ceives $1,000 of interest from a U.S. bank. Absent the proposed treaty's saving clause (which would allow the United States to tax the interest income as if the treaty were not in effect), the maximum amount of tax that could be imposed by the United States would be $100 (based on the 10-percent rate applicable after the treaty's five-year transition period). In computing the individual's Mexican income tax on the interest income, the proposed treaty would require Mexico to allow a credit against Mexican tax only for the amount of U.S. tax that the individual would have owed absent the saving clause (i.e., $100). Assuming the individual's marginal tax rate in Mexico is 40 percent, his pre-credit Mexican tax liability on the interest would be $400; and his after-credit liability would be $300.

In computing the individual's U.S. tax liability on the interest income, the proposed treaty would require the United States to grant a credit for the $300 of Mexican tax paid, subject to the limitation that the credit could not reduce the overall tax liability on that income below the $100 amount that Mexico credited against its tax.87 Assuming the individual's U.S. marginal tax rate is 36 percent, his pre-credit tax liability on the interest income would be $360. Because the proposed treaty would limit the cumulative amount of credit so as to not reduce tax liability below $100, the amount of credit allowed under the treaty would be $260. Thus, the total amount of tax paid would be the combination of the two liabilities, or $400 of which $300 would be paid to Mexico and $100 to the United States.

Article 25. Non-discrimination

The proposed treaty contains a comprehensive non-discrimination article relating to all taxes of every kind imposed at the national, state, or local level. It is similar to the non-discrimination article in the U.S. model treaty and to provisions that have been embodied in other recent U.S. income tax treaties. The non-discrimination article of the proposed treaty differs from the U.S. model in protecting all legal persons deriving their status as such from the United States, not only U.S. citizens. In this regard, the non-discrimination article of the proposed treaty more closely resembles that of the OECD model treaty.

In general, under the proposed treaty, one country could not discriminate by imposing other or more burdensome taxes (or requirements connected with taxes) on nationals of the other country than it would impose on its nationals in the same circumstances. According to the Technical Explanation, this provision would apply whether or not the nationals in question are residents of the United States or Mexico. By the express terms of the proposed treaty, a U.S. national who is subject to tax in the United States on worldwide income and a Mexican national who is not taxed in the United States on the basis of worldwide income would not be deemed to be in the same circumstances.88

87 Solely for this purpose, the interest income is treated as foreign source income.

88 This rule would apply reciprocally; i.e., a Mexican national who is taxable in Mexico on worldwide income and a U.S. national who is not taxable on worldwide income by Mexico would not be deemed to be in the same circumstances.

Under the proposed treaty, neither country could tax a permanent establishment of an enterprise of the other country less favorably than it taxes its own enterprises carrying on the same activities. Consistent with the U.S. and OECD model treaties, however, a country would not be obligated to grant residents of the other country any personal allowances, reliefs, or reductions for tax purposes on account of civil status or family responsibilities which it grants to its own residents.

The proposed treaty explicitly states that nothing in the non-discrimination article is to be construed as preventing either of the countries from imposing a branch profits tax or a branch-level interest tax.89 Moreover, nothing in this article is to be construed as preventing Mexico from denying a deduction for presumed expenses (without regard to where such expenses are incurred) to an individual resident of the United States who elects to be subject to tax in Mexico on a net basis with respect to income from real property. Each country is required (subject to the arm's-length pricing rules of Articles 9(1) (Associated Enterprises), 11(8) (Interest), and 12(5) (Royalties)) to allow its residents to deduct interest, royalties, and other disbursements paid by them to residents of the other country under the same conditions that it allows deductions for such amounts paid to residents of the same country as the payor. The term "other disbursements" is understood to include a reasonable allocation of executive and general administrative expenses, research and development expenses, and other expenses incurred for the benefit of a group of related enterprises. The staff understands that this provision is not intended to limit in any way the ability of the United States to deny deductions for interest expense under the so-called "earnings-stripping" rules of section 163(j) of the Code.

