreign corporation is 
subject to a flat 30-percent rate (or lower treaty rate) of tax 
on certain U.S.-source income if that income is not effectively 
connected with the conduct of a trade or business within the 
United States. The regular individual or corporate rates apply 
to income (from any source) which is effectively connected with 
the conduct of a trade or business within the United States.
    The treatment of income as effectively connected with a 
U.S. trade or business depends upon whether the source of the 
income is U.S. or foreign. In general, U.S.-source periodic 
income (such as interest, dividends, and rents), and U.S.-
source capital gains are effectively connected with the conduct 
of a trade or business within the United States if the asset 
generating the income is used in or held for use in the conduct 
of the trade or business or if the activities of the trade or 
business were a material factor in the realization of the 
income. All other U.S.-source income of a person engaged in a 
trade or business in the United States is treated as 
effectively connected with the conduct of a trade or business 
in the United States (referred to as a ``force of attraction'' 
rule).
    Foreign-source income generally is treated as effectively 
connected income only if the foreign person has an office or 
other fixed place of business in the United States and the 
income is attributable to that place of business. Only three 
types of foreign-source income are considered to be effectively 
connected income: rents and royalties for the use of certain 
intangible property derived from the active conduct of a U.S. 
business; certain dividends and interest either derived in the 
active conduct of a banking, financing or similar business in 
the United States or received by a corporation the principal 
business of which is trading in stocks or securities for its 
own account; and certain sales income attributable to a U.S. 
sales office. Special rules apply in the case of insurance 
companies.
    Any income or gain of a foreign person for any taxable year 
that is attributable to a transaction in another taxable year 
is treated as effectively connected with the conduct of a U.S. 
trade or business if it would have been so treated had it been 
taken into account in that other taxable year (Code sec. 
864(c)(6)). In addition, if any property ceases to be used or 
held for use in connection with the conduct of a trade or 
business within the United States, the determination of whether 
any income or gain attributable to a sale or exchange of that 
property occurring within ten years after the cessation of 
business is effectively connected with the conduct of a trade 
or business within the United States is made as if the sale or 
exchange occurred immediately before the cessation of business 
(Code sec. 864(c)(7)).
            Proposed treaty limitations on internal law
    Under the proposed treaty, business profits of an 
enterprise of one country are taxable in the other country only 
to the extent that they are attributable to a permanent 
establishment in the other country through which the enterprise 
carries on business. The taxation of business profits under the 
proposed treaty differs from U.S. rules for taxing business 
profits primarily by requiring more than merely being engaged 
in a trade or business before a country can tax business 
profits and by substituting an ``attributable to'' standard for 
the Code's ``effectively connected'' standard. <SUP>16</SUP> 
Under the Code, all that is necessary for effectively connected 
business profits to be taxed is that a trade or business be 
carried on in the United States.
---------------------------------------------------------------------------
    \16\ However, some articles of the proposed treaty use the phrase 
``effectively connected''; see, e.g., Article 10 (Dividends).
---------------------------------------------------------------------------
    The present treaty contains a force of attraction rule 
similar to that in the Code as described above. The proposed 
treaty eliminates this rule. The proposed treaty is consistent 
with the U.S. and OECD models and other existing U.S. treaties 
in this respect.
    The business profits of a permanent establishment are 
determined on an arm's-length basis. Thus, there are to be 
attributed to a permanent establishment the business profits 
which would reasonably be expected to have been derived by it 
if it were a distinct and separate entity engaged in the same 
or similar activities under the same or similar conditions and 
dealing wholly independently with the enterprise of which it is 
a permanent establishment. For example, this arm's-length rule 
applies to transactions between the permanent establishment and 
a branch of the resident enterprise located in a third country. 
Amounts may be attributed to the permanent establishment 
whether they are from sources within or without the country in 
which the permanent establishment is located.
    In computing taxable business profits, the proposed treaty 
provides that deductions are allowed for expenses incurred for 
the purposes of the permanent establishment. These deductions 
