pany pays be entitled to treaty reduction of source country taxation of the dividend.

Similarly, whereas the U.S. model provides for competent authority determination (on the basis of mutual agreement) on the mode of application of the treaty to a person other than an individual or a company that is a dual resident, no such rule is found in the proposed treaty. As would be the case for a dual resident company, such a person would be treated as a resident of neither the United States nor Mexico under the proposed treaty.

(6) The proposed treaty's definition of a permanent establishment diverges in some respects from the definition contained in the U.S. model. For instance, under the proposed treaty, a building site or construction or installation project, or an installation or drilling rig or ship used for the exploration or exploitation of natural resources (or related supervisory activity) that an enterprise of one country has in the other country would constitute a permanent establishment in that other country if it lasts more than six months. This six-month period is significantly shorter than the 12-month period provided for in the U.S. model.

In addition, some differences exist between the provisions of the U.S. model and those of the proposed treaty with respect to the determination of whether the activities in one of the countries (the "first country") of an agent (other than an independent agent as defined in the treaties) that is acting on behalf of an enterprise of the other country constitutes a permanent establishment. Both treaties provide that such an enterprise would be deemed to have a permanent establishment in the first country if the agent has and habitually exercises in that country an authority to conclude contracts in the name of the enterprise, unless the activities of the agent are limited to those activities specifically mentioned in the treaty as activities that would not give rise to a permanent establishment. The proposed treaty further provides that a permanent establishment would be deemed to exist in a case where the agent has no authority to conclude contracts in the name of the enterprise, but habitually processes in the first country on behalf of the enterprise goods or merchandise maintained there by that enterprise, provided that the processing is carried on using assets furnished (directly or indirectly) by that enterprise or a related person. In addition, the proposed treaty provides that an enterprise of one of the countries that is engaged in the insurance business would, except with respect to reinsurance activities, be deemed to have a permanent establishment in the other country if it collects premiums in the territory of that other country or insures risks situated therein through a representative other than an independent agent. The U.S. model treaty does not contain either of these latter two provisions.

With respect to the activities of independent agents, both the proposed treaty and the U.S. model provide that an enterprise of one country would not be deemed to have a permanent establishment in the other country merely because it carries on business in that other country through a broker, general commission agent, or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. The proposed treaty, however, places an additional limitation on the oper

ation of this rule that is not found in the U.S. model. Under the proposed treaty, this rule would not apply if in the persons' commercial or financial relations with the enterprise, conditions are made or imposed that differ from those generally agreed to by independent agents.

(7) The proposed protocol contains a special provision concerning the imposition of the assets tax by Mexico. A similar provision is not contained in the U.S. model because the United States does not impose a tax based on assets. Under the proposed protocol, the Mexican assets tax generally would not apply to a U.S. resident that, pursuant to Article 7 (Business Profits) of the proposed treaty, would not be taxable in Mexico on its business profits because it has no permanent establishment in Mexico. Notwithstanding this exception, the assets tax could be imposed on immovable property situated in Mexico and on certain tangible and intangible property specified in Article 12 (Royalties) that are furnished to Mexican residents.

Under Mexican law, the assets tax generally applies only to the extent that it exceeds any income tax paid to Mexico by the taxpayer. The proposed protocol contains a provision that would prevent the operation of the assets tax from negating certain income tax benefits granted under the proposed treaty.

(8) Unlike the U.S. model, the proposed treaty provides that a country could tax the business profits of an enterprise of the other country where those profits are attributable to a permanent establishment that the enterprise formerly had in the first country. This provision reflects the policy underlying Code section 864(c)(6) which was added by Congress in the Tax Reform Act of 1986 and permits the United States to tax certain deferred payments received by a foreign person without regard to whether the person is engaged in a U.S. trade or business in the taxable year of receipt of the payments.

Similarly, Article 13 (Capital Gains) of the proposed treaty clarifies that a country could tax the capital gains of a resident of the other country that are attributable either to a permanent establishment which that person has or had in the first country, or to a fixed base which is or was available to that person in the first country for the purpose of performing independent personal services. Addition of the words "or had" clarifies that, for purposes of the treaty rules stated above, any gain attributable to a permanent establishment (or fixed base) during its existence would be taxable in the country where the permanent establishment (or fixed base) is situated even if the gain is deferred until after the permanent establishment has ceased to exist. The Treasury Department has indicated that this language would accommodate the application of Code section 864(c)(7) to a resident of Mexico.

