[DOCID: f:er006.106]
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106th Congress                                               Exec. Rpt.
                                 SENATE
 1st Session                                                      106-6

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



 
                     TAX CONVENTION WITH VENEZUELA

                                _______
                                

                November 3, 1999.--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. 106-3]

    The Committee on Foreign Relations, to which was referred 
the Convention between the Government of the United States of 
America and the Government of the Republic of Venezuela for the 
Avoidance of Double Taxation and the Prevention of Fiscal 
Evasion with Respect to Taxes on Income and Capital, together 
with a Protocol, signed at Caracas on January 25, 1999, having 
considered the same, reports favorably thereon, with two 
understandings, 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...............................................3
VII. Budget Impact...................................................15
VIII.Explanation of Proposed Treaty and Proposed Protocol............15

 IX. Text of the Resolution of Ratification..........................60

                               I. Purpose

    The principal purposes of the proposed income tax treaty 
between the United States and Venezuela 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 January 25, 1999. No 
income tax treaty between the United States and Venezuela is in 
force at present.
    The proposed treaty was transmitted to the Senate for 
advice and consent to its ratification on June 29, 1999 (see 
Treaty Doc. 106-3). The Committee on Foreign Relations held a 
public hearing on the proposed treaty on October 27, 1999.

                              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''), the model income tax treaty of the Organization for 
Economic Cooperation and Development (``OECD model''), and the 
United Nations Model Double Taxation Convention between 
Developed and Developing Countries (the ``U.N. model''). 
However, the proposed treaty contains certain substantive 
deviations from those treaties and models.
    As in other U.S. tax treaties, these objectives principally 
are achieved through each country's agreement to limit, in 
certain specified situations, its right to tax income derived 
from its territory by residents of the other country.
    For example, the proposed treaty contains provisions under 
which each country generally agrees not to tax business income 
derived from sources within that country by residents of the 
other country unless the business activities in the taxing 
country are substantial enough to constitute a permanent 
establishment 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, 18 and 
21). The proposed treaty provides that dividends, interest, 
royalties, and certain capital gains derived by a resident of 
either country from sources within the other country generally 
may be taxed by both countries (Articles 10, 11, 12 and 13); 
however, the rate of tax that the source country may impose on 
a resident of the other country on dividends, interest, and 
royalties generally will be limited by the proposed treaty 
(Articles 10, 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, or alternatively, in the case 
of Venezuela, an exemption from Venezuelan income tax (Article 
24).
    The proposed treaty contains the standard provision (the 
``saving clause'') included in U.S. tax treaties pursuant to 
which each country retains the right to tax its residents and 
citizens as if the treaty had not come into effect (Article 1). 
In addition, the proposed treaty contains the standard 
provision providing that the treaty may not be applied to deny 
any taxpayer any benefits the taxpayer would be entitled 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 
treaty by third-country residents (Article 17).

                  IV. Entry Into Force and Termination


                          A. ENTRY INTO FORCE

    The proposed treaty will enter into force on the date on 
which the second of the two notifications of the completion of 
ratification requirements and accompanying instrument of 
ratification has been received. With respect to taxes withheld 
at source, the proposed treaty will be effective for amounts 
paid or credited on or after the first of January following the 
date on which the proposed treaty enters into force. With 
respect to other taxes, the proposed treaty will be effective 
for taxable periods beginning on or after the first of January 
following the date on which the proposed treaty enters into 
force.

                             B. TERMINATION

    The proposed treaty will continue in force until terminated 
by either country. Either country may terminate the proposed 
treaty at any time after the expiration of the five-year period 
from the date of its entry into force, provided that at least 
six months prior notice of termination has been given through 
diplomatic channels. A termination is effective, with respect 
to taxes imposed in accordance with Article 10 (Dividends), 
Article 11 (Interest), and Article 12 (Royalties) for amounts 
paid or credited on or after the first of January following the 
date on which notice of expiration is given. In the case of 
other taxes, a termination is effective for taxable periods 
beginning on or after the first day of January following the 
date on which such notice of expiration is given.

                          V. Committee Action

    The Committee on Foreign Relations held a public hearing on 
the proposed treaty with Venezuela (Treaty Doc. 106-3), as well 
as on other proposed treaties and protocols, on October 27, 
1999. The hearing was chaired by Senator Hagel. The Committee 
considered these proposed treaties and protocols on November 3, 
1999, and ordered the proposed treaty with Venezuela 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 two understandings, two 
declarations, and a proviso.

                         VI. Committee Comments

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

                   A. DEVELOPING COUNTRY CONCESSIONS

    The proposed treaty contains a number of developing country 
concessions, some of which are found in other U.S. income tax 
treaties with developing countries. The most significant of 
these concessions are described below.

Definition of permanent establishment

    The proposed treaty departs from the U.S. and OECD models 
by providing for broader source-basis taxation with respect to 
business activities. The proposed treaty's permanent 
establishment article, for example, permits the country in 
which business activities are carried on to tax the activities 
in circumstances where it would not be able to do so under the 
U.S. or OECD models. Under the proposed treaty, a building site 
or construction or installation project, or an installation or 
drilling rig or ship used for the exploration of natural 
resources, constitutes a permanent establishment if the site, 
project or activities continue in a country for more than 183 
days within any 12-month period. For example, under the 
proposed treaty, a U.S. enterprise's business profits that are 
attributable to a construction project in Venezuela will be 
taxable by Venezuela if the project lasts for more than 183 
days within a 12-month period. Under the U.S. and OECD models, 
such a site or project must last for more than one year in 
order to constitute a permanent establishment. Under the U.N. 
model and other U.S. treaties with developing countries, the 
site or project must last for more than six months in order to 
constitute a permanent establishment. Thus, the proposed 
treaty's 183-day period for establishing a permanent 
establishment is significantly shorter than the corresponding 
periods in the U.S. and OECD models but is similar to the six-
month period provided in U.S. treaties with developing 
countries.
    The proposed treaty contains a provision, not present in 
either the U.S. model or the OECD model, which deems a 
permanent establishment to exist where an enterprise provides 
services through its employees in a country if the activities 
continue for a period or periods aggregating more than 183 days 
within any 12-month period. The U.N. model contains a similar 
rule.

Taxation of certain equipment leasing

    The proposed treaty treats as royalties payments for the 
use of, or the right to use, industrial, commercial, or 
scientific equipment. In most other treaties, these payments 
are considered rental income; as such, the payments are subject 
to the business profits rules, which generally permit the 
source country to tax such amounts only if they are 
attributable to a permanent establishment located in that 
country, and the payments are taxed, if at all, on a net basis. 
By contrast, the proposed treaty permits gross-basis source 
country taxation of these payments, at a rate not to exceed 5 
percent, if the payments are not attributable to a permanent 
establishment situated in that country. If the payments are 
attributable to such a permanent establishment, the business 
profits article of the proposed treaty is applicable.

Other taxation by source country

    The proposed treaty includes additional concessions with 
respect to source-based taxation of amounts earned by residents 
of the other treaty country.
    The proposed treaty allows a maximum rate of source country 
tax on royalties of 5 or 10 percent, depending on the type of 
property involved. The 5-percent limitation applies to payments 
for the use of, or the right to use, industrial, commercial or 
scientific equipment. The 10-percent limitation applies to 
payments for the use of, or the right to use, any copyright of 
literary, artistic or scientific work, including 
cinematographic films, tapes and other means of image or sound 
reproduction, and payments for the use of, or the right to use, 
any patent, trademark, design or model, plan, secret formula or 
process, or other like right or property, or for information 
concerning industrial, commercial or scientific experience. The 
10-percent limitation also applies to gains derived from the 
alienation of such right or property to the extent that such 
gains are contingent on the productivity, use, or disposition 
thereof. By contrast, both the U.S. model and the OECD model 
generally would not permit source-country taxation of 
royalties.
    The proposed treaty generally permits source-country 
taxation of artistes and sportsmen if the amount of 
compensation derived by the individual in the source country 
exceeds $6,000 (including reimbursed expenses) for the taxable 
year concerned. By contrast, the U.S. model generally would 
permit source country taxation of artistes and sportsmen only 
if the gross receipts (including reimbursed expenses) exceed 
$20,000.
    The proposed treaty permits residence-country taxation 
under Article 22 (Other Income) for income of a resident of a 
country that is not dealt with in other articles of the 
proposed treaty. Under the proposed treaty, such income that 
arises in a treaty country may also be taxed by the source 
country. By contrast, the U.S. and OECD models generally would 
permit only a recipient's country of residence to tax such 
other income.

Committee conclusions

    One purpose of the proposed treaty is to reduce tax 
barriers to direct investment by U.S. firms in Venezuela. The 
practical effect of these developing country concessions could 
be greater Venezuelan taxation of future activities of U.S. 
firms in Venezuela than would be the case under rules that were 
comparable to those of either the U.S. model or the OECD model.
    There is a risk that the inclusion of these concessions in 
the proposed treaty could result in additional pressure on the 
United States to include such concessions in future treaties 
negotiated with developing countries. However, these precedents 
already exist in the U.N. model, and a number of existing U.S. 
income tax treaties with developing countries already include 
similar concessions. Such concessions arguably are necessary in 
order to obtain treaties with developing countries. Tax 
treaties with developing countries can be in the interest of 
the United States because they provide developing country tax 
relief for U.S. investors and a clearer framework within which 
the taxation of U.S. investors will take place.
    As part of its consideration of the proposed treaty, the 
Committee asked the Treasury Department about the 
appropriateness of the developing country concessions granted 
to Venezuela in the proposed treaty. The relevant portion of 
the Treasury Department's October 29, 1999, memorandum \1\ 
responding to this inquiry is reproduced below:
---------------------------------------------------------------------------
    \1\ Memorandum from the Treasury Department for Senator Hagel, 
October 29, 1999 (``October 29, 1999 Treasury Department memorandum'').

        Regarding whether Venezuela is an appropriate recipient 
        of developing country concessions, it should be noted 
        that for 1997, Venezuela's gross domestic product (GDP) 
        was $185 billion and its per capita GDP was $8,300. By 
        contrast, the United States' 1997 GDP was $8.1 trillion 
---------------------------------------------------------------------------
        and its per capita GDP was $30,200.

    The Committee is concerned that developing country 
concessions not be viewed as the starting point for future 
negotiations with developing countries. The Committee also 
questions whether such concessions serve to attract investment 
in developing countries. It must be clearly recognized that 
several of the rules of the proposed treaty represent 
substantial concessions by the United States, and that such 
concessions must be met with substantial concessions by the 
treaty partner. Thus, future negotiations with developing 
countries should not assume, for example, that the definition 
of a permanent establishment provided in the treaty necessarily 
will be available in every case; rather, such a definition will 
only be adopted in the context of an agreement that 
satisfactorily addresses the concerns of the United States.