The rule of non-discrimination also would apply to enterprises of one country that are owned in whole or in part by residents of the other country. Enterprises resident in one country, the capital of which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other country, would not be subjected in the first country to any taxation or any connected requirement which is other or more burdensome than the taxation and connected requirements that the first country imposes or may impose on its similar enterprises. The Technical Explanation includes examples of Code provisions which are understood by the two countries not to violate this provision of the proposed treaty. Those examples cover rules that impose a tax on a liquidating distribution of a U.S. subsidiary of a Mexican company and rules preventing foreign persons from owning stock in Subchapter S corporations.

The saving clause (which allows the country of residence or citizenship to tax notwithstanding certain treaty provisions) would not apply to the non-discrimination article.

Article 26. Mutual Agreement Procedure

The proposed treaty contains the standard mutual agreement provision, with some differences therefrom, that would authorize

89 See detailed discussion of proposed treaty rules regarding branch taxes under Article 11A above.

the competent authorities of the United States and Mexico to consult together to attempt to alleviate individual cases of double taxation not in accordance with the proposed treaty. The saving clause of the proposed treaty would not apply to this article, so that the application of this article might result in waiver (otherwise mandated by the proposed treaty) of taxing jurisdiction by the country of citizenship or residence.

Under this article, a resident of one country who considers that the action of one or both of the countries will cause him to pay a tax not in accordance with the proposed treaty would be permitted to present his case to the competent authority of the country of which he is a resident or national. The competent authority would then make a determination as to whether the objection appears justified. If the objection appears to it to be justified and if it is not itself able to arrive at a satisfactory solution, then that competent authority would endeavor to resolve the case by mutual agreement with the competent authority of the other country, with a view to the avoidance of taxation which is not in accordance with the proposed treaty.

The rules of the preceding paragraph would apply only if the competent authority of the other country is notified of the case within four and a half years from the due date or the date of filing of the return in question (whichever is later) in the other country. If this requirement is met, the provision provides that, notwithstanding the statute of limitations, any agreement reached between the two competent authorities could be implemented within ten years from the due date or date of filing of the return in question (whichever is later), or a longer period if permitted by the domestic laws of the other country.

The four-and-a-half-year limitation on presentation of competent authority cases is not the preferred U.S. treaty position. On the other hand, the OECD model treaty includes a three-year limitation. According to the Technical Explanation, the four-and-a-halfyear time limit was included in the proposed treaty in order to accommodate Mexico's five-year limit within which it may initiate an audit of a tax return.

The competent authorities of the countries would be mandated to resolve by mutual agreement any difficulties or doubts arising as to the interpretation or application of the proposed treaty. They could also consult together regarding cases not provided for in the treaty.

The proposed treaty would authorize the competent authorities to communicate with each other directly for purposes of reaching an agreement in the sense of this mutual agreement article. This provision would make clear that it would not be necessary to go through diplomatic channels in order to discuss problems arising in the application of the treaty.

The proposed treaty provides that if any difficulty or doubt arising as to the interpretation or application of the proposed treaty cannot be resolved by the competent authorities, the case could be submitted for arbitration if both competent authorities and the taxpayer or taxpayers so agree, and the taxpayer agrees in writing to be bound by the decision of the arbitration board. In such a case,

the decision of the arbitration board in a particular case would be binding on both treaty countries with respect to that case.

The proposed treaty provides that procedures for the arbitration process would be established by notes exchanged between the two countries through diplomatic channels. The arbitration provisions would not go into effect until after the countries have so agreed through the exchange of diplomatic notes. According to paragraph 18(a) of the proposed protocol, after a period of three years following the entry into force of the proposed treaty, the competent authorities of Mexico and the United States would consult in order to determine whether it would be appropriate to make the exchange of notes that would make effective the arbitration procedures.

