forth the following example. Assume a resident of the Netherlands has three separate businesses in the United States. One business is profitable, and constitutes a U.S. permanent establishment. The other two are trades or businesses that would earn effectively connected income as determined under the Code, but do not constitute permanent establishments as determined under the proposed treaty; one trade or business is profitable and the other incurs a net loss. Under the Code, all three operations would be subject to U.S. income tax, in which case the losses from the unprofitable line of business could offset the taxable income from the other lines of business. On the other hand, only the income of the operation which gives rise to a permanent establishment would be taxable by the United States under the proposed treaty. The Technical Explanation makes clear that the taxpayer could not invoke the proposed treaty to exclude the profits of the profitable trade or business and invoke U.S. internal law to claim the loss of the unprofitable trade or business against the taxable income of the permanent establishment.21 Article 2. Taxes Covered The proposed treaty generally applies to the income taxes of the United States and the Netherlands, and to the Dutch government's share in the net profits of the exploitation of certain natural resources. It also applies to certain excise taxes. United States In general In the case of the United States, the proposed treaty applies to the Federal income taxes imposed by the Code, but excluding social security taxes. Unlike the U.S. model and many U.S. income tax treaties in force, but like the present treaty, the proposed treaty applies to the accumulated earnings tax and the personal holding company tax. In addition, the proposed treaty applies to the excise taxes with respect to private foundations and, subject to an "anticonduit rule," to the U.S. excise tax imposed on insurance premiums paid to foreign insurers. Tax on insurance premiums Code rules.-Under the Code, the United States imposes an excise tax on certain insurance premiums received by a foreign insurer from insuring a U.S. risk or a U.S. person (Code secs. 43714374). Unless waived by treaty, the excise tax applies to those premiums which are exempt from U.S. net-basis income tax. Under the Code (in the absence of a contrary treaty provision), a foreign insurer is subject to U.S. net-basis income tax on income in situations where that insurance income is effectively connected with a U.S. trade or business. However, a foreign insurer insuring U.S. risks ordinarily will not be viewed as conducting a U.S. trade or business, and thus will not be subject to U.S. income tax, if it has no U.S. office or dependent agent and operates in the United States solely through independent brokers. In these situations, the insur 21 See Rev. Rul. 84-17, 1984-1 C.B. 10. ance excise tax is imposed (except as otherwise provided in a treaty) on the premiums paid for that insurance.22 The excise tax may be viewed as serving the same function as the tax imposed on dividends, interest, and other types of passive income paid to foreign investors. In general, the excise tax applies to insurance covering risks wholly or partly within the United States where the insured is (1) a U.S. person or (2) a foreign person engaged in a trade or business in the United States. Under the Code, the excise tax generally applies to a premium on any such insurance unless the amount is effectively connected with the conduct of a trade or business in the United States and not exempt by treaty from the statutory net-basis tax. The treatment of insurance income of foreign insurers is complicated somewhat in situations where, as is often the case, some portion of the risk is reinsured with other insurers in order to spread the risk. In situations where the foreign insurer is engaged in a U.S. trade or business and thus subject to the U.S. income tax, reinsurance premiums, whether paid to a U.S. or a foreign reinsurer, are allowed as deductions. Accordingly, the foreign insurer is taxable only on the income attributable to the portion of the risk it retains. However, while generally no excise tax is imposed on the insurance policy issued by the foreign insurer doing business in the United States, the one-percent excise tax on reinsurance is imposed if and when that insurer reinsures that U.S. risk with a foreign insurer not subject to U.S. net-basis income tax. Proposed treaty.-The insurance excise tax described above is covered by the proposed treaty, but only to the extent that the foreign insurer does not reinsure the risks in question with a person not entitled to relief from this tax under the proposed treaty or another U.S. treaty. More specifically, income of a Netherlands insurer from the insurance of U.S. risks or U.S. persons will not be subject to the insurance excise tax (except in situations where the risk is reinsured with a company not entitled to an exemption under this or another treaty). This waiver applies notwithstanding that insurance income is not attributable to a U.S. permanent establishment maintained by the Netherlands insurer, and hence not subject to U.S. net-basis tax pursuant to the business profits article (Article 7) and other income article (Article 23). This treatment is a departure from the present treaty, but is similar to