                           B. TREATY SHOPPING

    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 only residents 
of Venezuela and the United States, 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 Code (as 
interpreted by Treasury regulations) and in the U.S. model. The 
provision also is similar to the anti-treaty shopping provision 
in several recent treaties. The degree of detail included in 
these provisions is notable in itself. The proliferation of 
detail may reflect, in part, a diminution in the scope afforded 
the IRS and the courts to resolve interpretive issues adversely 
to a person attempting to claim the benefits of a 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. 
(In contrast, 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 treaties that may have 
somewhat simpler and more flexible 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 clear. The general test applied by 
those treaties to allow benefits to an entity that does not 
meet the bright-line ownership and base erosion tests is a 
broadly subjective one, looking to whether the acquisition, 
maintenance, 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 
allows denial of benefits only with respect to income not 
derived in connection with (or incidental to) the active 
conduct of a substantial trade or business. (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 benefits may 
be denied with respect to such a business regardless of how 
actively it is conducted). In addition, the proposed treaty 
(like all recent treaties) gives the competent authority of the 
country in which the income arises the authority to determine 
that the benefits of the treaty will be granted to a person 
even if the specified tests are not satisfied.
    The practical difference between the proposed treaty tests 
and the corresponding tests in other treaties will depend upon 
how they are interpreted and applied. Given the relatively 
bright line rules provided in the proposed treaty, the range of 
interpretation under it may be fairly narrow.
    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 the Treasury 
Department has to adjust the operation of the proposed treaty, 
the rules as applied should adequately deter treaty shopping 
abuses. The proposed anti-treaty-shopping provision may be 
effective in preventing third-country investors from obtaining 
treaty benefits by establishing investing entities in Venezuela 
because third-country investors may be unwilling to allow more 
than 50 percent of such investing entities to be owned by U.S. 
or Venezuelan residents or other qualified owners in order to 
meet the ownership test of the anti-treaty-shopping provision. 
In addition, the base erosion test provides protection from 
certain potential abuses of a Venezuelan conduit. On the other 
hand, implementation of the tests for treaty shopping set forth 
in the 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.

                  C. VENEZUELAN TERRITORIAL TAX SYSTEM

Current territorial tax system

    The proposed treaty raises unique issues because Venezuela 
currently has a territorial tax system. Under this system, 
Venezuela taxes income of residents or nonresidents only with 
respect to income from Venezuelan sources. Foreign source 
income is not subject to Venezuelan tax.
    The Committee believes that it is inappropriate to forego 
U.S. tax when, because of the territorial tax system of the 
treaty partner, the result would be total elimination of any 
tax paid by the foreign investor on U.S. source income. In 
general, Venezuela does not tax the foreign source business 
income of a Venezuelan resident doing business in the United 
States. Under the proposed treaty, a Venezuelan resident 
engaged in business in the United States but not at a level 
that gives rise to a permanent establishment would not pay U.S. 
tax, and would not pay any tax to Venezuela under its 
territorial system (assuming that the income was treated as not 
being from Venezuelan sources). In the absence of the proposed 
treaty, that person likely would be considered to be engaged in 
a U.S. trade or business and would be subject to U.S. tax on 
such income. Similarly, under the proposed treaty, a Venezuelan 
individual performing independent personal services in the 
United States would not be taxable in the United States on 
income earned from such services if not attributable to a fixed 
base. Assuming Venezuela did not tax such income under its 
territorial tax system, the result would be a complete 
exemption from tax. In addition, under the proposed treaty, the 
reduced rates of U.S. withholding tax on certain payments to 
Venezuelan persons (e.g., for dividends, interest and 
royalties) would provide additional relief for such persons 
from taxation by both countries.
    One of the principal purposes of a tax treaty is to 
eliminate double taxation of income (by both the source country 
and residence country). One way this goal is achieved is for 
the source country to cede its jurisdiction to tax the income 
to the residence country. This concept is less relevant where 
the residence country exempts the income from taxation. The 
Committee believes that it generally is not appropriate to 
enter into a treaty that results in double exemptions from 
taxation. In other U.S. treaties with countries that do not tax 
certain types of income earned abroad by its taxpayers until 
repatriated (i.e., a remittance-based tax system), the United 
States has included provisions denying U.S. rate reductions and 
exemptions for income which is not remitted to and, thus, not 
subject to tax by the treaty partner.\2\ The Committee believes 
that a similar limitation is appropriate here, until such time 
as Venezuela's new worldwide tax system becomes effective in 
replacement of its current territorial tax system. (It is 
anticipated that Venezuela's new worldwide tax regime will be 
effective for taxable years beginning on or after January 1, 
2001). The Committee believes that this concern with double 
exemptions of tax can be addressed by including an 
understanding to the proposed treaty that the treaty benefits 
exempting income from tax under Article 7 (Business Profits) or 
Article 14 (Independent Personal Services) would be granted to 
a Venezuelan person only when the income to which such treaty 
benefits relate is subject to tax in Venezuela.
---------------------------------------------------------------------------
    \2\ Such provisions are included in the U.S. treaties with Jamaica 
and the United Kingdom.
---------------------------------------------------------------------------
    The Committee recognizes that the proposed treaty generally 
would provide relief from potential double taxation for U.S. 
persons. A U.S. person is taxable by the United States on 
worldwide income. Such income could also be subject to 
Venezuelan tax if treated as being from Venezuelan sources 
under its territorial tax system. Current Venezuelan sourcing 
rules relating to income and deductions may vary and may be 
inconsistent with corresponding U.S. sourcing rules. Double 
taxation could result in cases where the income earned by such 
person is treated as being from U.S. sources under U.S. rules 
and from Venezuelan sources under Venezuelan rules. For 
example, absent the proposed treaty, Venezuela levies 
withholding tax on payments for certain services performed in 
the United States. Because the United States would treat this 
payment as being from U.S. sources, the U.S. foreign tax credit 
limitation in many cases would prevent the U.S. recipient of 
such income from claiming a credit against U.S. taxes for the 
Venezuelan taxes. The proposed treaty generally would address 
such potential cases of double taxation by preventing Venezuela 
from imposing tax on income from the performance of services 
except when the income is attributable to a fixed base or 
permanent establishment in Venezuela. The Committee believes 
that the relief from double taxation in such circumstances is 
an appropriate function for an income tax treaty.
    The proposed treaty also would prevent double taxation that 
would result from the calculation of net income under 
Venezuela's statutory rules. Because Venezuela currently does 
not tax foreign source income, it does not permit foreign 
source deductions in calculating taxable income. This would 
prohibit a Venezuelan permanent establishment from deducting 
its share of the entity's home office expenses incurred for the 
benefit of the entire entity. Moreover, Venezuela generally 
would not permit its residents to deduct payments to foreign 
persons even if such payments would be deductible if paid to a 
Venezuelan person. Under the business profits (Article 7) and 
non-discrimination (Article 25) articles of the proposed 
treaty, these deductions would be permitted.
    The exchange of information and mutual agreement provisions 
of the proposed treaty will provide additional benefits. These 
provisions are useful for purposes of preventing fiscal 
evasion, as well as addressing cases of potential double 
taxation (not otherwise specifically addressed under the 
treaty). In addition, the reduced rates of source country tax 
under the proposed treaty would provide U.S. investors with 
relief, for example, from Venezuelan statutory withholding 
taxes (e.g., on interest and royalties). This would have the 
effect of encouraging additional trade with, and investment in, 
Venezuela.\3\
---------------------------------------------------------------------------
    \3\ It should be noted that Venezuela has entered into tax treaties 
with the Czech Republic, Germany, Italy, the Netherlands, Portugal, 
Switzerland, Trinidad and Tobago, and the United Kingdom. Venezuela 
also has entered into a tax treaty with France that covers income taxes 
and air and shipping activities.
---------------------------------------------------------------------------

New worldwide tax system

    Venezuela is in the process of moving from a territorial 
tax system to a worldwide tax system. On April 26, 1999, an 
enabling law authorized President Chavez to take 
``extraordinary economic and financial measures,'' including 
reforming Venezuela's income tax laws. Among other things, the 
enabling law specifically authorizes the President to amend 
Venezuela's tax laws to adopt a worldwide tax system (in lieu 
of Venezuela's current territorial tax system) with a credit 
system to provide relief from international double taxation. 
The enabling law authorizes the President to publish a decree 
within six months of the authorization (i.e., no later than 
October 26, 1999) which contains these and other changes to 
Venezuelan tax laws. In September 1999, the Council of 
Ministers, with the President presiding, approved a draft of a 
new income tax law which includes provisions adopting a 
worldwide tax system.
    The new tax law was sent to be published in Venezuela's 
Official Gazette on October 22, 1999. In general, laws are 
enacted in Venezuela by means of publication in Venezuela's 
Official Gazette. The new tax law has not yet been officially 
published in the Official Gazette; however, the text of the new 
tax law that was sent to be published in the Official Gazette 
was made available to the Committee (in Spanish) on November 2, 
1999. Previous drafts of the new tax law have been reviewed but 
may be different from the final published law. For example, the 
Committee understands that last minute changes were made to a 
new Venezuelan branch profits tax. The Committee understands 
that even if the new tax law is published in the Official 
Gazette at a later date, the law will be deemed to have been 
enacted as of October 22, 1999 (the date the law was sent to be 
printed). The new tax law generally will be effective for 
taxable years beginning after this date. However, the new 
worldwide tax system is anticipated to be effective for taxable 
years beginning on or after January 1, 2001.
    In general, it is anticipated that the new worldwide tax 
system will be similar to the U.S. system. The Committee 
understands that the new tax law also will provide for several 
fundamental changes in Venezuela's tax laws beyond the adoption 
of a worldwide tax system, including the imposition of taxes on 
dividends, the adoption of rules on transfer pricing, as well 
as general anti-abuse rules to allow the tax authorities to 
disregard transactions entered into with a principal purpose to 
evade, avoid, or otherwise reduce income taxes.

