ple, the Understanding appears to commit the United States to afford treaty benefits to any widely held Dutch investment company that holds stocks and securities the income from which is not predominately U.S. source, as long as the company employs in the Netherlands a substantial staff actively engaged in the company's stock and securities trading.

The practical difference between the proposed treaty tests and predecessor tests will depend upon how they are interpreted and applied. For example, the active business tests in other treaties theoretically might be applied leniently (so that any colorable business activity suffices to preserve treaty benefits), or it may be applied strictly (so that the absence of a relatively high level of activity suffices to deny them). Given the bright line rules unique to the proposed treaty, the range of interpretation under it may be narrower. It may be possible that a relatively narrow reading of the active business test in other treaties and the branch tax regulations could theoretically be stricter than the proposed treaty tests, and could operate to deny benefits in potentially abusive situations more often.

Exempt foreign income of a Dutch resident

By themselves, the anti-treaty shopping rules do nothing to prevent the proposed treaty from reducing or eliminating U.S. tax on income of a Dutch resident in a case where no other substantial tax is imposed on that income. Moreover, broad classes of persons other than Dutch residents, for example certain publicly traded corporations, may be the ultimate beneficial owners of Dutch entities that qualify for treaty benefits under the anti-treaty shopping article. As mentioned above, a Dutch resident may in some cases be wholly or partially exempt from Dutch tax on foreign (i.e., non-Dutch) in

come.

For example, assume that a Dutch corporation establishes a permanent establishment outside the Netherlands such that neither the Netherlands nor the place where the branch is located taxes its income. The branch earns U.S. source income of a type that may be entitled to treaty relief from U.S. tax under a U.S.-Dutch treaty like the present or proposed treaties. For U.S. tax purposes, the branch is not a "person" subject to tax. The corporation of which the branch is a part is treated as earning the income earned by the branch. Since the corporation is a Dutch resident, the present or proposed treaty may require the United States to reduce or eliminate its tax on the income of the branch, even though the branch's income is not subject to significant tax by any other country.

Neither the present nor the proposed treaty denies U.S. income tax reductions simply because the reduction would otherwise apply to income with respect to which a Dutch resident pays little or no tax. The same can be said about other treaties between the United States and countries that exempt certain third-country income from tax: were the Dutch resident in this example instead a resident of any other country with which the United States has an income tax treaty, and were that country to exempt the resident's third-country income from tax, the U.S. tax reductions generally available under that treaty also would not be denied. By contrast, one limitation on benefits provision proposed at the time that the U.S. model

treaty was proposed provides that any relief from tax provided by the United States to a resident of the other country under the treaty shall be inapplicable to the extent that, under the law in force in that other country, the income to which the relief relates bears significantly lower tax than similar income arising within that other country derived by residents of that other country.

In recognition that the absence of such a rule poses a serious policy concern, the proposed treaty provides that either additional Dutch laws must be enacted to prevent income tax avoidance or evasion in certain cases, or the two countries must agree on a provision aimed at such income tax avoidance or evasion, which agreement must be laid down in a separate protocol to the proposed treaty. The Dutch law or protocol to be adopted must, under the terms of the proposed treaty, deal with the situation where a Dutch enterprise derives foreign-source interest or royalties attributable to a permanent establishment in a third country, and the permanent establishment is subject to little or no taxation in the Netherlands and the third jurisdiction because of a "tax haven" regime. The latter term includes, but is not necessarily limited to, regimes intended to encourage use of the third country for tax avoidance purposes with respect to investment income. The proposed protocol would amend the proposed treaty to combat abuse in certain cases where U.S. source interest or royalties are earned by a Dutch resident's permanent establishment in a third jurisdiction, and are subject to low aggregate Dutch and third-jurisdiction tax. Where the protocol applies, its effect is to permit the United States to impose a 15-percent withholding tax on the interest and royalties, notwithstanding the proposed treaty's general exemption of interest and royalties from source country tax.