include a reasonable allocation of executive and general 
administrative expenses, research and development expenses, 
interest, and other expenses incurred for the purposes of the 
enterprise as a whole (or, if not the enterprise as a whole, at 
least the part of the enterprise that includes the permanent 
establishment). According to the Technical Explanation, under 
this language, the United States is free to use its current 
expense allocation rules, including the rules for allocating 
deductible interest expense under Treas. Reg. sec. 1.882-5, in 
determining deductible amounts. Thus, for example, an Austrian 
company which has a branch office in the United States but 
which has its head office in Austria will, in computing the 
U.S. tax liability of the branch, be entitled to deduct a 
portion of the executive and general administrative expenses 
incurred in Austria by the head office for purposes of 
operating the U.S. branch, allocated and apportioned in 
accordance with Treas. Reg. sec. 1.861-8.
    Business profits will not be attributed to a permanent 
establishment merely by reason of the purchase of merchandise 
by a permanent establishment for the enterprise. Thus, where a 
permanent establishment purchases goods for its head office, 
the business profits attributed to the permanent establishment 
with respect to its other activities will not be increased by 
the profit element with respect to its purchasing activities.
    The amount of profits attributable to a permanent 
establishment must be determined by the same method each year 
unless there is good and sufficient reason to change the 
method. Where business profits include items of income which 
are dealt with separately in other articles of the treaty, 
those other articles, and not the business profits article, 
will govern the treatment of such items of income. Thus, for 
example, dividends are taxed under the provisions of Article 10 
(Dividends), and not as business profits, except as provided in 
paragraph 6 of Article 10.
    Under the proposed treaty, the term ``business profits'' 
includes income from the rental of tangible personal property. 
Under the present treaty, income from the rental of certain 
tangible personal property is treated as royalties.
    The proposed treaty contains a special rule which treats 
income derived from an Austrian ``sleeping partnership'' 
(Stille Gesellschaft) by a U.S. ``sleeping partner'' as 
business profits attributable to the permanent establishment of 
the partnership in Austria. According to the Technical 
Explanation, a sleeping partnership is a contract concluded 
under commercial law by which an investor (the sleeping 
partner) contributes money or money's worth to the business of 
the contracting partner in exchange for a share in the profits 
of the business and the right to obtain specified information 
about the development of the business. The sleeping partner may 
agree under the contract to bear a portion of the losses of the 
business.
    The Technical Explanation states that there are two types 
of sleeping partnerships under Austrian tax law: the typical 
form and the non-typical form. In a typical sleeping 
partnership, a sleeping partner does not participate in the 
capital and assets of the business, and his rights upon 
withdrawal from the partnership are limited to the return of 
his investment. The profits of a sleeping partner in a typical 
sleeping partnership generally are treated as income from 
investment activities for Austrian tax purposes. In a non-
typical sleeping partnership, a sleeping partner is entitled to 
participate in the increase in net wealth of the business 
property as well as profits and losses of the business. Unlike 
profits in a typical sleeping partnership, the profits of a 
sleeping partner in a non-typical sleeping partnership are 
treated as income from commercial activities for Austrian tax 
purposes. Whether a particular sleeping partnership should be 
characterized as typical or non-typical under Austrian tax law 
may be unclear.
    Under the proposed treaty, any income earned during the 
existence of and attributable to a permanent establishment or 
fixed base is taxable in the country where that permanent 
establishment or fixed base is situated, even if the payments 
with respect to such income are deferred until such permanent 
establishment or fixed base has ceased to exist. Thus, the 
proposed treaty permits the United States to apply the 
principles of Code section 864(c)(6) to the profits that rely 
for their taxability upon a nexus with a permanent 
establishment or fixed base. The proposed treaty rule that 
corresponds to the rule of Code section 864(c)(7) is discussed 
below in connection with the taxation of capital gains (Article 
13). <SUP>17</SUP>
---------------------------------------------------------------------------
    \17\ This rule applies to business profits (Article 7, paragraphs 1 
and 2), dividends (Article 10, paragraph 4), interest (Article 11, 
paragraph 3), royalties (Article 12, paragraph 4), capital gains 
(Article 13, paragraph 3), independent personal services (Article 14), 
and other income (Article 21, paragraph 2).
---------------------------------------------------------------------------