Committee conclusions

    The Committee has concerns about entering into an income 
tax treaty with a country that has a territorial tax system, 
because of the opportunities for income to be excluded from 
taxation by both countries (i.e., double exemptions of tax). 
Accordingly, the Committee has included in its recommended 
resolution of ratification an understanding which states that 
if income is relieved from tax in one country under either 
Article 7 (Business Profits) or Article 14 (Independent 
Personal Services), and under the law in force in the other 
country a person is not subject to tax in that other country in 
respect of such income, then the relief to be allowed under the 
proposed treaty in the first country will apply only to so much 
of the income as is subject to tax in the other country. Thus, 
a Venezuelan person who is engaged in a U.S. trade or business 
and who earns U.S. source income with respect to activities 
that do not give rise to the level of a U.S. permanent 
establishment under the proposed treaty, will nevertheless be 
subject to U.S. tax on such U.S. source income if such income 
is not subject to tax in Venezuela under its present 
territorial tax system. This rule would cease to have effect 
once the provisions of Venezuela's new worldwide tax system 
become effective.
    The Committee is encouraged that Venezuela is moving from 
its current territorial tax system to a worldwide tax system. 
The new worldwide tax system is expected to be more similar to 
that of the United States and, thus, would be more consistent 
with one of the principal purposes of the treaty--to avoid 
double taxation.
    Although the Committee recognizes the importance of 
entering into the proposed treaty, and the benefits that will 
be provided to U.S. and Venezuelan persons, the Committee is 
concerned that because the change in Venezuelan tax law is so 
recent and the final version of that new law has not yet been 
officially published, there is less information on which the 
Committee can base its decision than is normally available when 
a treaty is being considered. The Committee believes that it 
would not be prudent to ratify the proposed treaty until the 
new tax law has been thoroughly reviewed and consideration has 
been given to potential implications the new tax law may have 
with respect to the proposed treaty. Consequently, the 
Committee has included in its recommended resolution of 
ratification a declaration that before the President of the 
United States may notify Venezuela pursuant to Article 29 
(Entry Into Force) of the proposed treaty that the United 
States has completed the required ratification procedures, he 
must certify to the Committee that: (1) the new Venezuelan tax 
law (implementing the new worldwide tax system) has been 
enacted in accordance with Venezuelan law, (2) the Treasury 
Department, in consultation with the State Department, has 
thoroughly examined the new Venezuelan tax law, and (3) the new 
Venezuelan tax law is fully consistent with and appropriate to 
the obligations under the proposed treaty. To the extent that 
the President cannot so certify, the Committee expects that the 
Treasury Department will consult with the Committee regarding 
major issues that may arise under the proposed treaty in light 
of the new Venezuelan tax law, including whether it is 
necessary for the Treasury Department to expeditiously 
negotiate a protocol with Venezuela regarding these matters or 
use other diplomatic means to resolve such issues.
    The Committee has identified an issue in the treaty that 
needs to be addressed in light of the new Venezuelan tax law. 
It is anticipated that the new Venezuelan tax law will include 
provisions that would impose a 34-percent branch profits tax on 
foreign companies (such as a U.S. company) that have a branch 
in Venezuela. Currently such a tax is not imposed by Venezuela. 
Article 11A (Branch Tax) of the proposed treaty provides that a 
company that is a resident of one country may be subject in the 
other country (the source country) to a tax in addition to the 
tax on profits. Such additional tax may not exceed 5 percent of 
the ``dividend equivalent amount,'' a term that is defined in 
the proposed protocol only with respect to the United States. 
The article is not drafted specifically to apply to the 
Venezuelan branch profits tax, because there was no Venezuelan 
branch profits tax in existence at the time the proposed treaty 
was negotiated. Accordingly, the Committee has included in its 
recommended resolution of ratification an understanding to the 
proposed treaty that: (1) the reference to an ``additional 
tax'' in Article 11A (Branch Tax) of the proposed treaty 
includes the Venezuelan branch profits tax that may be imposed 
by Venezuela under its new tax law, and (2) the limit imposed 
under Article 11A (Branch Tax) of the proposed treaty will 
apply with respect to the new Venezuelan branch profits tax and 
that for purposes of that article, the Venezuelan branch 
profits tax will be imposed only on an amount not in excess of 
the amount that is analogous to the ``dividend equivalent 
amount'' defined in subparagraph (a) of paragraph 10 of the 
proposed protocol with respect to the United States. 
Accordingly, once the new Venezuelan branch profits tax becomes 
effective, \4\ U.S. persons with a branch in Venezuela would be 
entitled to the reduced 5-percent rate of tax under 11A (Branch 
Tax) of the proposed treaty with respect to the new Venezuelan 
branch profits tax.
---------------------------------------------------------------------------
    \4\ The Committee understands that the new Venezuelan branch 
profits tax will become effective for taxable years beginning on or 
after January 1, 2001.
---------------------------------------------------------------------------

                     D. STABILITY OF VENEZUELAN LAW

    In the past the Treasury Department has maintained that a 
country's political situation should be a factor in determining 
whether to build stronger economic ties with that country. In a 
July 5, 1995, letter to the Senate Foreign Relations Committee 
the Treasury Department wrote:

          A country's political situation is a factor that is 
        considered in determining whether to build stronger 
        economic ties with that country. When consideration of 
        this and other factors leads to a policy of building 
        stronger economic ties with a particular country, a tax 
        treaty becomes a logical part of that policy. One of a 
        treaty's main purposes is to foster the competitiveness 
        of U.S. firms that enter the treaty partner's market 
        place. As long as it is U.S. policy to encourage U.S. 
        firms to compete in these market places, it is in the 
        interest of the United States to enter tax treaties.

    Moreover, in countries where an unstable political climate 
may result in rapid and unforeseen changes in economic and 
fiscal policy, a tax treaty can be especially valuable to U.S. 
companies, as the tax treaty may restrain the government from 
taking actions that would adversely impact U.S. firms, and 
provide a forum to air grievances that otherwise would be 
unavailable. \5\
---------------------------------------------------------------------------
    \5\ This quote appears in the Report of the Senate Foreign 
Relations Committee on the Income Tax Convention with Ukraine, Exec. 
Rept. 104-5, August 10, 1995, regarding an issue that was raised with 
respect to that treaty in connection with the stability of the 
Ukrainian tax law.
---------------------------------------------------------------------------

Background of political developments in Venezuela

    Venezuela currently is in a period of constitutional and 
institutional change. In a recent statement, Peter F. Romero, 
Acting Assistant Secretary of State for Western Hemisphere 
Affairs, described the political situation in Venezuela as 
follows.

          Hugo Chavez was elected president of Venezuela by a 
        wide margin in December 1998 on the promise of 
        eliminating corruption and inefficiency in government 
        and ensuring social justice. Seven months after his 
        inauguration, Chavez continues to enjoy an approval 
        rating around 80%.
          In April, Venezuelans returned to the polls to vote 
        on a referendum, voting overwhelmingly in favor of the 
        formation of a National Constituent Assembly (ANC) to 
        draft a new Constitution. Elected on July 25, the vast 
        majority of the 131-member ANC supports President 
        Chavez. The ANC was given 6 months to complete a draft 
        of a new Constitution; however, Chavez has asked the 
        ANC to accelerate its work and to finish within 3 
        months.
          The process was off to a difficult start in August, 
        when turf conflicts between the new ANC and established 
        institutions threatened to overtake action on 
        Venezuela's needed reforms. In August the ANC issued 
        two decrees to establish committees to investigate the 
        judicial and legislative branches. The Assembly's claim 
        to ``originating'' powers (in essence, establishing its 
        superiority to the existing branches of government) was 
        indirectly upheld in a Supreme Court opinion and the 
        President of the Court resigned in protest. The 
        Congress attempted to come back into plenary session, 
        despite a previous agreement to remain in recess, and 
        the ANC issued emergency decrees limiting Congress's 
        powers. Approximately two weeks after the crisis began, 
        an agreement brokered by the Catholic Church, resulted 
        in a new written ``cohabitation'' accord. Under the 
        terms of the agreement, the Congress will resume 
        plenary sessions on October 2, the traditional end of 
        the summer recess.
          In the wake of the public dispute with the Congress, 
        the ANC declared it would intensify its work on the new 
        Constitution. While further political friction is 
        almost certain, it appears that the [government], the 
        ANC and the opposition are buckling down to the work of 
        writing the constitution and revamping the country's 
        institutions. \6\
---------------------------------------------------------------------------
    \6\ Statement of Ambassador Peter F. Romero, Acting Assistant 
Secretary of State for Western Hemisphere Affairs, before the Western 
Hemisphere Subcommittee of the House International Relations Committee 
on ``Current Issues in the Western Hemisphere Region,'' September 29, 
1999.

    President Chavez's popularity, his appeal to the 
disadvantaged of Venezuela, his failed military coup attempt in 
1992, and the possibility of change to existing political 
institutions have raised both expectations and fears regarding 
institutional change. Some of President Chavez's recent 
statements raise questions regarding his desire to maintain a 
productive relationship with the United States. The Committee 
encourages a continued dialogue and reiterates the United 
States interest in promoting stable democratic institutions and 
strengthening cooperation on regional issues.

Committee conclusions

    Several issues arise in the consideration of a tax treaty 
with a government that is experiencing political instability. 
One is that it may be difficult to identify correctly the other 
country's competent authority in situations where there are 
competing claims as to who is authorized to exercise 
legislative, executive, or judicial authority. Another issue is 
the extent to which any political instability also causes 
uncertainty as to the precise nature of the substantive law of 
that country. These uncertainties may make it difficult to 
administer the treaty.
    A more specific issue arises in the context of the exchange 
of information provisions of the proposed treaty (Article 27 of 
the proposed treaty, as explicated by paragraph 19 of the 
proposed protocol). The exchange of information provision 
requires that information that is exchanged shall be treated as 
secret by the receiving country in the same manner as 
information obtained under its local laws and may only be 
disclosed to persons involved in the assessment, collection, or 
administration of taxes covered by the provision. Several 
issues may arise with respect to the utilization of this 
provision with a government that is experiencing political 
instability. First, it may be more difficult to assess whether 
confidentiality will be respected when the information is 
initially exchanged. Second, it may be more difficult to assess 
the possibility that inappropriate use will be made in the 
future of the exchanged information. Third, the country 
receiving the information could weaken (or potentially 
eliminate) the confidentiality protections under its local 
laws, which would concomitantly weaken or eliminate those 
protections for exchanged information.
    The relevant portion of the Treasury Department's October 
29, 1999, memorandum responding to this issue is reproduced 
below:

          The Internal Revenue Service and the Treasury 
        Department are committed to ensuring that information 
        exchanged under tax treaties is used only for permitted 
        purposes. The treaty provides that any information 
        exchanged in accordance with its provisions shall be 
        used exclusively for tax purposes. In the context of 
        our review of Venezuela, we consulted other government 
        agencies, including agencies experienced in exchanging 
        information with many Latin American countries. In this 
        consultation we were not advised to anticipate abuses 
        of exchanged information on the part of Venezuela. It 
        should also be noted that Moreover, we also understand 
        that the new draft constitution being written by the 
        National Constituent Assembly contains strong 
        protections for civil and individual rights.

    The Committee has considered the political situation in 
Venezuela and its implications for the proposed treaty. While 
the Committee believes that a fundamental level of political 
stability is a prerequisite for entering into a tax treaty 
relationship and remains concerned by recent events in 
Venezuela, the Committee recognizes the benefits this treaty 
would provide to U.S. taxpayers and the positive impact the 
treaty could have on the Venezuelan economic environment. On 
balance, the Committee believes that it is appropriate to 
proceed with the consideration of this proposed treaty and 
recommends its ratification (subject to the various 
understandings, declarations and proviso set forth in this 
report, including the certification from the Treasury 
Department (described in the preceding section)).

