ities of persons who left the Netherlands between May 1939 and 1945, and the territorial extension of the present treaty to overseas parts of the Kingdom of the Netherlands, and overseas territory of the United States. (52) The proposed treaty takes effect on the first day of January in the year following the date of entry into force. However, during the first 12 months when the proposed treaty is in effect, taxpayers may elect to be taxed instead as if the present treaty continued to have effect. (53) The termination of the present treaty by the entry into force of the proposed treaty does not affect territorial extensions of the present treaty. In 1955, prior to its amendment by the 1963 protocol and the 1965 supplementary convention, the U.S.-Netherlands income tax treaty was extended to the Netherlands Antilles. In general, the extension was terminated effective in 1988, but the interest article as extended remains in force. That article is different from the interest articles in both the present and the proposed treaties, and generally exempts from U.S. taxation U.S. source interest on any form of indebtedness (other than interest from mortgages secured by real property) paid to unrelated persons. II. ISSUES The proposed treaty presents the following specific issues: (1) Anti-abuse provisions In general In a fundamental departure from the present U.S.-Netherlands income tax treaty, the proposed treaty addresses significant issues of tax treaty abuse. In general, when seeking Senate advice and consent to the ratification of any income tax treaty, the Administration historically has represented that the purpose of the treaty is to benefit residents of the treaty countries through avoidance of double taxation and prevention of fiscal evasion. This is true of both the present and the proposed treaties with the Netherlands. However, residents of third countries and their tax advisers have, over the years, discovered ways of exploiting U.S. treaties; moreover, treaties have been successfully used to avoid all tax on U.S. income. In recognition that this is contrary to the purpose for which the United States enters into income tax treaties, the Treasury Department has sought for approximately 30 years, if not more, to ensure that new treaties are not susceptible to these abuses, and that existing treaties are amended to cure abuses which have been discovered. However, until recently, U.S. and Dutch negotiators had made little visible progress toward bilaterally curing the abuse potential inherent in the present Dutch treaty, which was originally signed in 1948 and has not been amended since 1966. Some believe that the difficulty reflected a belief that the Netherlands itself derived a benefit from the use of the present treaty as a device for third-country residents to achieve reductions of U.S. tax on U.S. income. Among existing U.S. income tax treaties, it is believed that the present Dutch treaty has been notable in its susceptibility to abuse. The combination of Dutch internal law and the Dutch treaty network, including the present treaty, makes it possible in some cases for persons including residents of third countries to earn U.S. income relatively free of all tax, U.S., Dutch, or otherwise. Dutch law in many cases exempts Dutch residents from tax on foreign income, including foreign income that bears very little tax; in addition, payments by a Dutch resident to a foreign resident can be structured at times to bear little or no Dutch withholding tax, either due to Dutch internal law which generally exempts interest and royalties from withholding tax, or due to tax treaties that exempt or favor dividends as well. Finally, the present treaty ensures a U.S. dividend withholding rate as low as that available under U.S. treaties with any other country, forbids U.S. withholding tax on U.S. source interest and royalties, and forbids so-called "second-level" U.S. withholding taxes on dividends or interest paid by a Dutch company but attributable to its U.S. income. The Committee may wish to consider whether, in light of all the relevant circumstances, the proposed treaty adequately addresses the issue of curbing abuse. Treaty shopping The effort by residents of third countries to obtain treaty benefits 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 attempt to secure a lower rate of tax by, for example, lending money to a U.S. person indirectly through a country whose treaty with the United States provides for a lower rate. The third-country investor may attempt to do this by establishing in that treaty country a subsidiary, trust, or other investing entity which then makes the loan to the U.S. person and claims the treaty reduction for the interest it receives. The proposed treaty, like a number of U.S. income tax treaties, generally limits the class of treaty country residents eligible for benefits. Benefits are bestowed only upon those treaty country residents with a sufficient additional nexus, beyond simple residence, to the treaty country. In its outlines, the anti-treaty shopping provision of the proposed treaty is somewhat similar to the anti-treaty shopping provision in the branch tax provisions of the Internal Revenue Code (as interpreted by Treasury regulations) and in several newer treaties. In its details, on the other hand, the proposed treaty is in many ways unprecedented. The degree of detail relative to all other treaties is notable in itself for several reasons. First, 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 the treaty; this diminution represents a bilateral commitment, not alterable by future internal U.S. legislation, unless that legislation would override the treaty. (To the same extent as is provided under other treaties, the IRS generally is not limited under the proposed treaty in its discretion to allow treaty benefits under the anti-treaty shopping rules.) In addition, the detail in the proposed treaty represents added guidance for taxpayers that may be absent under other treaties, although detail of this magnitude may itself engender a need for further guidance or clarification. In general, the provisions of the anti-treaty shopping article of the proposed treaty tend to be at least somewhat more lenient than the comparable rules in the U.S. regulations under the branch tax, and other U.S. treaties, although every existing anti-treaty shopping standard potentially may be satisfied through the exercise of more or less broad discretion of the Secretary of the Treasury. The proposed treaty is also one of the first to provide mechanical rules under which so-called "derivative benefits" are afforded.3 Under these rules, a Dutch entity is afforded benefits based in part on its ulti 3 The U.S. income tax treaty with Jamaica and the proposed U.S. income tax treaty with Mexico would also provide for such benefits, but in a much more limited way. mate ownership by a third country resident who would