In the past, the Committee has stated its belief that the United States should maintain its policy of limiting treaty shopping opportunities whenever possible. The Committee has further expressed its concern that, in exercising any latitude Treasury has to adjust the operation of a treaty, the treaty rules as applied should adequately deter treaty shopping abuses. The present income tax treaty between the United States and the Netherlands does not contain anti-treaty shopping or other anti-abuse rules. On the other hand, implementation of the tests for treaty shopping set forth in the treaty, or of the tests for treaty abuse set forth in the proposed protocol, raise factual, administrative, and other issues. For example, although the proposed protocol addresses an abuse not addressed in U.S. treaties currently in force, the proposed protocol does not allow the United States to impose source tax on interest and royalties in all cases resulting in low overall tax; nor does the proposed protocol allow the United States to impose tax on items other than interest and royalties that may be subject to low overall tax. This contrasts with the proposed model treaty provision, described above, which denies treaty benefits for all types of low-taxed income. The primary issue is whether the anti-abuse rules in the proposed treaty provision are adequate under the circumstances.

(2) Real property gains

Under the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), a foreign person is taxed by the United States on gain

from the sale of direct ownership interests in U.S. real property as if the gain were effectively connected with a trade or business conducted in the United States. Generally, the right of the United States to impose tax on this gain was not restricted under the terms of the present treaty, nor is it restricted under the proposed treaty. Also, under FIRPTA a foreign person is subject to U.S. tax on the gain from disposing of stock in a U.S. corporation having (at any time in the previous 5 years) 50 percent or more of its gross asset value comprised of U.S. real property interests. (Such a corporation may be a referred to as a "U.S. real property holding corporation".) Both real property itself, and stock in a corporation with the requisite real property holdings, are referred to in the Code as "U.S. real property interests."

Generally, the United States was forbidden to tax gains from stock constituting a U.S. real property interest under the terms of the present treaty. FIRPTA generally applies to sales after June 18, 1980. The legislation specifically overrides contrary rules in existing treaties if those rules conflict with its provisions. In such an override case, however, the legislation took effect on January 1, 1985. Since that date the U.S. tax on stock gains under FIRPTA has applied to Dutch residents notwithstanding the present treaty. Under FIRPTA, a foreign person is taxed on the entire gain realized on the sale of a U.S. real property interest regardless of when purchased. Congress decided not to give a step-up in basis (or "fresh start") to fair market value as of the effective date of the legislation. The proposed treaty, by contrast, does provide for a fresh start in certain circumstances. Under the proposed treaty, certain Dutch investors get an effective step-up in the basis of certain of their U.S. real property interests (for purposes of computing the U.S. tax on sale of the property interests) to January 1, 1985 (the effective date of FIRPTA's override of existing treaties). The stepup applies to cases-e.g., recognition of gain on the stock in a U.S. real property holding corporation-where the present Dutch treaty would have prohibited taxation but for the FIRPTA treaty override. This treatment generally applies if a Dutch investor either owned the interest on June 18, 1980, the general effective date of FIRPTA, or acquired it in a non-recognition transaction from a Dutch investor who owned it on that date.

In 1984, the Committee reported on a proposed treaty and proposed protocols with Canada that also provided a basis step-up in applying FIRPTA to gains of Canadian residents.5 Unlike the stepup in the proposed Dutch treaty, the Canadian treaty provided a step-up generally for all U.S. real property interests, rather than only U.S. real property interests in the form of stock in a U.S. corporation. In its report, the Committee stated its belief that it was clearly the intent of Congress in 1980 that the United States should tax foreign investors when they derive gain on the disposition of an interest in U.S. real estate, even when the foreigner is a resident of a treaty partner. Accordingly, the Committee did not think that treaty provisions should restrict in any way the United

4 See Article V, which provides that "Income from real property (including gains derived from the sale of such property, ...)... may be taxed in the Contracting State in which such property is situated." 5 Exec. Rep. No. 98-22, 98th Cong., 2d Sess. (1984).

States' right under FIRPTA to tax foreign investors on gains from the disposition of U.S. real estate. The Committee decided not to recommend a reservation in connection with the then-proposed Canadian treaty. However, the Committee made it clear that its decision in that case not to recommend a reservation on the FIRPTA issue should not be taken as precedent in ongoing or future treaty negotiations. The Committee stated that it would continue to consider seriously recommending a reservation on any treaty provision, including a fresh-start, that restricts the right of the United States under FIRPTA to tax gains of foreign investors on dispositions of U.S. real property interests.6

Since that time, several U.S. income tax treaties have been negotiated or renegotiated. Residents of other countries have not been afforded this kind of basis step-up for U.S. tax purposes. Moreover, such a step-up did not apply to Dutch investors that disposed of U.S. real property interests between 1985 and the effective date of the proposed treaty. Some may argue that Dutch investors making future dispositions should not obtain such preferential treatment on their U.S. real estate investments. Conversely, others may argue that to the extent the present treaty would have exempted gain from tax at source, had the gain been recognized before 1985, a step-up in basis would be a reasonable transition rule.