                           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 1999-2008 period.

       VIII. Explanation of Proposed Treaty and Proposed Protocol

    A detailed, article-by-article explanation of the proposed 
income tax treaty between the United States and Venezuela, as 
supplemented by the proposed protocol, is set forth below.

Article 1. General Scope

    The general scope article describes the persons who may 
claim the benefits of the proposed treaty. The proposed treaty 
generally applies to residents of the United States and to 
residents of Venezuela, with specific modifications to such 
scope provided in other articles (e.g., Article 20 (Government 
Service), Article 25 (Non-Discrimination) and Article 27 
(Exchange of Information)). The determination of whether a 
person is a resident of the United States or Venezuela is made 
under the provisions of Article 4 (Residence).
    The proposed treaty provides that it does not restrict in 
any manner any exclusion, exemption, deduction, credit, or 
other allowance accorded by internal law or by any other 
agreement between the United States and Venezuela. Thus, the 
proposed treaty will not apply to increase the tax burden of a 
resident of either the United States or Venezuela. According to 
the Treasury Department's Technical Explanation (hereinafter 
referred to as the ``Technical Explanation''), the fact that 
the proposed treaty only applies to a taxpayer's benefit does 
not mean that a taxpayer may select inconsistently among treaty 
and internal law provisions in order to minimize its overall 
tax burden. In this regard, the Technical Explanation sets 
forth the following example. Assume a resident of Venezuela has 
three separate businesses in the United States. One business is 
profitable and constitutes a U.S. permanent establishment. The 
other two businesses generate effectively connected income as 
determined under the Internal Revenue Code (the ``Code''), but 
do not constitute permanent establishments as determined under 
the proposed treaty; one business is profitable and the other 
business generates a net loss. Under the Code, all three 
businesses would be subject to U.S. income tax, in which case 
the losses from the unprofitable business could offset the 
taxable income from the other businesses. On the other hand, 
only the income of the business which gives rise to a permanent 
establishment is taxable by the United States under the 
proposed treaty. The Technical Explanation makes clear that the 
taxpayer may not invoke the proposed treaty to exclude the 
profits of the profitable business that does not constitute a 
permanent establishment and invoke U.S. internal law to claim 
the loss of the unprofitable business that does not constitute 
a permanent establishment to offset the taxable income of the 
permanent establishment.\7\
---------------------------------------------------------------------------
    \7\ See Rev. Rul. 84-17, 1984-1 C.B. 308.
---------------------------------------------------------------------------
    The proposed treaty provides that the dispute resolution 
procedures under its mutual agreement procedure article 
(Article 26) (and not the corresponding provisions of any other 
agreement to which the United States and Venezuela are parties) 
exclusively apply in determining whether a measure is within 
the scope of the proposed treaty. Unless the competent 
authorities agree that a taxation 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 
Venezuela, generally apply to that law or other measure. The 
only exception to this general rule is such national treatment 
or most favored nation obligations as may apply to trade in 
goods under the General Agreement on Tariffs and Trade. For 
purposes of this provision, the term ``measure'' means a law, 
regulation, rule, procedure, decision, administrative action, 
or any other similar provision or action.
    Like all U.S. income tax treaties and the U.S. model, the 
proposed treaty includes a ``saving clause.'' Under this 
clause, with specific exceptions described below, the proposed 
treaty does not 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 Venezuela as if the treaty were not in force. 
``Residents'' for purposes of the proposed treaty (and, thus, 
for purposes of the saving clause) includes persons defined as 
such in Article 4 (Residence), including corporations and other 
entities as well as individuals.
    The proposed protocol contains a provision under which the 
saving clause (and therefore the U.S. jurisdiction to tax) 
applies for U.S. tax purposes to a former U.S. citizen whose 
loss of citizenship status had as one of its principal purposes 
the avoidance of U.S. tax; such application is limited to the 
ten-year period following the loss of citizenship status. The 
proposed treaty also contains a provision under Article 17 
(Limitation on Benefits) which denies treaty benefits to former 
long-term residents of the United States for ten years 
following the loss of such residence status if such loss of 
status had as one of its principal purposes the avoidance of 
U.S. tax. Section 877 of the Code provides special rules for 
the imposition of U.S. income tax on former U.S. citizens and 
long-term residents for a period of ten years following the 
loss of citizenship or resident; these special tax rules apply 
to a former citizen or long-term resident only if his or her 
loss of U.S. citizenship or resident status had as one of its 
principal purposes the avoidance of U.S. income, estate or gift 
taxes. 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.
    Exceptions to the saving clause are provided for the 
following benefits conferred by a treaty country: the allowance 
of corresponding adjustments when the profits of an associated 
enterprise are adjusted by the other country (Article 9, 
paragraph 2); relief from double taxation through the provision 
of a foreign tax credit or, in the case of Venezuela, an 
exemption of income from tax (Article 24); protection from 
discriminatory tax treatment (Article 25); and benefits under 
the mutual agreement procedures (Article 26). These exceptions 
to the saving clause permit residents and citizens of the 
United States or Venezuela to obtain such benefits of the 
proposed treaty with respect to their country of residence or 
citizenship.
    In addition, the saving clause does not apply to the 
following benefits conferred by one of the countries upon 
individuals who neither are citizens of that country nor have 
immigrant status in that country. Under this set of exceptions 
to the saving clause, the specified treaty benefits are 
available to, for example, a Venezuelan citizen who spends 
enough time in the United States to be taxed as a U.S. resident 
but who has not acquired U.S. immigrant status (i.e., does not 
hold a ``green card''). The benefits that are covered under 
this set of exceptions are the exemptions from host country tax 
for certain government service salaries and pensions (Article 
20), certain income received by visiting students, trainees, 
teachers and researchers (Article 21), and certain income of 
diplomats and consular officers (Article 28).

Article 2. Taxes Covered

    The proposed treaty generally applies to the income taxes 
of the United States and Venezuela. However, Article 27 
(Exchange of Information) generally is applicable to all taxes 
imposed by the United States and by Venezuela.
    In the case of the United States, the proposed treaty 
applies to the Federal income taxes imposed by the Code, but 
excludes social security taxes. Unlike many U.S. income tax 
treaties in force, but like the U.S. model, the proposed treaty 
applies to the accumulated earnings tax and the personal 
holding company tax. The proposed treaty generally does not 
apply to any U.S. State or local income taxes; however, Article 
25 (Non-Discrimination) applies to all taxes, including those 
imposed by state or local governments.
    In the case of Venezuela, the proposed treaty generally 
applies to the income tax and the business assets tax. Under 
Article 24 (Relief from Double Taxation), however, the United 
States is not required under the proposed treaty to grant a 
U.S. foreign tax credit for business assets taxes paid to 
Venezuela.
    The proposed treaty also contains a rule generally found in 
U.S. income tax treaties and the U.S., OECD and U.N. models 
which provides that the proposed treaty applies to any 
identical or substantially similar taxes that are imposed 
subsequently in addition to or in place of the taxes covered. 
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, and of any 
official published material concerning the application of the 
proposed treaty. The Technical Explanation states that the term 
``significant'' means that changes must be reported that are 
significant to the operation of the proposed treaty.

Article 3. General Definitions

    The proposed treaty provides definitions of a number of 
terms for purposes of the proposed treaty. Certain of the 
standard definitions found in most U.S. income tax treaties are 
included in the proposed treaty.
    The term ``Venezuela'' means the Republic of Venezuela.
    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. The Technical 
Explanation states that the term ``United States'' includes the 
territorial seas of the United States.
    The proposed protocol provides that when referred to in the 
geographical sense, ``Venezuela'' and ``United States'' include 
the areas of the seabed and subsoil adjacent to their 
respective territorial seas in which they may exercises rights 
in accordance with domestic legislation and international laws. 
The Technical Explanation states that the extension of these 
terms to areas adjacent to the territorial seas of the United 
States and Venezuela (as the case may be) applies to the extent 
that the United States or Venezuela exercises sovereignty in 
accordance with domestic legislation and international law for 
the purpose of natural resource exploration and exploitation of 
such areas. The Technical Explanation further states that the 
extension of such terms applies only if the person, property or 
activity to which the proposed treaty is being applied is 
connected with such natural resource exploration or 
exploitation.
    The terms ``a Contracting State'' and ``the other 
Contracting State'' mean the United States or Venezuela, 
according to the context in which such terms are used.
    The term ``person'' includes an individual, an estate, a 
trust, a partnership, a company, and any other body of persons. 
The Technical Explanation states that the term ``person'' 
includes Venezuelan ``entidades'' or ``colectividades,'' which 
are not legal persons under Venezuelan law, but are taxable 
persons for Venezuelan tax purposes.
    A ``company'' under the proposed treaty is any body 
corporate or any entity which is treated as a body corporate 
for tax purposes.
    The terms ``enterprise of a Contracting State'' and 
``enterprise of the other Contracting State'' mean, 
respectively, an enterprise carried on by a resident of a 
treaty country and an enterprise carried on by a resident of 
the other treaty country. The terms also include an enterprise 
carried on by a resident of a treaty country through an entity 
(such as a partnership) that is treated as fiscally transparent 
in that country. The Technical Explanation states that the 
definition in the proposed treaty is intended to make clear 
that an enterprise conducted by a fiscally transparent entity 
will be treated as carried on by a resident of a treaty country 
to the extent its partners or other owners are residents. The 
proposed treaty does not define the term ``enterprise.'' The 
Technical Explanation states that the term ``enterprise'' 
generally is understood to refer to any activity or set of 
activities that constitutes a trade or business.
    The proposed treaty provides that the term ``national'' 
means any individual possessing the nationality of the United 
States or Venezuela, and any legal person, association or other 
entities (including a Venezuelan ``entidad'' or 
``colectividad'') deriving their status as such from the laws 
in force in the United States or Venezuela.
    The term ``international operation of ships or aircraft'' 
means any transport by a ship or aircraft, except when such 
transport is solely between places within a country. This 
definition principally applies in the context of Article 8 
(Shipping and Air Transport), which refers to the term 
``operation of ships or aircraft in international traffic.'' 
The Technical Explanation states that such terms are understood 
to have the same meaning. The Technical Explanation also states 
that transport that constitutes international traffic includes 
any portion of the transport that is between two points within 
a country, even if the internal portion of the transport 
involves a transfer to a land vehicle or is handled by an 
independent contractor (provided that the original bills of 
lading include such portion of the transport).
    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). On interpretative issues, the latter acts with 
the concurrence of the Associate Chief Counsel (International) 
of the IRS. The Venezuelan ``competent authority'' is the 
Integrated National Service of Tax Administration (Servicio 
Nacional Integrado de Administracion Tributaria--SENIAT), its 
authorized representative or the authority which is designated 
by the Ministry of Finance as a competent authority.
    The proposed treaty also contains the standard provision 
that, unless the context otherwise requires or the competent 
authorities agree to a common meaning pursuant to the 
provisions of the mutual agreement procedures of the proposed 
treaty (Article 26), all terms not defined in the proposed 
treaty have the meaning that they have under the laws of the 
country concerning the taxes to which the proposed treaty 
applies.