be entitled to U.S. treaty benefits under an existing treaty between the United States and the third country. Anti-treaty shopping articles in treaties often have an "ownership/base erosion" test. To qualify for benefits under such a test, an entity must meet two requirements, one concerning the connection of its owners to the treaty countries (the "ownership" requirement), the other concerning the destination of payments that it deducts from its income (the base reduction or "erosion" requirement). The ownership requirement in one anti-treaty shopping provision proposed at the time the U.S. model treaty was proposed allows benefits to be denied to a company residing in a treaty country unless more than 75 percent of its stock is held by individual residents of the same country. The proposed treaty (like other U.S. treaties and an anti-treaty shopping branch tax provision in the Code) lowers the qualifying percentage to 50, and broadens the class of qualifying shareholders to include entities and individuals resident in either treaty country (and citizens of the United States). For some purposes, the proposed treaty, unlike previous treaties, broadens the class of qualifying shareholders to take into account also residents of member countries in the European Communities (the "EC") with which the United States and the Netherlands each has a bilateral income tax treaty. Thus, the ownership requirement under the proposed treaty is somewhat more generous to taxpayers than some predecessor requirements. Counting for this purpose shareholders who are residents of either treaty country would not appear to invite the type of abuse at which the provision is aimed, since the targeted abuse is ownership by third-country residents attempting to obtain treaty benefits. Counting for this purpose residents of EC member countries may generally also limit abuses in light of the treaties between the United States and those countries. The base erosion requirement in recent treaties allows benefits to be denied if 50 percent or more of the resident's gross income is used, directly or indirectly, to meet liabilities (including liabilities for interest or royalties) to certain classes of persons not entitled to treaty benefits. A similar test applies under the branch tax. The "base reduction" test in the proposed treaty modifies this test in several respects. First, it does not count the use of income to meet liabilities, contracted at arm's length, to obtain tangible property in the ordinary course of business, or services performed in the payer's residence country. In some cases, payments to residents of EC member countries are also afforded favorable treatment. Thus, the base reduction test in the proposed treaty is different, and maybe more favorable to taxpayers, than its predecessors. Another provision of the anti-treaty shopping article requires a source country to allow benefits with respect to income derived in connection with the active conduct of a trade or business in the residence country that is substantial in relation to the income-producing activity, or derived incidentally to that trade or business. (This active trade or business test generally does not apply with respect to a business of making or managing investments, so benefits can be denied with respect to such a business regardless of how actively it is conducted.) To the extent described above, the proposed treaty's active business test is similar to its predecessors. In con trast to the practice followed in the drafting of other such treaty tests, however, the way in which the proposed treaty's active business test is to operate is laid out in great detail in the treaty itself, as well as in the accompanying Understanding. In some cases, the details mirror provisions in the branch tax regulations, but may be more generous to taxpayers. Like some recent U.S. treaties, the proposed treaty attributes to the treaty resident active trades or businesses conducted by other entities. The proposed treaty provides for greater certainty in this regard than its predecessors. The attribution rules in the proposed treaty may result in more taxpayers being eligible for treaty benefits, and permit in some cases the treatment of third country business operations within the EC as if they were carried on in the Netherlands. The proposed treaty is similar to other U.S. treaties and the branch tax rules in affording treaty benefits to certain publicly traded companies. The treaty definition of "publicly traded" is explained in much greater detail in the proposed treaty than in any existing U.S. treaty. Again as in the case of the active business test, in some cases this elaboration mirrors the branch tax regulations, but is less rigorous. Also like the branch tax rules, the treaty allows benefits to be afforded to the wholly-owned subsidiary of a publicly traded company. Unlike any predecessor, the proposed treaty provides that benefits must be afforded to certain joint ventures of publicly traded companies, including in some cases joint ventures involving publicly traded companies resident in EC member countries other than the Netherlands. However, the proposed treaty requires that if benefits are to be afforded a company resident in a treaty country on the basis of public trading in the stock of the company's shareholder or shareholders, then the company seeking treaty benefits must also meet one of two additional tests that measure base erosion. That is, the company either must not be a "conduit company" or, if it is a conduit company, the company must meet a “conduit company base reduction test." A conduit company is one that pays out currently at least 90 percent of its aggregate receipts in deductible payments (including royalties and interest, but excluding those at arm's length for tangible property in the ordinary course of business or services performed in the payer's residence country). A conduit company meets the conduit base reduction test if less than a threshold fraction (generally 50 percent) of its gross income is paid to associated enterprises subject to a particularly low tax rate (relative to the tax rate normally applicable in the payer's residence country). The proposed treaty also guarantees benefits to a resident that is a "headquarter company" of a multinational corporate group. A headquarter company is one that provides a group which is sufficiently geographically dispersed with substantial supervision and administration (including group financing if that is not its primary function). Like other treaties and the branch tax rules, the proposed treaty gives the competent authority of the source country the power to allow benefits where the anti-treaty shopping test are not met. The Understanding accompanying the treaty elaborates on the standards for applying these rules, and requires each competent authority to consult the other before issuing an adverse ruling. For exam |