(3) Creditability of the Dutch state profit share

Under the proposed treaty, the share of the Dutch government in profits from exploiting Dutch natural resources such as oil and gas will be treated as an income tax and creditable for U.S. tax purposes, subject to special computation limitations. In the absence of this provision, the state profit share may not be creditable under Treasury regulations. The treaty credit, because it will probably be larger than the income tax credit otherwise allowed under the regulations, may reduce the U.S. taxes collected from U.S. oil companies operating in the Dutch sector of the North Sea. For these reasons, and also because it is no longer U.S. treaty policy generally to give treaty credits for special taxes on foreign oil and gas extraction income, it can be argued that the treaty should not allow a credit against U.S. tax for the state profit share. On the other hand, it can be argued that fairness requires that the treaty allow a credit since credits are allowed for arguably comparable oil and gas taxes imposed by the United Kingdom and Norway under the U.S. income tax treaties with those countries currently in force. Since the ratification of those treaties, a proposed U.S. income tax treaty with Denmark containing a similar provision was reported on favorably by the Committee in 1985. However, the Senate has yet to give its advice and consent to ratification thereof.

It can be argued in favor of the provision that the credit is subject to special computation limitations under the treaty that may in some cases be more restrictive than those applying under Code to the credit for foreign oil and gas extraction income taxes (sec. 907). However, the special limitations in the proposed treaty are drafted differently than the corresponding limitations in the U.K. and Norway treaties. In general neither of those treaties requires

• Id. at 10.

the United States to provide credits, against U.S. tax on income from activities subject to the otherwise non-creditable petroleum tax, in excess of the product of the maximum applicable U.S. tax rate times the income, from sources in the particular treaty country, from activities subject to the otherwise non-creditable petroleum tax. The staff understands that it was not the intention of the negotiators that the proposed treaty would require the United States to provide credits in excess of the product of the U.S. statutory corporate tax rate times the income subject to the profit share that is derived from Dutch sources, determined under U.S. principles. There may be some uncertainty whether the language of the proposed treaty makes this intention clear. If so, the Committee may wish to consider whether and how this matter ought to be clarified in advance of ratification of the proposed treaty.

(4) Summonses to designated agents

Under the Code, any domestic corporation that is 25-percent owned by one foreign person, and any foreign corporation that conducts a trade or business in the United States (a "reporting corporation"), must furnish the IRS with such information as the Secretary may prescribe regarding transactions carried out directly or indirectly with certain foreign persons treated as related to the reporting corporation ("reportable transactions").

In addition, the Code provides that in order to avoid certain consequences with respect to certain reportable transactions, each foreign person that is a related party of a reporting corporation must agree to authorize the latter to act as its agent in connection with any request or summons by the IRS to examine records or produce testimony related to any reportable transaction. Failure of a related party to designate a reporting corporation as its agent for accepting service of process in connection with reportable transactions, or, under certain circumstances, noncompliance with IRS summonses in connection with reportable transactions or other matters, can result in the application of the so-called "noncompliance rule." This rule permits the Secretary of the Treasury to determine the tax consequences to the reporting corporation of certain transactions or other items in his or her sole discretion, based on any information in the knowledge or possession of the Secretary or on any information that the Secretary may obtain through testimony or otherwise.

The legislative history accompanying the enactment of these rules indicates an expectation that where records of a related party are obtainable on a timely and efficient basis under information-exchange procedures provided under a tax treaty, the IRS generally would make use of those procedures before issuing a summons to the designated agent on behalf of the related party.7 Treasury regulations contain this language.8 For this purpose, the regulation provides that information is available on a timely and efficient basis if it can be obtained within 180 days of the request. However, the legislative history also indicates a cognizance of undue audit delays that have been caused by the Service's inability to quickly

7 Committee on Finance, Explanation of Provisions Approved by the Committee on October 3, 1989, Senate Finance Committee Print, 101st Cong., 1st Sess., pp. 115-116 (1989).

8 Treas. Reg. sec. 1.6038A-6(b).