Article 4. Residence

    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 proposed treaty. Furthermore, 
issues arising because of dual residency, including situations 
of double taxation, may be avoided by the assignment of one 
treaty country as the country of residence when under the 
internal laws of the treaty countries a person is a resident of 
both countries.
            Internal taxation rules

United States

    Under U.S. law, the residence of an individual is important 
because a resident alien, like a U.S. citizen, is taxed on his 
or her 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 sufficient time in the United States in 
any year or over a three-year period generally is treated as a 
U.S. resident. A permanent resident for immigration purposes 
(i.e., a ``green card'' holder) also is treated as a U.S. 
resident.
    Under U.S. law, a company is taxed on its worldwide income 
if it is a ``domestic corporation.'' A domestic corporation is 
one that is created or organized in the United States or under 
the laws of the United States, a State, or the District of 
Columbia.

Venezuela

    Under current Venezuelan law, individuals and corporations 
generally are taxed under a territorial-based system, that is, 
based on income from sources in Venezuela. The sourcing rules 
of Venezuela's territorial system generally apply to residents 
and nonresidents. However, the tax rates imposed on Venezuelan 
source income, as well as the manner in which the income is 
taxed (e.g., on a net or gross basis), differ for Venezuelan 
residents and nonresidents.
    Individuals are considered to be residents of Venezuela if 
they are present in Venezuela for more than 180 days in the 
current or preceding calendar year. A Venezuelan corporation is 
one that is registered under a commercial registry in Venezuela 
(i.e., incorporated in Venezuela).
    Venezuela is in the process of enacting new tax legislation 
that would replace its current territorial tax system with a 
worldwide tax system. Although the new law has not yet been 
officially published, the Committee understands that under the 
new worldwide tax system, Venezuelan resident individuals and 
corporations are taxable on worldwide income, while nonresident 
individuals and foreign corporations generally are taxable only 
on income from Venezuelan sources. The Committee also 
understands that the new worldwide tax system will be effective 
for taxable years beginning on or after January 1, 2001.
            Proposed treaty rules
    The proposed treaty provides rules to determine whether a 
person is a resident of the United States or Venezuela for 
purposes of the proposed treaty.
    The proposed treaty generally defines ``resident of a 
Contracting State'' separately in the case of the United States 
and Venezuela, respectively, to determine whether a person is a 
resident of the United States or a resident of Venezuela for 
purposes of the proposed treaty. The Technical Explanation 
states that these separate definitions are provided due to 
differences in the structure of the U.S. and Venezuelan tax 
systems.
    Under the proposed treaty, a resident of the United States 
means any person who, under the laws of the United States, is 
liable to tax in the United States by reason of the person's 
domicile, residence, citizenship, place of incorporation, or 
any other criterion of a similar nature. The proposed treaty 
provides that a U.S. citizen or an alien admitted lawfully to 
the United States for permanent residence (a ``green card'' 
holder), who is not a resident of Venezuela under the basic 
residence rules, will be treated as a U.S. resident only if 
such individual has a permanent home or habitual abode in the 
United States. If such individual is a resident of Venezuela 
under the basic residence rules, he or she is considered to be 
a resident of both countries and his or her residence for 
purposes of the proposed treaty is determined under the tie-
breaker rules described below.
    Under the proposed treaty, a resident of Venezuela means 
any resident individual (``domiciliado''), any legal person 
that is created or organized under the laws of Venezuela, and 
any entity or collectivity (``entidad o colectividad'') formed 
under the laws of Venezuela which is not a legal person but is 
subject to the taxation applicable to corporations in 
Venezuela. The Technical Explanation states that those 
entidades and colectividades that are not taxed as corporations 
in Venezuela are treated as fiscally transparent entities under 
Venezuelan law and, thus, are subject to the special rules for 
such fiscally transparent entities described below.
    The proposed protocol provides that the term ``resident of 
a Contracting State'' also includes the United States or 
Venezuela and any of its political subdivisions or local 
authorities.
    The proposed protocol also provides a special rule to treat 
as residents of a treaty country certain organizations that 
generally are exempt from tax in that country. Under this rule, 
pension trusts and any other organizations that are constituted 
and operated exclusively to provide pension benefits, or for 
religious, charitable, scientific, artistic, cultural, or 
educational purposes and that are residents of that country 
according to its laws, are treated as residents of such country 
notwithstanding that all or part of its income may be exempt 
from tax under the domestic law of that country.
    The proposed treaty provides a special rule for fiscally 
transparent entities. Under this rule, an item of income, 
profit or gain derived through an entity that is fiscally 
transparent under the laws of either country will be considered 
to be derived by a resident of a country to the extent that the 
item is treated, for purposes of the tax laws of such country, 
as the income, profit, or gain of a resident of such country. 
The Technical Explanation states that in the case of the United 
States, such fiscally transparent entities include 
partnerships, common investment trusts under section 584 of the 
Code, grantor trusts and U.S. limited liability companies 
treated as partnerships for U.S. tax purposes. For example, if 
a corporation resident in Venezuela distributes a dividend to 
an entity treated as fiscally transparent for U.S. tax 
purposes, the dividend will be considered to be derived by a 
resident of the United States only to the extent that U.S. tax 
laws treat one or more U.S. residents (whose status as U.S. 
residents is determined under U.S. tax laws) as deriving the 
dividend income for U.S. tax purposes.
    The Technical Explanation states that these rules for 
income derived through fiscally transparent entities apply 
regardless of where the entity is organized (i.e., in the 
United States, Venezuela, or a third country). The Technical 
Explanation also states that these rules apply even if the 
entity is viewed differently under the tax laws of the other 
country. As an example, the Technical Explanation states that 
income from Venezuelan sources received by an entity organized 
under the laws of Venezuela, which is treated for U.S. tax 
purposes as a corporation and is owned by a U.S. shareholder 
who is a U.S. resident for U.S. tax purposes, is not considered 
derived by the shareholder of that corporation, even if under 
the tax laws of Venezuela the entity is treated as fiscally 
transparent. Rather, for purposes of the proposed treaty, the 
income is treated as derived by the Venezuelan entity.
            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. Under these rules, an individual is deemed to be a 
resident of the country in which he or she has a permanent home 
available. If the individual has a permanent home in both 
countries, the individual's residence is deemed to be the 
country with which his or her personal and economic relations 
are closer (i.e., his or her ``center of vital interests''). If 
the country in which the individual has his or her center of 
vital interests cannot be determined, or if he or she does not 
have a permanent home available in either country, he or she 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, he or she 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 
country, the competent authorities of the countries will settle 
the question of residence by mutual agreement.

Entities

    In the case of any person other than an individual that is 
a resident of both countries under the basis residence rules, 
the proposed treaty requires the competent authorities to 
settle the issue of residence by mutual agreement and to 
determine the mode of application of the proposed treaty to 
such person. Under the proposed treaty, if the competent 
authorities are unable to make such a determination, the person 
will not be considered a resident of either country and, thus, 
will not be granted benefits under the proposed treaty.

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, the 
OECD model and the U.N. 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 items of income will be taxed as business 
profits.
    In general, under the proposed treaty, a permanent 
establishment is a fixed place of business through which the 
business of an enterprise is wholly or partly carried on. A 
permanent establishment includes a place of management, a 
branch, an office, a factory, a workshop, and a mine, an oil or 
gas well, a quarry, or any other place of extraction of natural 
resources. It also includes a building site or construction or 
installation project, or an installation or drilling rig or 
ship used for the exploration of natural resources, but only if 
such site, project, or activities continue for more than 183 
days within any 12-month period beginning or ending in the 
taxable year concerned. The Technical Explanation states that 
the 183-day test applies separately to each individual site or 
project, with a series of contracts or projects that are 
interdependent both commercially and geographically treated as 
a single project. The Technical Explanation further states that 
if the 183-day threshold is exceeded, the site or project 
constitutes a permanent establishment as of the first day of 
activity. The 183-day period for establishing a permanent 
establishment in connection with a site, project, rig, or ship 
is significantly shorter than the twelve-month period provided 
in the corresponding rule of the U.S. and OECD models, but is 
the same as the periods contained in the U.N. model and U.S. 
treaties with some other countries.
    The proposed protocol provides that it is understood that 
if an enterprise which is a general contractor undertakes the 
performance of a comprehensive project and subcontracts parts 
of such project to a subcontractor, the time spent by such 
subcontractor is considered to be time spent by the general 
contractor for purposes of the 183-day test. The subcontractor 
will have a permanent establishment only if its activities 
satisfy the 183-day test. The proposed protocol provides that 
the 183-day period begins as of the date on which the 
construction activity itself begins, and does not take into 
account time spent solely on preparatory activities such as 
obtaining permits.
    The proposed treaty further provides that a permanent 
establishment includes the furnishing of services, including 
consultancy services, by an enterprise through employees or 
other personnel engaged by the enterprise for such purpose, but 
only if the activities of that nature continue (for the same or 
a connected project) within that country for a period or 
periods aggregating more than 183 days within any 12-month 
period beginning or ending in the taxable year concerned. This 
rule regarding the performance of services as constituting a 
permanent establishment is not contained in the U.S. or OECD 
models. A similar rule is contained in the U.N. model.
    Under the proposed treaty, the following activities are 
deemed not to constitute a permanent establishment: the use of 
facilities solely for storing, displaying, or delivering goods 
or merchandise belonging to the enterprise; 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; the maintenance of a fixed 
place of business solely for the purchase of goods or 
merchandise or for the collection of information for the 
enterprise; 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; and the 
maintenance of a fixed place of business solely for the purpose 
of any combination of the forgoing activities described above, 
provided that the overall activity of the fixed place of 
business resulting from this combination is of a preparatory or 
auxiliary character. The proposed protocol provides that it is 
understood that in order for these rules to apply, the 
activities described above that are conducted by a resident of 
a country must each be of a preparatory or auxiliary character. 
Thus, maintaining sales personnel in a country would not be an 
activity excepted from treatment as a permanent establishment 
under these rules, and, if other requirements of the permanent 
establishment article are satisfied, would constitute a 
permanent establishment. The Technical Explanation gives 
advertising and supplying information as examples of 
preparatory and auxiliary activities that would not give rise 
to a permanent establishment. The rules in the proposed treaty 
are similar to the rule in the OECD model. Unlike the proposed 
treaty and the OECD model, the U.S. model provides that the 
maintenance of a fixed place of business solely for any 
combination of the above-listed activities does not constitute 
a permanent establishment, without requiring that the overall 
combination of activities be of a preparatory or auxiliary 
character.
    If a person, other than an independent agent, is acting on 
behalf of an enterprise and has and habitually exercises in a 
country the authority to conclude contracts in the name of the 
enterprise, the enterprise generally will be deemed to have a 
permanent establishment in that country in respect of any 
activities that person undertakes for the enterprise. This rule 
does not apply where the activities of such person are limited 
to those activities specified above, such as storage or display 
of merchandise, which do not constitute a permanent 
establishment.
    Under the proposed treaty, no permanent establishment is 
deemed to arise merely because the enterprise carries on 
business in a country through a broker, general commission 
agent, or any other agent of independent status, provided that 
such persons are acting in the ordinary course of their 
business. Unlike the U.S. model, but similar to the U.N. model, 
the proposed treaty provides that when the activities of such 
agent are devoted wholly or almost wholly on behalf of that 
enterprise and the transactions between the agent and the 
enterprise are not made under arm's length conditions, such 
agent will not be considered to be an independent agent for 
purposes of the foregoing rule.
    The fact that a company that is a resident of one country 
controls or is controlled by a company that is a resident of 
the other country or that carries on business in the other 
country (whether through a permanent establishment or 
otherwise) does not of itself cause either company to be a 
permanent establishment of the other.