(9) The business profits article of the U.S. model treaty omits the force of attraction rules contained in the Code, providing instead that the business profits to be attributed to the permanent establishment shall include only the profits derived from the assets or activities of the permanent establishment. The proposed treaty, on the other hand, contains a limited force of attraction rule under which a country (the "first country") could tax sales in that country by a resident of the other country of goods or merchandise of the

same or similar kind as the goods or merchandise that are sold by that person through its permanent establishment in the first country. Such profits would not be taxable by the first country, however, if the enterprise demonstrates that the sales have been carried out for reasons other than obtaining a treaty benefit. This rule is narrower in scope than the Code's force of attraction rules.

(10) Both the U.S. model and the proposed treaty provide that in determining the business profits of a permanent establishment, there would be allowed as deductions expenses which are incurred for the purposes of the permanent establishment, including a reasonable allocation of executive and general administrative expenses, research and development expenses, interest, and other expenses wherever incurred, for the purposes of the enterprise as a whole (or part thereof which includes the permanent establishment). The proposed treaty (as amended by the proposed protocol), but not the U.S. model, specifies that this rule would apply only to the extent that the expenses have not been deducted by the enterprise and are not reflected in other deductions allowed to the permanent establishment, such as the deduction for the cost of goods sold or the value of purchases. In a further divergence from the U.S. model, the proposed treaty provides that no such deduction would be allowed in respect of such amounts, if any, paid (otherwise than toward reimbursement of actual expenses) by the permanent establishment to the head office of the enterprise or any of its other offices by way of royalties, fees or other similar payments in return for the use of patents or other rights, by way of commission, for specific services performed or for management, or except in the case of a banking enterprise, by way of interest on moneys lent to the permanent establishment.

(11) As is true of some other existing U.S. income tax treaties, the proposed treaty would not provide protection from source country taxation of income from bareboat (i.e., without crew) leases of ships and aircraft in international traffic to the same extent as the U.S. model treaty, which exempts such income from source country tax as income from the operation of ships or aircraft in international traffic. For example, the model provides for exemption from tax in the source country for a bareboat lessor (such as a financial institution or a leasing company) that does not operate ships or aircraft in international traffic, but that leases ships or aircraft to others for use in international traffic. Under the proposed treaty, the exemption for shipping profits would not apply to profits from the rental on a bareboat basis of ships or aircraft unless those profits are accessory to international shipping income of the lessor.

(12) The proposed protocol specifies that if the law of one of the treaty countries calls for a payment to be characterized in whole or in part as a dividend or limits the deductibility of such payment because of thin capitalization rules or because the relevant debt instrument includes an equity interest, that country could treat such payment in accordance with such law. Thus, for example, the proposed treaty would foreclose any suggestion that the proposed treaty might preclude the United States from applying (or limit the application of its so-called "earnings stripping" rules (sec. 163(j)) re

lating to the deductibility of interest expense. No similar provision is contained in the U.S. model treaty.

(13) The proposed treaty and the U.S. model treaty differ in their respective treatment of rental income. Under the U.S. model, the term "business profits" includes income of a trade or business which is derived from the rental of tangible personal property and the rental or licensing of cinematographic films or films or tapes used for radio or television broadcasting. Thus, such income could only be taxed by the source country if it were attributable to a permanent establishment situated therein. Under the proposed treaty, on the other hand, such income generally is treated as "royalties" and, accordingly, is subject to the rules of Article 12. Under Article 12, the source country would be permitted to tax royalties derived by a resident of the other country at a rate not in excess of 10 percent. Alternatively, royalties that are attributable to a permanent establishment located in the source country would be taxable on a net basis as business profits.