Article 8. Shipping and Air Transport

    Article 8 of the proposed treaty covers income from the 
operation of ships and aircraft in international traffic. The 
rules governing income from the sale of ships and aircraft 
operated in international traffic are contained in Article 13 
(Capital Gains).
    Under the Code, the United States generally taxes the U.S.-
source income of a foreign person from the operation of ships 
or aircraft to or from the United States. An exemption from 
U.S. tax is provided if the income is earned by a corporation 
that is organized in, or an alien individual who is resident 
in, a foreign country that grants an equivalent exemption to 
U.S. corporations and residents. The United States has entered 
into agreements with a number of countries, including Austria, 
providing such reciprocal exemptions. Benefits accorded under 
such an agreement are not restricted by the proposed treaty.
    Under the proposed treaty, profits which are derived by an 
enterprise of one country from the operation in international 
traffic of ships or aircraft (``shipping profits'') are taxable 
only in that country, regardless of the existence of a 
permanent establishment in the other country. The proposed 
treaty defines ``international traffic'' as any transport by a 
ship or aircraft operated by an enterprise of one of the treaty 
countries, except when the ship or aircraft is operated solely 
between places in one of the treaty countries (Article 
3(1)(d)(General Definitions)). Accordingly, with respect to an 
Austrian enterprise, purely domestic transport in the United 
States is excluded. The present treaty exempts all profits 
derived by an enterprise from the operation of ships or 
aircraft from source-country tax.
    For purposes of the proposed treaty, shipping profits 
include rental income from full or bareboat leases of ships or 
aircraft, if such ships or aircraft are operated in 
international traffic by the lessee or if the rental income is 
incidental to profits from the operation of ships or aircraft 
in international traffic. Thus, the exemption from source-
country tax for shipping profits applies to a bareboat lessor 
(such as a financial institution or a leasing company) that 
does not operate ships or aircraft in international traffic, 
but that leases ships or aircraft for use in international 
traffic.
    According to the Technical Explanation, exemption also is 
available for profits from the inland transport of property or 
passengers within a country if such transport is undertaken as 
part of international traffic. Like the U.S. model, the 
proposed treaty expressly provides that income derived by an 
enterprise of one country from the use, maintenance, or rental 
of containers (including trailers, barges, and related 
equipment for the transport of containers) used in 
international traffic is exempt from tax by the other country. 
The Technical Explanation states that the same rule applies to 
a such income derived by a resident of either country through a 
partnership or other pass-through entity.
    The shipping and air transport provisions of the proposed 
treaty, other than the foregoing provisions with respect to 
income from container leasing, also apply to profits from 
participation in a pool, joint business, or international 
operating agency. This refers to various arrangements for 
international cooperation by carriers in shipping and air 
transport. The Technical Explanation clarifies that container 
leasing profits, which are supplementary or incidental to the 
operation of international traffic of ships or aircraft, from 
the participation in a pool, a joint business or an 
international operating agency also are exempt from source-
country tax.

Article 9. Associated Enterprises

    The proposed treaty, like most other U.S. tax treaties, 
contains an arm's-length pricing provision. The proposed treaty 
recognizes the right of each country to determine the profits 
taxable by that country in the case of transactions between 
related enterprises, if the profits of an enterprise do not 
reflect the conditions which would have been made between 
independent enterprises. The proposed treaty provides that it 
is understood, however, that the fact that associated 
enterprises have concluded arrangements, such as cost-sharing 
arrangements or general services agreements, for or based on 
the allocation of executive, general administrative, technical 
and commercial expenses, research and development expenses, and 
other similar expenses, is not in itself a condition giving 
rise to this right.
    For purposes of the proposed treaty, an enterprise of one 
country is related to an enterprise of the other country if one 
of the enterprises participates directly or indirectly in the 
management, control, or capital of the other enterprise. 
Enterprises are also related if the same persons participate 
directly or indirectly in the management, control, or capital 
of such enterprises.
    Like the present Austrian treaty and the U.S. and OECD 
models, the proposed treaty does not include the paragraph 
contained in many other U.S. tax treaties which provides that 
the rights of the treaty countries to apply internal law 
provisions relating to adjustments between related parties are 
fully preserved. Nevertheless, the Technical Explanation 
provides that the respective countries retain the right to 
apply their internal intercompany pricing rules (e.g., Code 
sec. 482, in the case of the United States).
    When a redetermination of tax liability has been properly 
made by one country, the other country will make an appropriate 
adjustment to the amount of tax charged in that country on the 
redetermined income. This ``correlative adjustment'' clause has 
no counterpart in the present treaty. In making that 
adjustment, due regard is to be given to other provisions of 
the treaty and the competent authorities of the two countries 
will consult with each other if necessary. For example, under 
the mutual agreement article (Article 24), a correlative 
adjustment cannot necessarily be denied on the ground that the 
time period set by internal law for claiming a refund has 
expired. To avoid double taxation, the proposed treaty's saving 
clause retaining full taxing jurisdiction in the country of 
residence or nationality (discussed above in connection with 
Article 1 (Personal Scope)) will not apply in the case of such 
adjustments.