Article 6. Income from Immovable Property (Real Property)

    This article covers income from real property. The rules in 
Article 13 (Gains) cover gains from the sale of real property.
    Under the proposed treaty, income derived by a resident of 
one country from immovable property (real property), including 
income from agriculture or forestry, situated in the other 
country may be taxed in the country where the property is 
located. This rule is consistent with the rules in the U.S., 
OECD and U.N. models.
    The term ``immovable property (real property)'' has the 
meaning which it has under the law of the country in which the 
property in question is situated.\8\ The proposed treaty 
specifies that the term in any case includes property accessory 
to immovable property (real property); livestock and equipment 
used in agriculture and forestry; rights to which the 
provisions of general law respecting landed property apply; 
usufruct of immovable property (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. Ships, boats, and aircraft are not 
considered to be immovable property (real property).
---------------------------------------------------------------------------
    \8\ In the case of the United States, the term is defined in Treas. 
Reg. sec. 1.897-1(b).
---------------------------------------------------------------------------
    The proposed treaty specifies that the country in which the 
property is situated may tax income derived from the direct 
use, letting, or use in any other form of immovable property 
(real property). The proposed treaty further provides that the 
rules of this article permitting source-country taxation apply 
to the income from immovable property (real property) of an 
enterprise and to income from immovable property (real 
property) used for the performance of independent personal 
services.
    Similar to the U.S. model and other U.S. income tax 
treaties, the proposed treaty provides residents of a country 
with an election to be taxed by the other country on a net 
basis on income from real property in that country, as if such 
income were business profits attributable to a permanent 
establishment in such other country (where such treatment is 
not otherwise allowed). Such election is binding for the 
taxable year and all subsequent taxable years unless the 
competent authority of the country in which the property is 
situated agrees to terminate the election. U.S. internal law 
provides such a net-basis election in the case of income of a 
foreign person from U.S. real property (Code secs. 871(d) and 
882(d)).

Article 7. Business Profits

            U.S. internal law
    U.S. law distinguishes between the U.S. business income and 
the 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, rents, and wages) 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 (under what is referred to as the ``force 
of attraction'' rule).
    Foreign-source income generally is 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 for purposes of determining 
the foreign-source income that is effectively connected with a 
U.S. business of an insurance company.
    Any income or gain of a foreign person for any taxable year 
that is attributable to a transaction in another 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 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

Business profits subject to host country tax

    Under the proposed treaty, the business profits of an 
enterprise of one of the countries are taxable in the other 
country if the enterprise carries on business through a 
permanent establishment within the other country, but only so 
much of the business profits that is attributable to that 
permanent establishment.
    The taxation of business profits under the proposed treaty 
differs from U.S. internal law 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. Under the 
proposed treaty, some level of fixed place of business would 
have to be present and the business profits generally would 
have to be attributable to that fixed place of business.
    The proposed treaty provides that there will be attributed 
to a permanent establishment the business profits which it 
might be expected to make if it were a distinct and independent 
enterprise engaged in the same or similar activities under the 
same or similar conditions. The Technical Explanation states 
that amounts may be attributed to the permanent establishment 
whether or not they are from sources within the country in 
which the permanent establishment is located.
    Nothing in this article will affect the application of any 
law of a country relating to the determination of the tax 
liability of a person in cases where the information available 
to the competent authority of that country is inadequate to 
determine the profits to be attributed to a permanent 
establishment. In such cases, the determination of the profits 
of the permanent establishment must be consistent with the 
principles stated in this article (i.e., to reflect arm's 
length pricing and appropriate deductions of expenses).

Treatment of expenses

    In computing taxable business profits, the proposed treaty 
provides that deductions are allowed for expenses, wherever 
incurred, which are incurred for the purposes of the permanent 
establishment, including executive and general administrative 
expenses so incurred. However, no deductions are allowed for 
amounts paid by the permanent establishment to its head office 
or other offices of the enterprise (other than reimbursement 
for actual expenses) by way of royalties, fees, or other 
similar payments in return for the use of patents or other 
rights, or by way of commission for specific services performed 
or for management, or by way of interest for loans to the 
permanent establishment. The Technical Explanation states that 
there should be no profit element in such intra-company 
transfers. Similarly, no account is taken for amounts charged 
by the permanent establishment to its head office or other 
offices of the enterprise (other than reimbursement for actual 
expenses) by way of royalties, fees, or other similar payments 
in return for the use of patents or other rights, or by way of 
commission for specific services performed or for management, 
or by way of interest for loans to the head office of the 
enterprise or any other of its offices. The Technical 
Explanation states that a permanent establishment may not 
increase its business profits by the amount of any notional 
fees for ancillary services performed for another unit of the 
enterprise, and also may not deduct expenses in providing such 
services, because those expenses would be incurred for purposes 
of a business unit other than the permanent establishment.
    A country may, consistent with its law, impose limitations 
on deductions taken by the permanent establishment so long as 
these limitations are consistent with the concept of net 
income. The Technical Explanation states that this rule would 
not permit the countries to deny a deduction for wages and 
interest expenses because such expenses are so fundamental that 
denial of such deductions would be inconsistent with the 
concept of net income.
    The proposed protocol provides that expenses allowed as a 
deduction include a reasonable allocation of expenses, 
including executive and general administrative expenses, 
research and development expenses, interest, and other expenses 
incurred in the taxable year for the purposes of the enterprise 
as a whole (or the part thereof which includes the permanent 
establishment), regardless of where incurred. However, such 
expenses are allowed as deductions only to the extent that such 
expenses have not been deducted by such enterprise and are not 
reflected in other deductions allowed to the permanent 
establishment, such as the deduction for cost of goods sold or 
the value of the purchases. The proposed protocol provides that 
the allocation of expenses must be accomplished in a manner 
that reflects to a reasonably close extent the factual 
relationship between the deduction and the permanent 
establishment and the enterprise. The proposed protocol 
provides examples of bases and factors which may be considered, 
including but not limited to: (1) comparison of units sold; (2) 
comparison of the amount of gross sales or receipts; (3) 
comparison of cost of goods sold; (4) comparison of profit 
contribution; (5) comparison of expenses incurred, assets used, 
salaries paid, space utilized, and time spent that are 
attributable to the activities of the permanent establishment; 
and (6) comparison of gross income.\9\ The Technical 
Explanation states that these rules permit (but do not require) 
each country to apply the type of expense allocation rules 
provided by U.S. law, such as in Treas. Reg. secs. 1.861-8 and 
1.882-5. The Committee believes that it is appropriate to apply 
reasonable allocation methods for these purposes.
---------------------------------------------------------------------------
    \9\ These bases and factors are taken from those described in Temp. 
Treas. Reg. sec. 1.861-8T(c)(1).
---------------------------------------------------------------------------
    The proposed protocol provides that research and 
development expenses incurred with respect to the same product 
line may be allocated to a permanent establishment based on 
gross receipts (i.e., the ratio of gross receipts of the 
permanent establishment to the total gross receipts of the 
enterprise with respect to that product line). The proposed 
protocol further provides that Venezuela will not allow a 
deduction with respect to any expenses allocable to income not 
subject to tax in Venezuela under its territorial system of 
taxation.

Other rules

    Business profits are not attributed to a permanent 
establishment merely by reason of the mere purchase of goods or 
merchandise by the 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 are not 
increased by a profit element in its purchasing activities.
    The business profits attributable to a permanent 
establishment must be determined under the same method each 
year unless there is a good and sufficient reason to the 
contrary. The Technical Explanation states that this rule does 
not restrict a treaty country from imposing additional 
requirements, such as the rules under Code section 481, to 
prevent amounts from being duplicated or omitted following a 
change in accounting method.
    The proposed treaty provides that business profits 
attributable to a permanent establishment include only the 
profits or losses derived from the assets or activities of the 
permanent establishment. The proposed treaty does not 
incorporate the limited force of attraction rule of Code 
section 864(c)(3). The proposed treaty is consistent with the 
U.S. model and other existing U.S. treaties in this regard.
    Where business profits include items of income that are 
dealt with separately in other articles of the proposed treaty, 
those other articles, and not the business profits article, 
govern the treatment of those items of income (except where 
such other articles specifically provide to the contrary). 
Thus, for example, dividends are taxed under the provisions of 
Article 10 (Dividends), and not as business profits, except as 
specifically provided in Article 10.
    The proposed treaty incorporates the rule of Code section 
864(c)(6) and provides that any income or gain attributable to 
a permanent establishment or a fixed base during its existence 
is taxable in the country where the permanent establishment or 
fixed base is located even though payments are deferred until 
after the permanent establishment or fixed base has ceased to 
exist. This rule applies with respect to business profits 
(Article 7, paragraphs 1 and 2), dividends (Article 10, 
paragraph 6), interest (Article 11, paragraph 6), royalties 
(Article 12, paragraph 4), gains (Article 13, paragraph 3), 
independent personal services income (Article 14), and other 
income (Article 22, paragraph 2).

