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This pamphlet,1 prepared by the staff of the Joint Committee on Taxation, provides an explanation of the proposed income tax treaty, as modified by the proposed protocol, between the United States of America and the United Mexican States ("Mexico"). The proposed treaty and protocol were both signed on September 18, 1992. The Senate Committee on Foreign Relations has scheduled a public hearing on the proposed treaty on October 27, 1993.
The proposed treaty (as amended by the proposed protocol) is similar to other recent U.S. income tax treaties, the 1981 proposed U.S. model income tax treaty ("U.S. model"), and the 1977 model income tax treaty of the Organization of Economic Cooperation and Development ("OECD model"). However, there are certain substantive deviations from those documents. Among other things, the proposed treaty includes a number of provisions to accommodate aspects of the Tax Reform Act of 1986.
Part I of the pamphlet summarizes the principal provisions of the proposed treaty and protocol. Part II presents a discussion of issues raised by the proposed treaty and protocol. Part III provides an overview of U.S. tax laws relating to international trade and investment and U.S. income tax treaties in general. This is followed in part IV by a detailed, article-by-article explanation of the proposed treaty including, where appropriate, explanation of the provisions of the proposed protocol.2
This pamphlet may be cited as follows: Joint Committee on Taxation, Explanation of Proposed Income Tax Treaty (and Proposed Protocol) Between the United States Mexico (JCS-1693), October 26, 1993.
2 For a copy of the proposed tax treaty and protocol, see Senate Treaty Doc. 103-7, May 20, 1993.
The principal purposes of the proposed income tax treaty between the United States and Mexico 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 promote close economic cooperation between the two countries and to eliminate possible barriers to trade caused by overlapping taxing jurisdictions of the two countries. It is intended to enable the two countries to cooperate in preventing avoidance and evasion of taxes.
As in other U.S. tax treaties, these objectives are principally achieved by each country agreeing to limit, in certain specified situations, its right to tax income derived from its territory by residents of the other. For example, the treaty contains the standard treaty provisions that neither country would 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 treaty contains the standard "commercial visitor" exemptions under which residents of one country performing personal services in the other country would not be required to pay tax in the other country unless their contact with the other country exceeds specified minimums (Articles 14, 15, and 18). 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 could be taxed by both countries (Articles 10, 11, 12, and 13); generally, however, the rate of tax that the source country could impose on a resident of the other country on dividends, interest, and royalties would be limited by the proposed treaty (Articles 10, 11, and 12).
In situations where the country of source would retain the right under the proposed treaty to tax income derived by residents of the other country, the treaty generally would provide for the relief from the potential double taxation by the country of residence allowing a tax credit for certain foreign taxes paid to the other country (Article 24).
The proposed treaty contains the standard provision (the "saving clause") contained in U.S. tax treaties that each country would retain the right to tax its citizens and residents as if the treaty had not come into effect (Article 1(3)). In addition, the proposed treaty contains the standard provision that it would not be applied to deny any taxpayer any benefits it would be entitled to under the domestic law of a country or under any other agreement between
the two countries (Article 1(2)); that is, the treaty would only be applied to the benefit of taxpayers.
Differences between proposed treaty and model treaties
The proposed treaty differs in certain respects from other U.S. income tax treaties and from the U.S. model and OECD model treaties. Some of these differences are as follows:
(1) The saving clause of the U.S model provides that a country may tax its citizens as if the treaty were not in effect. For this purpose, it includes as a citizen a person who is a former citizen whose loss of citizenship had as one of its principal purposes the avoidance of income tax, but only for a period of ten years following such loss. The proposed treaty contains a similar ten-year rule for excitizens, except that it would apply to any such person whose loss of citizenship had as one of its principal purposes the avoidance of tax. Thus, for example, the proposed treaty's saving clause would apply to a former citizen whose principal purposes for renouncing his or her citizenship included the avoidance of U.S. estate or gift tax.
(2) The U.S. model specifically permits the competent authorities to agree to a common meaning of any term that is not defined in the treaty. The proposed treaty does not contain such specific authority.3 Under the proposed treaty, any undefined term would have the meaning which it has under the laws of the taxing country unless the context requires otherwise.
(3) For purposes of determining an individual's country of residence (and thus, his or her entitlement to treaty benefits), the U.S. model generally treats a citizen of one of the treaty countries as a resident of that country. The proposed treaty and protocol, by contrast, provides that Mexico would consider a U.S. citizen to be a U.S. resident for treaty purposes only if he or she has a substantial presence in the United States or would be a U.S. resident (and not a resident of any other country) under the proposed treaty's tiebreaker rules for determining residency. The proposed protocol contains a similar limitation, also not present in the U.S. model, for aliens admitted to the United States for permanent residence (i.e., "green card" holders).
(4) The proposed treaty explicitly provides that the governments of Mexico and the United States (including political subdivisions and local authorities) would be treated as residents of Mexico and the United States, respectively. Neither the U.S. model nor the OECD model contain specific residency rules for the governments of the countries that are parties to the treaty.
(5) The proposed treaty, unlike the U.S. model, does not treat a dual resident company (i.e., a company that is a resident of both treaty countries) as a resident of the country under whose laws it was created. Under the proposed treaty, a dual resident company would be treated as a resident of neither the United States nor Mexico for treaty purposes, and, hence, would be entitled to no treaty benefits. Nor would the recipient of a dividend such a com
3 The proposed treaty does provide that the competent authorities may consult together regarding cases not provided for in the treaty. It is not clear whether this language is intended to permit them to agree to a common meaning of an otherwise undefined term.