Article 10. Dividends

            Overview
    The proposed treaty replaces the dividend article of the 
present treaty with a new article that makes several changes. 
First, the proposed treaty generally liberalizes the conditions 
under which the 5-percent direct dividend withholding rate 
limitation is imposed. Second, the proposed treaty permits 
exceptions to the general 5-percent and 15-percent source-
country tax rates on dividends from a regulated investment 
company (``RIC'') or a REIT. Third, the proposed treaty permits 
the application by the source country of the treaty's dividend 
tax rates to income from arrangements, including debt 
obligations, carrying the right to participate in profits. 
Finally, the proposed treaty expressly permits the United 
States to collect a 5-percent branch profits tax from an 
Austrian company.
            U.S. internal law

Dividends and second-level withholding tax

    The United States generally imposes a 30-percent tax on the 
gross amount of U.S.-source dividends paid to nonresident alien 
individuals and foreign corporations. The 30-percent tax does 
not apply if the foreign recipient is engaged in a trade or 
business in the United States and the dividends are effectively 
connected with that trade or business. In such a case, the 
foreign recipient is subject to U.S. tax on such dividends on a 
net basis at graduated rates in the same manner that a U.S. 
person would be taxed.
    Under U.S. law, the term dividend generally means any 
distribution of property made by a corporation to its 
shareholders, either from accumulated earnings and profits or 
current earnings and profits. However, liquidating 
distributions generally are treated as payments in exchange for 
stock and thus are not subject to the 30-percent withholding 
tax described above (see discussion of capital gains in 
connection with Article 13 below).
    Dividends paid by a U.S. corporation generally are U.S.-
source. Also treated as U.S.-source dividends for this purpose 
are portions of certain dividends paid by a foreign corporation 
that conducts a U.S. trade or business. The U.S. 30-percent 
withholding tax imposed on the U.S.-source portion of the 
dividends paid by a foreign corporation is referred to as the 
``second-level'' withholding tax. This second-level withholding 
tax is imposed only if a treaty prevents application of the 
statutory branch profits tax.
    In general, corporations are not entitled under U.S. law to 
a deduction for dividends paid. Thus, the withholding tax on 
dividends theoretically represents imposition of a second-level 
of tax on corporate taxable income. Treaty reductions of this 
tax reflect the view that where the United States already 
imposes corporate level tax on the earnings of a U.S. 
corporation, a 30-percent withholding rate may represent an 
excessive level of source-country taxation. Moreover, the 
reduced rate of tax often applied by treaty to dividends paid 
to direct investors reflects the view that the source-country 
tax on payments of profits to a substantial foreign corporate 
shareholder may properly be reduced further to avoid double 
corporate-level taxation and to facilitate international 
investment.
    A REIT is a corporation, trust, or association that is 
subject to the regular corporate income tax, but that receives 
a deduction for dividends paid to its shareholders if certain 
conditions are met. In order to qualify for the deduction for 
dividends paid, a REIT must distribute most of its income. 
Thus, a REIT is treated, in essence, as a conduit for federal 
income tax purposes. Because a REIT is taxable as a U.S. 
corporation, a distribution of its earnings is treated as a 
dividend rather than income of the same type as the underlying 
earnings. Such distributions are subject to the U.S. 30-percent 
withholding tax when paid to foreign owners.
    A REIT is organized to allow persons to diversify ownership 
in primarily passive real estate investments. As such, the 
principal income of a REIT often is rentals from real estate 
holdings. Like dividends, U.S.-source rental income of foreign 
persons generally is subject to the 30-percent withholding tax 
(unless the recipient makes an election to have such rental 
income taxed in the United States on a net basis at the regular 
graduated rates). Unlike the withholding tax on dividends, 
however, the withholding tax on rental income generally is not 
reduced in U.S. income tax treaties.
    U.S. internal law also generally treats a RIC as both a 
corporation and a conduit for income tax purposes. The purpose 
of a RIC is to allow investors to hold a diversified portfolio 
of securities. Thus, the holder of stock in a RIC may be 
characterized as a portfolio investor in the stock held by the 
RIC, regardless of the proportion of the RIC's stock owned by 
the dividend recipient.