Article 8. Shipping and Air Transport

    Article 8 of the proposed treaty covers income from the 
operation or rental of ships, aircraft, and containers in 
international traffic. The rules governing income from the 
disposition of ships, aircraft, and containers are contained in 
Article 13 (Gains).
    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 providing such reciprocal exemptions.
    The proposed treaty provides that profits which are derived 
by an enterprise of one country from the operation in 
international traffic of ships or aircraft are taxable only in 
that country, regardless of the existence of a permanent 
establishment in the other country. International traffic means 
any transport by a ship or aircraft, except where the transport 
is solely between places in the other country.
    The proposed treaty provides that profits from the rental 
of ships or aircraft on a full (time or voyage) basis 
constitute profits from the operation of ships or aircraft. 
Thus, such profits from the rental of ships or aircraft for use 
in international traffic are exempt from tax in the other 
country. In addition, the proposed treaty provides that profits 
from the operation of ships or aircraft include profits derived 
from the rental of ships or aircraft on a bareboat basis if 
such ships or aircraft are operated in international traffic by 
the lessee or if such rental profits are incidental to profits 
from the operation of ships or aircraft in international 
traffic. The proposed treaty further provides that profits 
derived by an enterprise from the inland transport of property 
or passengers within either country is treated as profits from 
the operation of ships or aircraft in international traffic if 
such transport is undertaken as part of international traffic.
    Like the U.S. model, the proposed treaty provides that 
profits derived by an enterprise of a country from the use, 
maintenance, or rental of containers (including trailers, 
barges, and related equipment for the transport of containers) 
used in international traffic are taxable only in that country.
    Like the U.S. model, the shipping and air transport 
provisions of the proposed treaty also apply to profits from 
participation in a pool, joint business, or international 
operating agency. This rule covers profits derived pursuant to 
an arrangement for international cooperation between carriers 
in shipping and air transport.
    The proposed protocol provides that this article will not 
affect the provisions of the December 29, 1987, agreement 
between the United States and Venezuela for the avoidance of 
double taxation with respect to shipping and air transport.

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 make an allocation of 
profits to an enterprise of that country in the case of 
transactions between related enterprises, if conditions are 
made or imposed between the two enterprises in their commercial 
or financial relations which differ from those which would be 
made between independent enterprises. In such a case, a country 
may allocate to such an enterprise the profits which it would 
have accrued but for the conditions so imposed. This treatment 
is consistent with the U.S. model.
    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 their management, control, or 
capital.
    Under the proposed treaty, when a redetermination of tax 
liability has been made by one country under the provisions of 
this article, the other country will make a corresponding 
adjustment to the amount of tax paid in that country on the 
redetermined income if it agrees that the adjustment was 
correct. In making such adjustment, due regard is to be given 
to other provisions of the proposed treaty, and the competent 
authorities of the two countries are to consult with each other 
if necessary. The proposed treaty's saving clause retaining 
full taxing jurisdiction in the country of residence or 
citizenship does not apply in the case of such adjustments. 
Accordingly, internal statute of limitations provisions do not 
prevent the allowance of appropriate correlative adjustments.
    This article does not replace the internal law provisions 
that permit this type of adjustment. Under the proposed treaty, 
this article does not limit any law provisions of either 
country that permit the distribution, apportionment, or 
allocation of income, deductions, credits, or allowances 
between persons (whether or not residents of one of the treaty 
countries) that are owned or controlled directly or indirectly 
by the same interests when necessary in order to prevent 
evasion of taxes or to clearly reflect income. The Technical 
Explanation states that adjustments are permitted under 
internal law provisions even if such adjustments are different 
from, or go beyond, the adjustments authorized by this article, 
provided that such adjustments are consistent with the general 
principles of this article permitting adjustments to reflect 
arm's-length terms. The Technical Explanation states that this 
article also permits the tax authorities of the countries to 
address thin capitalization issues.

Article 10. Dividends

            Internal taxation rules

United States

    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 gains in connection with 
Article 13 below).
    Dividends paid by a U.S. corporation generally are U.S.-
source income. 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 real estate investment trust (``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 regulated 
investment company (``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.

Venezuela

    Venezuela currently does not impose a withholding tax on 
dividends. Venezuela is in the process of enacting new tax 
legislation that would impose a 34-percent withholding tax on 
dividends paid to nonresident individuals and foreign 
corporations. Although the new tax law has not yet been 
officially published, the Committee understands that the new 
dividend withholding tax is effective for dividends paid on or 
after January 1, 2001.
            Proposed treaty limitations on internal law
    Under the proposed treaty, dividends paid by a company that 
is a resident of a treaty country to a resident of the other 
country may be taxed in such other country. Such dividends may 
also be taxed by the country in which the payor company is 
resident, and according to the laws of that country, but the 
rate of such tax is limited. Under the proposed treaty, source-
country taxation (i.e., taxation by the country in which the 
payor company is resident) generally is limited to 5 percent of 
the gross amount of the dividend if the beneficial owner of the 
dividend is a resident of the other country and is a company 
which owns at least 10 percent of the voting stock of the payor 
company. The source-country dividend withholding tax generally 
is limited to 15 percent of the gross amount of the dividends 
beneficially owned by residents of the other country in all 
other cases.
    The Technical Explanation states that the term ``beneficial 
owner'' is not defined in the proposed treaty and, thus, is 
defined under the internal law of the source country. The 
Technical Explanation further states that the beneficial owner 
of a dividend for purposes of this article is the person to 
which the dividend income is attributable for tax purposes 
under the laws of the source country.
    The rates of source-country dividend withholding tax 
permitted under the proposed treaty are consistent with those 
provided for in the U.S. model, the OECD model, and most other 
U.S. income tax treaties. The proposed treaty provides that 
these rules do not affect the taxation of the paying company on 
the profits out of which the dividends are paid.
    The proposed treaty allows the United States to impose a 
15-percent tax on a U.S.-source dividend paid by a RIC to a 
Venezuelan person. The proposed treaty allows the United States 
to impose a 15-percent tax on a U.S.-source dividend paid by a 
REIT to a Venezuelan person if: (1) the beneficial owner of the 
dividend is an individual holding an interest of not more than 
10 percent of the REIT; (2) the dividend is paid with respect 
to a class of stock that is publicly traded and the beneficial 
owner of the dividend is a person holding an interest of not 
more than 5 percent of any class of the REIT's stock; or (3) 
the beneficial owner of the dividend is a person holding an 
interest of not more than 10 percent of the REIT and the REIT 
is diversified. There is no limitation in the proposed treaty 
on the tax that may be imposed by the United States with 
respect to a REIT dividend that does not satisfy at least one 
of these requirements. Thus, such a dividend is taxable at the 
30-percent U.S. statutory withholding rate. For purposes of 
this provision, the Technical Explanation states that a REIT 
will be considered to be diversified if the value of no single 
interest in the REIT's real property exceeds 10 percent of the 
REIT's total interests in real property.
    The proposed treaty provides that dividends may not be 
taxed by the source country if the beneficial owner of the 
dividends is (1) the other country or a political subdivision 
or local authority thereof, or (2) a governmental entity 
constituted and operated exclusively to administer or provide 
pension benefits. This rule does not apply if the dividends are 
derived from carrying on a trade or business or from an 
associated enterprise. For these purposes, the proposed 
protocol provides that it is understood that a ``governmental 
entity constituted and operated exclusively to administer or 
provide pension benefits'' includes, in the case of Venezuela, 
private, public or mixed entities operating under or pursuant 
to the Ley del Subsistema de Pensiones (Law of the Pension 
System), enacted under the Ley Orgnica del Sistema de Seguridad 
Social Integral (Organic Law of the Integrated Social Security 
System).
    The Technical Explanation states that Venezuela is 
currently considering ways of reforming its government-run 
social security system. The Ley del Subsistema de Pensiones 
currently is proposed legislation that would replace 
Venezuela's existing regime with a system of privatized funds 
that would be permitted to invest in equities. The Technical 
Explanation states that the inclusion of the proposed funds 
within the exemption for dividend payments was judged warranted 
because the system under the proposed legislation is similar to 
a government-run social security system (as opposed to a 
private pension plan system).
    The Technical Explanation states that because the Ley del 
Subsistema de Pensiones has not been enacted, additional 
general requirements are listed in the proposed protocol to 
ensure that the exemption for dividend payments will apply only 
to entities that operate under or pursuant to a final version 
of the law that includes the significant features of the 
proposed law. In order to satisfy these requirements, the 
version of the Ley del Subsistema de Pensiones that is enacted 
must: (1) provide universal coverage; (2) require mandatory 
contributions by both employers and employees; (3) limit the 
discretion of employers or employees to direct investment; (4) 
restrict distributions or borrowings, directly or indirectly, 
except upon death, retirement or disability; and (5) require 
that accounts be maintained at only one such qualifying entity 
at a time. The proposed protocol further provides that such 
entities also must be operated, and their investment parameters 
established, pursuant to governmental oversight and regulation. 
For purposes of the rules described above, the term 
``governmental entity constituted and operated exclusively to 
administer or provide pension benefits'' also includes any 
equivalent entities in the United States.
    The proposed treaty defines ``dividends'' as income from 
shares or other rights, which are not debt claims and which 
participate in profits. The term also includes income from 
other corporate rights if such income is subjected to the same 
tax treatment as income from shares by the country in which the 
distributing corporation is resident. Furthermore, dividends 
include income from arrangements, including debt obligations, 
that carry the right to participate in, or determined with 
reference to, profits to the extent such income is so 
characterized under the laws of the country in which the income 
arises.
    The proposed treaty's reduced rates of tax on dividends do 
not apply if the dividend recipient carries on business through 
a permanent establishment in the source country, or performs in 
the source country independent personal services from a fixed 
base located in that country, and the dividend is attributable 
to such permanent establishment or fixed base. In such cases, 
the dividend attributable to the permanent establishment or the 
fixed base is taxed as business profits (Article 7) or as 
income from the performance of independent personal services 
(Article 14), as the case may be. Under the proposed treaty, 
these rules also apply if the permanent establishment or fixed 
base no longer exists when the dividends are paid but such 
dividends are attributable to the former permanent 
establishment or fixed base.
    The proposed treaty provides that a country may not impose 
any tax on dividends paid by a company that is a resident of 
the other country, except to the extent that the dividends are 
paid to a resident of the first country or the dividends are 
attributable to a permanent establishment or fixed base 
situated in that first country. Thus, this provision generally 
overrides the ability of the United States to impose its 
second-level withholding tax on the U.S.-source portion of 
dividends paid by a Venezuelan corporation.

Article 11. Interest

            Internal taxation rules

United States

    Subject to several exceptions (such as those for portfolio 
interest, bank deposit interest, and short-term original issue 
discount), the United States imposes a 30-percent withholding 
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 by the U.S. 
trade or business of a foreign corporation.
    Portfolio interest generally is defined as any U.S.-source 
interest that is not effectively connected with the conduct of 
a trade or business if such interest (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 does not apply 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 generally is treated 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, 
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.