(14) The proposed protocol specifies that nothing in the business profits article of the proposed treaty would affect the application of any law of either the United States or Mexico relating to the determination of the tax liability of a person in any case where the information available to the competent authority of that country is inadequate to determine the profits to be attributed to a permanent establishment or in the cases covered by Article 23 of the Income Tax Law of Mexico, provided that, on the basis of the available information, the determination of the profits of the permanent establishment is consistent with the principles of the business profits article. A provision of this nature is not found in the U.S. model trea

ty.

(15) The associated enterprises article of the proposed treaty differs in two principal respects from that article of the U.S. model treaty. First, under the proposed treaty, either treaty country would be required to correlatively adjust any tax liability it previously imposed on an enterprise for profits reallocated to an associated enterprise by the other treaty country, if the first country agrees with the substance of the second country's adjustment. The corresponding U.S. model language is slightly different in that it does not condition the making of the correlative adjustment on the first country's agreement to the original adjustment made by the other country. Second, the proposed protocol provides that the rule requiring the country of residence to make a correlative adjustment would not apply in the case of fraud, gross negligence, or willful default.

(16) Under the proposed treaty, direct investment dividends (i.e., dividends paid to companies resident in the other country that own directly at least 10 percent of the voting shares of the payor) would generally be taxable by the source country at a rate no greater than 5 percent. Portfolio investment dividends (i.e., those paid to companies owning less than a 10 percent voting share interest in the payor, or to noncorporate residents of the other country) would generally be taxable by the source country, after the treaty is fully

phased in, at a rate no greater than 10 percent.4 (Different rules, discussed below, are provided for dividends from a regulated investment company or real estate investment trust.) The U.S. model prescribes maximum source country tax rates of 5 percent on direct investment dividends and 15 percent on other dividends.

The proposed protocol contains a unique "most-favored nation" clause relating to the taxation of dividends. Under that clause, if the United States agrees in a treaty with another country to impose a rate of tax on direct investment dividends that is lower than the 5-percent rate contained in the proposed treaty, then the United States and Mexico would apply that lower rate as if it were the rate specified by the proposed treaty.

(17) The proposed protocol would apply a withholding rate of 10 percent (15 percent during the transition period) on dividends if those dividends are paid by a U.S. regulated investment company (RIC) regardless of whether the RIC dividends are paid to a direct or portfolio investor. The proposed treaty would not provide for a reduction of U.S. withholding tax on dividends if those dividends are paid by a U.S. real estate investment trust (REIT), unless the dividend is beneficially owned by an individual Mexican resident holding a less than 10 percent interest in the REIT.

(18) The U.S. model treaty_provides an exemption from source country taxation on interest. To the contrary, the proposed treaty provides that certain categories of interest derived by a resident of one country which arises from sources in the other country could be taxed by the other country, subject to maximum rates established in the treaty (ranging from 4.9 percent to 15 percent depending on the category in which the interest falls and when it is received).

(19) Under the proposed protocol, no reduction of U.S. withholding tax would be granted under the proposed treaty to a Mexican resident that is a holder of a residual interest in a U.S. real estate mortgage investment conduit (REMIC) with respect to any excess inclusion.5 Moreover, if either country develops an entity that, although not identical to a REMIC, is substantially similar to a REMIC or an instrument that is substantially similar to a residual interest in a REMIC, the competent authorities of the two countries would be required to consult with each other to determine whether the above-described treatment applicable to REMICS would apply to such instrument or entity. The interest article of the U.S. model treaty does not contain a provision dealing with residual interests in REMICS or similar entities.

(20) Unlike the U.S. model treaty (which was drafted before enactment of the branch taxes in the United States), the proposed treaty expressly would permit the United States to impose the branch profits tax. The proposed treaty also would expressly prevent imposition of any other form of second-level withholding tax. The U.S. branch profits tax could be imposed at a rate not exceed

4 For a period of five years from the date on which the provisions of the dividends article takes effect, such dividends would be taxable by the source country at a rate of 15 percent.

5 Similarly, upon notification of the U.S. competent authority by the Mexican competent authority that Mexico has authorized the marketing of securitized mortgages in a manner identical to a REMIC, no treaty reduction in Mexican withholding tax would apply to a U.S. resident that is a holder of an interest in such an entity with respect to income that is comparable to an excess inclusion.