U.S. branch profits tax rules

    A foreign corporation engaged in the conduct of a trade or 
business in the United States is subject to a flat 30-percent 
branch profits tax on its ``dividend equivalent amount.'' The 
dividend equivalent amount is the corporation's earnings and 
profits which are attributable to its income that is 
effectively connected with its U.S. trade or business, 
decreased by the amount of such earnings that are reinvested in 
business assets located in the United States (or used to reduce 
liabilities of the U.S. business), and increased by any such 
previously reinvested earnings that are withdrawn from 
investment in the U.S. business. The dividend equivalent amount 
is limited by (among other things) aggregate earnings and 
profits accumulated in taxable years beginning after December 
31, 1986.
            Austrian internal law
    Austria generally imposes a 25-percent withholding tax on 
certain Austrian-source payments that include dividends. The 
withholding tax generally applies to dividends, other corporate 
distributions, and interest on profit-sharing and convertible 
bonds by an Austrian corporation whether paid to individual or 
corporate residents or nonresidents. The withholding tax does 
not apply to a dividend paid to a foreign corporation residing 
in a European Union (``EU'') member country, if the dividend is 
subject to Austrian tax law provisions enacted in response to 
the so-called ``parent-subsidiary directive'' approved by the 
EC Council of Ministers on July 23, 1990.
    Like U.S. corporate tax law, Austrian tax law generally 
embodies the so-called ``classical system'' under which 
corporate income may be taxed at the corporate level, and then 
taxed again at the shareholder level upon a distribution. A 
participation exemption is available if the recipient company 
owns 25 percent or more of the share capital of the payor 
company directly and continuously for at least 12 months prior 
to the end of the taxable year in which the dividend is paid.
    Austria does not impose a branch profits tax.
            Proposed treaty limitations on internal law

Reduction of withholding tax

    Under the proposed treaty, each country may tax dividends 
paid by its resident companies, but the rate of tax is limited 
by the proposed treaty if the beneficial owner of the dividends 
is a resident of the other country. Source-country taxation 
generally is limited to 5 percent of the gross amount of the 
dividends if the beneficial owner of the dividends is a company 
(other than a partnership) which holds directly at least 10 
percent of the voting shares of the payor company. Under the 
proposed treaty, the tax generally is limited to 15 percent of 
the gross amount of the dividends paid to residents of the 
other country in all other cases. Under the present treaty, 
source-country tax may be imposed at a 15-percent rate, rather 
than only a 5-percent rate, unless a higher ownership threshold 
is met (95-percent stock ownership by one recipient corporation 
residing in the other country).
    Under the present treaty, the prohibition on source-country 
tax at a rate exceeding 5 percent does not apply in certain 
cases where more than 25 percent of the gross income of the 
dividend payor consisted of interest and dividends. The 
proposed treaty eliminates this rule, and replaces it with 
rules similar to those adopted in recent U.S. treaties that 
allow source-country tax in excess of 5 percent on direct 
investment dividends from a RIC or REIT.
    The proposed treaty provides that the 15-percent maximum 
tax rate applies to dividends paid by a RIC. The proposed 
treaty provides that the 15-percent maximum tax rate applies to 
dividends paid by a REIT to an individual owning less than 10-
percent of the REIT. There is no limitation in the proposed 
treaty on the tax that may be imposed by the United States on a 
REIT dividend that is beneficially owned by an Austrian 
resident, if the beneficial owner of the dividend is either an 
individual holding a 10-percent-or-greater interest in the REIT 
or if the beneficial owner is not an individual. The MOU makes 
clear that such a dividend is taxable at the 30-percent United 
States statutory rate.

Definition of dividends

    Unlike the U.S. and OECD models, the present treaty 
provides no express definition of the term ``dividends''. The 
proposed treaty provides a definition of dividends that is 
broader than the definition in the U.S. model and some other 
recent U.S. treaties. Similar to the U.S. model, the proposed 
treaty generally defines ``dividends'' as income from shares or 
other rights (not being debt claims) participating in profits. 
Dividends also include income from other corporate rights that 
is subjected to the same tax treatment as income from shares by 
the country in which the distributing company is resident. The 
proposed treaty also provides (unlike the U.S. model) that the 
term dividends includes income from arrangements, including 
debt obligations, carrying the right to participate in profits, 
to the extent such income is characterized as dividends under 
the law of the country in which the income arises.