The proposed protocol (paragraph 18(b)) further provides that if the competent authorities of the two countries agree to submit a disagreement regarding the interpretation or application of the proposed treaty to arbitration, the following seven procedures would apply:

First, the competent authorities could agree to invoke arbitration only after the other competent authority procedures spelled out in the treaty have been fully exhausted, and only if at least two years have lapsed since the case was originally submitted to one of the competent authorities. The competent authorities would not accede to arbitration with respect to matters concerning either the tax policy or the domestic tax law of either treaty country.

Second, the competent authorities would establish an arbitration board for each specific case that is taken to arbitration. Each board would have at least three members. Each competent authority would appoint the same number of members, and these members would agree on the appointment of the other member or members of the board. Further criteria for selecting the other member, or other members, of the arbitration board could be issued by the competent authorities. All board members and their staffs would be required to agree in writing to abide by, and be subject to, the applicable confidentiality and disclosure rules of both countries and of the proposed treaty.90

Third, the competent authorities could agree on, and instruct the arbitration board regarding, specific procedural rules (e.g., appointment of a chairman, procedures for reaching a decision, or establishment of time limits). Otherwise, the board would establish its own procedural rules which would be consistent with generally accepted principles of equity.

Fourth, taxpayers and their representatives would be given the opportunity to present their views on the case to the arbitration board.

Fifth, the arbitration board would decide each specific case on the basis of the proposed treaty, giving due consideration to the domestic laws of the treaty countries and the principles of international law. The board would provide the competent authorities with an explanation of its decision. The decision, although binding on both countries and the taxpayers with respect to the case at

90 In cases where there are conflicting applicable confidentiality and disclosure standards, the proposed protocol specifies that the most restrictive condition would apply.

issue, would not have precedential effect. However, it is expected that the decisions ordinarily would be taken into account in subsequent competent authority cases involving the same taxpayer or taxpayers, the same issue or issues, and substantially similar facts. Decisions could also be taken into account in other cases where appropriate.

Sixth, each treaty country would be required to bear the costs of compensating its appointees, and half of the compensation of the appointees chosen by the arbitration board members. Each country would also be required to bear the cost of remuneration for its representation in the proceedings before the arbitration board. However, the arbitration board would be given authority to allocate costs differently, and each competent authority of a treaty country would be given the authority to require the taxpayer or taxpayers to agree to bear that country's share of the costs as a prerequisite for arbitration.

Seventh, the competent authorities of the two countries could agree to modify or supplement the procedures detailed above; however, they would continue to be bound by the general principles established in the proposed treaty and protocol.

Article 27. Exchange of Information and Administrative Assistance

In general

This article forms the basis for cooperation between the two countries in their attempts to deal with avoidance or evasion of their respective taxes and to obtain information so that they can properly administer the treaty. Notwithstanding the provisions of Article 2 (Taxes Covered), the proposed treaty's information exchange provisions would apply to all taxes imposed in either country at the Federal level.

The proposed treaty provides that the competent authorities would exchange information as provided in the Agreement Between the United States of America and the United Mexican States for the Exchange of Information with Respect to Taxes that was signed on November 9, 1989 (the "Tax Information Exchange Agreement" or "TIEA"). Pursuant to paragraph 19 of the proposed protocol, if at some future point the Tax Information Exchange Agreement is terminated, the United States and Mexico would promptly endeavor to conclude a protocol to the proposed treaty to accomplish the purposes of this article.

The proposed treaty further provides that if the Tax Information Exchange Agreement is terminated, the two competent authorities would exchange such information as would be necessary to carry out the provisions of the proposed treaty or to administer and enforce the domestic laws of the two countries concerning taxes to which the proposed treaty would apply insofar as the taxation under those domestic laws would not be contrary to the proposed treaty. This exchange of information would not be restricted by Article 1 (General Scope). Therefore, third-country residents would be covered.

Any information exchanged under the proposed treaty would be treated as secret in the same manner as information obtained