Venezuela

    Venezuela generally imposes a withholding tax on interest 
paid to nonresidents at a rate of 34 percent on 95 percent of 
the gross payment (i.e., an effective rate of 32.3 percent). 
However, interest paid to nonresident financial institutions is 
subject to withholding tax at a rate of 4.95 percent.
            Proposed treaty limitations on internal law
    The proposed treaty provides that interest arising in one 
of the countries and derived by a resident of the other country 
generally may be taxed in both countries. This is contrary to 
the position of the U.S. model which provides for an exemption 
from source-country tax for interest beneficially owned by a 
resident of the other country.
    The proposed treaty limits the rate of source-country tax 
that may be imposed on interest income if the beneficial owner 
of the interest is a resident of the other country. The source-
country tax on such interest may not exceed 4.95 percent of the 
gross amount of the interest if it is beneficially owned by any 
financial institution, including an insurance company. The 
Technical Explanation states that this rate is based on the 
Venezuelan statutory rate of interest withholding for payments 
made to financial institutions. In all other cases, the rate of 
source-country tax on interest generally may not exceed 10 
percent of the gross amount of such interest. These rates are 
higher than the rates permitted under the U.S. model and many 
U.S. income tax treaties.
    The proposed treaty provides for a complete exemption from 
source-country withholding tax in the case of certain 
categories of interest arising in a country and earned by 
residents of the other country. Interest that is paid by a 
treaty country (or a political subdivision or local authority 
thereof) is exempt from source-country tax. In addition, 
exemptions from source-country tax apply to cases in which the 
beneficial owner of the interest is (1) the other country (or a 
political subdivision or local authority thereof) or an 
instrumentality wholly owned by the other country), or (2) a 
resident of that other country and the interest is paid with 
respect to debt obligations made, guaranteed, or insured 
(directly or indirectly) by that country or an instrumentality 
wholly owned by that country. The proposed protocol states that 
instrumentalities, referred to above, include the U.S. Export-
Import Bank, the Federal Reserve Banks and the Overseas Private 
Investment Corporation, the Venezuelan Banco de Comercio 
Exterior, the Banco Central de Venezuela and the Fondo de 
Inversiones de Venezuela, and such other instrumentalities as 
the competent authorities may agree upon.
    The proposed treaty provides two anti-abuse exceptions to 
the general source-country reduction in tax discussed above. 
The first exception relates to ``contingent interest'' 
payments. If interest is paid by a source-country resident to a 
resident of the other country and is determined with reference 
(1) to receipts, sales, income, profits, or other cash flow of 
the debtor or a related person, (2) to any change in the value 
of any property of the debtor or a related person, or (3) to 
any dividend, partnership distribution, or similar payment made 
by the debtor to a related person, such interest may be taxed 
in the source country in accordance with its internal laws. 
However, if the beneficial owner is a resident of the other 
country, such interest may not be taxed at a rate exceeding 15 
percent (i.e., the rate prescribed in subparagraph (b) of 
paragraph 2 of Article 10 (Dividends)). The second anti-abuse 
exception provides that the reductions in and exemption from 
source country tax do not apply to excess inclusions with 
respect to a residual interest in a REMIC. Such income may be 
taxed in accordance with each country's internal law.
    The proposed treaty defines the term ``interest'' 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 from bonds or debentures, including 
premiums or prizes attaching to such securities, bonds, or 
debentures. Furthermore, interest includes any other income 
that is treated as interest by the tax law of the country in 
which the income arises. The proposed treaty provides that the 
term ``interest'' does not include amounts treated as dividends 
under Article 10 (Dividends) or penalty charges for late 
payment.
    The proposed treaty's reductions in source country tax on 
interest do not apply if (1) the beneficial owner of the 
interest carries on business in the source country through a 
permanent establishment located in that country, or performs 
independent personal services in the source country from a 
fixed base located in that country, and (2) the interest paid 
is attributable to such permanent establishment or fixed base. 
In such events, the interest is taxed as business profits 
(Article 7) or as independent personal services income (Article 
14), as the case may be. These rules also apply if the 
permanent establishment or fixed base no longer exists when the 
interest is paid but such interest is attributable to the 
former permanent establishment or fixed base.
    The proposed treaty provides that interest is treated as 
arising in a country if the payor is that country, including 
its political subdivisions and local authorities, or if the 
payor is a resident of that country.\10\ If, however, the payor 
of the interest has a permanent establishment or a fixed base 
in a country and such interest is borne by the permanent 
establishment or fixed base, then such interest is sourced to 
the country in which the permanent establishment or fixed base 
is situated. In addition, if a person derives profits that are 
taxable on a net basis in such country under paragraph 5 of 
Article 6 (Income From Immovable Property (Real Property)) or 
paragraph 1 of Article 13 (Gains), and the interest is 
allocable to such profits, then such interest is sourced to the 
country in which such profits are derived. Thus, for example, 
if a French resident has a permanent establishment in Venezuela 
and that French resident incurs indebtedness to a U.S. person, 
the interest on which is borne by the Venezuelan permanent 
establishment, the interest would be treated as having its 
source in Venezuela.
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    \10\ This is consistent with the source rules of U.S. law, which 
provide as a general rule that interest income has as its source the 
country in which the payor is resident.
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    The proposed treaty addresses the issue of non-arm's-length 
interest charges between related parties (or parties otherwise 
having a special relationship) by providing that the amount of 
interest for purposes of applying this article is the amount of 
interest that would have been agreed upon by the payor and the 
beneficial owner in the absence of the special relationship. 
Any amount of interest paid in excess of such amount is taxable 
according to the internal laws of each country, taking into 
account the other provisions of the proposed treaty. For 
example, excess interest paid by a subsidiary corporation to 
its parent corporation may be treated as a dividend under 
internal law and thus subject to the provisions of Article 10 
(Dividends).

Article 11A. Branch Tax

            Internal taxation rules

United States

    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,'' which 
is a measure of the accumulated U.S. effectively connected 
earnings of the corporation that are removed in any year from 
its U.S. trade or business. The dividend equivalent amount is 
limited by (among other things) the foreign corporation's 
aggregate earnings and profits accumulated in taxable years 
beginning after December 31, 1986. The Code provides that no 
U.S. treaty shall exempt any foreign corporation from the 
branch profits tax (or reduce the amount thereof) unless the 
foreign corporation is a ``qualified resident'' of the treaty 
country. The definition of a ``qualified resident'' under U.S. 
internal law is somewhat similar to the definition of a 
corporation eligible for benefits under the proposed treaty 
(discussed below in connection with Article 17 (Limitation on 
Benefits)).
    A foreign corporation is 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.

Venezuela

    Venezuela currently does not impose a branch profits tax. 
Venezuela is in the process of enacting new tax legislation 
that would impose a branch profits tax. Although the new law 
has not yet been officially published, the Committee 
understands that the new branch profits tax will be imposed on 
a presumed dividend at a tax rate of 34 percent. The Committee 
also understands that the new Venezuelan branch profits will be 
effective for taxable years beginning on or after January 1, 
2001.
            Proposed treaty limitations on internal law
    The proposed treaty provides that a company that is a 
resident of a country may be subject in the other country to a 
tax in addition to the tax on profits.
    This article is drafted to apply to the U.S. branch profits 
tax. The proposed treaty permits the United States to impose 
its branch profits tax, but limits the rate of such tax to 5 
percent. The article refers to a maximum 5-percent tax on the 
``dividend equivalent amount.'' \11\ The proposed protocol 
provides that in the case of the United States, the term 
``dividend equivalent amount'' has the meaning it has under 
U.S. laws, as it may be amended from time to time without 
changing the general principle thereof. The Technical 
Explanation states that the term ``dividend equivalent amount'' 
has the same meaning it has under Code section 884, as it may 
be amended, provided that the amendments are consistent with 
the purposes of the branch profits tax.
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    \11\ In this regard, the proposed treaty permits the United States 
to impose a tax on the ``dividend equivalent amount'' of the business 
profits of a Venezuelan corporation which are attributable to a U.S. 
permanent establishment or that are subject to tax on a net basis as 
income or gains from real property.
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    Venezuela is in the process of enacting a new Venezuelan 
branch profits tax. This article is not drafted specifically to 
apply to this new tax. The article only refers to a maximum 5-
percent tax on the ``dividend equivalent amount,'' which is not 
a term that is anticipated to be used in the new Venezuelan tax 
law. The Committee has included in its recommended resolution 
of ratification an understanding to the proposed treaty to 
clarify that U.S. entities with a branch in Venezuela are 
entitled to the reduced 5-percent rate of tax under this 
article with respect to the new Venezuelan branch profits tax.
    The proposed treaty permits the imposition of the U.S. tax 
on excess interest, but limits the rate of source-country tax. 
In this regard, the proposed protocol provides that for these 
purposes, excess interest means the excess, if any of (1) 
interest deductible in one or more years in computing the 
profits of a corporation that are either attributable to a 
permanent establishment or that are subject to tax on a net 
basis as income or gains from real property, over (2) the 
interest paid by or from such permanent establishment or trade 
or business. The proposed treaty provides that the rate of tax 
imposed on such excess interest may not exceed the specified 
rates in the interest article (i.e., 4.95 or 10 percent, as the 
case may be, under Article 11(2)). Thus, for example, if the 
enterprise is a financial institution, the excess interest tax 
would be imposed at a 4.95 percent rate.

Article 12. Royalties

            Internal taxation rules

United States

    Under the same system that applies to dividends and 
interest, the United States imposes a 30-percent withholding 
tax on U.S.-source royalties paid to foreign persons. U.S.-
source royalties include royalties for the use of or the right 
to use intangible property in the United States.

Venezuela

    Venezuela generally imposes a withholding tax on royalties 
paid to nonresidents at a rate of 34 percent. The 34 percent 
rate is applied to 90 percent of notional income (i.e., an 
effective rate of 30.6 percent) in the case of certain 
turnover-based royalties, and to 50 percent of notional income 
(i.e., an effective rate of 17 percent) in the case of certain 
lump-sum royalties.
            Proposed treaty limitations on internal law
    The proposed treaty provides that royalties arising in a 
treaty country and derived by a resident of the other country 
may be taxed by that other country. In addition, the proposed 
treaty allows the country where the royalties arise (the 
``source country'') to tax such royalties according to its 
laws. However, if the beneficial owner of the royalties is a 
resident of the other country, the source country tax is 
limited.
    The proposed treaty provides that the rate of source-
country tax on certain royalties may not exceed 5 percent of 
the gross royalties. The 5-percent limitation applies to 
payments of any kind for the use of, or the right to use, 
industrial, commercial or scientific equipment. Unlike the 
proposed treaty, the U.S. model treats such income as business 
profits, and not as royalties.
    The proposed treaty further provides that the rate of 
source-country tax on certain royalties may not exceed 10 
percent of the gross royalties. The 10-percent limitation 
applies to payments of any kind received in consideration for 
the use of, or the right to use, any copyright of literary, 
dramatic, musical, artistic, or scientific work, including 
cinematographic films, tapes, and other means of image or sound 
reproduction, any patent, trademark, design or model, plan, 
secret formula or process, or other like right or property, or 
for information concerning industrial, commercial or scientific 
experience. The proposed treaty also treats as royalties 
subject to the 10-percent limitation gains derived from the 
alienation of such right or property to