Special rules and exceptions

    The proposed treaty's reduced rates of tax on dividends do 
not apply if the recipient of the dividend carries on business 
through a permanent establishment (or a fixed base, in the case 
of an individual who performs independent personal services) in 
the source country and the holding on which the dividends are 
paid is effectively connected with the permanent establishment 
(or fixed base). Dividends paid on such holdings of a permanent 
establishment or a fixed base is taxed as business profits 
(Article 7) or as income from the performance of independent 
personal services (Article 14). In addition, dividends 
attributable to a permanent establishment or fixed base, but 
received after the permanent establishment or fixed base is no 
longer in existence are taxable in the country where the 
permanent establishment or fixed base existed (Article 7, 
paragraph 9).
    The proposed treaty contains a general limitation on the 
taxation by one country of dividends paid by companies that are 
residents of the other country. Under this provision, the 
United States may not, except in two cases, impose any taxes on 
dividends paid by an Austrian resident company that derives 
profits or income from the United States. The first exception 
is the case where the dividends are paid to U.S. residents. The 
second exception is where the holding in respect of which the 
dividends are paid is effectively connected with a U.S. 
permanent establishment or a fixed base in the United States. 
This rule is somewhat less restrictive of the United States' 
taxing jurisdiction than the corresponding rule in the present 
treaty. The present treaty provides that dividends paid by an 
Austrian corporation are exempt from U.S. tax in any case where 
the recipient is not a U.S. citizen, resident, or corporation.

Branch profits tax

    The proposed treaty allows the United States to impose the 
branch profits tax (as opposed to the branch-level excess 
interest tax (Code sec. 884(f)), described below) on an 
Austrian resident corporation that either has a permanent 
establishment in the United States, or is subject to tax on a 
net basis in the United States on income from real property or 
gains from the disposition of real property interests. Like the 
U.S. model, the proposed treaty permits at most a 5-percent 
branch profits tax rate, and, in cases where a foreign 
corporation conducts a trade or business in the United States, 
but not through a permanent establishment, the proposed treaty 
completely eliminates the branch profits tax that the Code 
imposes on such corporation.
    In general, the proposed treaty provides that the branch 
profits tax may be imposed by the source country only on that 
portion of the business profits of the foreign corporation 
attributable to its source-country permanent establishment, or 
the corporation's real property income subject to tax on a net 
basis. In general, the branch profits tax also may be imposed 
by the source country on the foreign corporation's gains from 
the disposition of real property. The proposed treaty permits 
the United States to impose its branch profits tax on the 
``dividend equivalent amount'' (as that term is defined under 
the Code as it may be amended from time to time) to the extent 
that this definition is in conformity with the principles of 
the branch tax article.
    None of the restrictions on the operation of U.S. branch 
tax provisions apply, however, unless the corporation seeking 
treaty protection meets the conditions of the proposed treaty's 
limitation on benefits article (Article 16). As discussed 
below, the limitation on benefits requirements of the proposed 
treaty are similar in some respects to the analogous provisions 
of the branch profits tax provisions of the Code described 
above.

Article 11. Interest

            U.S. internal law
    Subject to numerous exceptions (such as those for portfolio 
interest, bank deposit interest, and short-term original issue 
discount), the United States imposes a 30-percent tax on U.S.-
source interest paid to foreign persons under the same rules 
that apply to dividends. U.S.-source interest, for purposes of 
the 30-percent tax, generally is interest on the debt 
obligations of a U.S. person, other than a U.S. person that 
meets specified foreign business requirements. Also subject to 
the 30-percent tax is interest paid to a foreign person by the 
U.S. trade or business of a foreign corporation. A foreign 
corporation is also subject to a branch-level excess interest 
tax with respect to certain ``excess interest'' of a U.S. trade 
or business of such corporation; under this rule an amount 
equal to the excess of the interest deduction allowed with 
respect to the U.S. business over the interest paid by such 
business is treated as if paid by a U.S. corporation to a 
foreign parent and therefore is subject to a withholding tax.
    Portfolio interest generally is defined as any U.S.-source 
interest that is not effectively connected with the conduct of 
a trade or business and that (1) is paid on an obligation that 
satisfies certain registration requirements or specified 
exceptions thereto, and (2) is not received by a 10-percent 
owner of the issuer of the obligation, taking into account 
shares owned by attribution. However, the portfolio interest 
exemption is inapplicable to certain contingent interest 
income.
    If an investor holds an interest in a fixed pool of real 
estate mortgages that is a real estate mortgage interest 
conduit (``REMIC''), the REMIC is treated generally for U.S. 
tax purposes as a pass-through entity and the investor is 
subject to U.S. tax on a portion of the REMIC's income (which 
in turn generally is interest income). If the investor holds a 
so-called ``residual interest'' in the REMIC, the Code provides 
that a portion of the net income of the REMIC that is taxed in 
the hands of the investor--referred to as the investor's 
``excess inclusion''--may not be offset by any net operating 
losses of the investor, must be treated as unrelated business 
income if the investor is an organization subject to the 
unrelated business income tax, and is not eligible for any 
reduction in the 30-percent rate of withholding tax (by treaty 
or otherwise) that would apply if the investor were otherwise 
eligible for such a rate reduction.
            Austrian internal law
    Austria generally does not impose any tax on interest 
income of nonresidents. As described above in connection with 
the dividend article (Article 10), the Austrian dividend tax 
applies to proceeds from profit sharing bonds, and under the 
proposed treaty, such proceeds are treated as dividends rather 
than interest for Austrian withholding purposes. In addition, a 
nonresident individual or corporation may be subject to 
Austrian tax with respect to interest on loans secured by 
Austrian-situs real property.
            Proposed treaty limitations on internal law

Elimination of withholding tax

    The proposed treaty generally exempts from the U.S. 30-
percent tax interest (within the proposed treaty's definition 
of that term) paid to Austrian residents. The proposed treaty 
also exempts from Austrian tax, where any such taxes are 
otherwise applicable, Austrian-source interest paid to U.S. 
residents. These reciprocal exemptions are similar to those in 
effect under the present treaty and in the U.S. model. 
According to the Technical Explanation, the proposed treaty 
also exempts Austrian corporations from imposition by the 
United States of the branch-level excess interest tax.
    The exemptions apply only if the interest is beneficially 
owned by a resident of one of the countries. Accordingly, they 
do not apply if the recipient of the interest is a nominee for 
a nonresident.
    No such exemption applies to an excess inclusion with 
respect to a residual interest in a REMIC. Thus, such 
inclusions may be taxed at 30 percent under the proposed 
treaty. In addition, the proposed treaty does not prevent the 
United States from imposing its withholding tax on contingent 
interest that does not qualify as portfolio interest under U.S. 
law and to analogous types of interest under Austrian law.
    Exemptions from source-country tax will not apply if the 
beneficial owner of the interest carries on a business through 
a permanent establishment (or a fixed base, in the case of an 
individual who performs independent personal services) in the 
source country and the obligation on which the interest is paid 
is effectively connected with the permanent establishment (or 
fixed base). In that event, the interest is taxed as business 
profits (Article 7) or income from the performance of 
independent personal services (Article 14). In addition, 
interest on an obligation that is effectively connected with a 
permanent establishment or fixed base which is received after 
the permanent establishment or fixed base is no longer in 
existence is taxable in the country where the permanent 
establishment or fixed base existed (Article 7, paragraph 9).
    The proposed treaty addresses the issue of non-arm's-length 
interest charges between related parties (or parties having an 
otherwise special relationship) by stating that this article 
will apply only to the amount of arm's-length interest. Any 
amount of interest paid in excess of the arm's-length interest 
will be taxable according to the laws of each country, taking 
into account the other provisions of the proposed treaty. For 
example, interest paid to a parent corporation in excess of an 
arm's-length amount may be treated as a dividend under local 
law and thus entitled to the benefits of Article 10 (Dividends) 
of the proposed treaty.

Definition of interest

    The proposed treaty defines interest generally as income 
from debt claims of every kind, whether or not secured by a 
mortgage and whether or not carrying a right to participate in 
the debtor's profits. In particular, it includes income from 
government securities and bonds or debentures, including 
premiums or prizes attaching to such securities, bonds, or 
debentures. The proposed treaty also defines interest to 
include an excess inclusion with respect to a REMIC. However, 
the term does not include income dealt with in the dividend 
article (Article 10). Thus, the interest exemption does not 
prevent Austria from imposing the dividend tax on interest paid 
on profit-sharing bonds. Penalty charges for late payment are 
not considered interest for purposes of the proposed treaty.

Article 12. Royalties

            Internal law
    Under the same system that applies to dividends and 
interest, the United States imposes a 30-percent tax on U.S.-
source royalties paid to foreign persons, and on gains from the 
disposition of certain intangible