that provided in some other recent U.S. tax treaties, for example, the treaties with Finland, France, Germany, Hungary, India, Italy, and Spain. The excise tax on premiums paid to foreign insurers is a covered tax under the U.S. model treaty. In exempting from the U.S. income tax and the insurance excise tax all insurance income which is not attributable to a permanent establishment in the United States, the proposed treaty makes two changes in the statutory rules governing the taxation of insurance income of Netherlands insurers. First, any insurance income which is effectively connected with a U.S. trade or business but is not attributable to a U.S. permanent establishment will not be subject to 22 The excise tax is currently imposed at a rate of four percent of the premiums paid on casualty insurance and indemnity bonds, and one percent of the premiums paid on life, sickness, and accident insurance, annuity contracts, and reinsurance (Code secs. 4371-4374). U.S. income tax. This exemption is contained in the present treaty. As is true under the present treaty, those Netherlands insurers that continue to maintain a U.S. permanent establishment after the proposed treaty enters into force will remain subject to the U.S. income tax on their net U.S. insurance income attributable to the permanent establishment. Second, Dutch insurers not engaged in a U.S. trade or business generally will no longer be subject to the insurance excise tax. This exemption is not contained in the present treaty. The insurance excise tax will continue to apply, however, when a Dutch insurer with no U.S. trade or business reinsures a policy it has written on a U.S. risk with a foreign reinsurer, other than a resident of the Netherlands or another insurer entitled to exemption under a different tax treaty (such as the U.S.-France treaty). The tax liability may be imposed on the Dutch insurer which, for withholding purposes, is treated in the same manner as a U.S. resident person transferring the premium to the foreign reinsurer. The excise tax also will apply to such reinsurance when the Dutch insurance company has a U.S. trade or business, but no U.S. permanent establishment, and thus will not be subject to U.S. income tax on the net income it derives on the portion of the risk it retains. For example, assume a Dutch company not engaged in a U.S. trade or business insures a U.S. casualty risk and receives a premium of $200. The company reinsures part of the risk with a Danish insurance company (not currently entitled to exemption from the excise tax) and pays that Danish company a premium of $100. The four-percent excise tax on casualty insurance applies to the premium paid to the Dutch insurance company to the extent of the $100 reinsurance premium. Thus, the U.S. insured is liable for an excise tax of $4, which is four percent of the portion of its premium paid to the Dutch insurer which was used by the Dutch insurer to reinsure the risk. It is the responsibility of the U.S. insured to determine to what extent, if any, the risk is to be reinsured with a nonexempt person. Under an administrative procedure currently in effect, the burden of this responsibility effectively can be shared with the Dutch insurer (see Rev. Proc. 87-13, 1987-1 C.B. 596; and Rev. Proc. 92-39, 1992-1 C.B. 860). Netherlands In the case of the Netherlands, the proposed treaty applies to the income tax (de inkomstenbelasting), the wages tax (de loonbelasting), the dividend tax (de dividendbelasting), and the company tax (de vennootschapsbelasting), including the so-called Dutch state "profit share." This last term refers to the government share in the net profits of the exploitation of natural resources levied pursuant to the Mining Act 1810 (Mijnwet 1810) with respect to concessions issued from 1967, or pursuant to the Netherlands Continental Shelf Mining Act of 1965 (Mijnwet Continentaal Plat 1965). The state profit share is discussed in connection with the double taxation article (Article 25). Other rules For purposes of the non-discrimination article (Article 28), the treaty applies to taxes of all kinds imposed by the countries, in cluding any taxes imposed by their political subdivisions or local authorities. The proposed treaty also contains a provision generally found in U.S. income tax treaties (including the present treaty) to the effect that it will apply to any identical or substantially similar taxes that either country may subsequently impose. The proposed treaty obligates the competent authority of each country to notify the competent authority of the other country of any significant changes in its internal tax laws. This clause is similar, but not identical, to U.S. model treaty language. Article 3. General Definitions Certain of the standard definitions found in most U.S. income tax treaties are contained in the proposed treaty. The term "State" means the Netherlands or the United States, as the context requires. The term "States" means the Netherlands and the United States. The term "the Netherlands" comprises the part of the Kingdom of the Netherlands that is situated in Europe, and the part of the sea bed and its sub-soil under the North Sea over which the Kingdom of the Netherlands has sovereign rights in accordance with international law for the purpose of exploration for and exploitation of the natural resources of such areas, but only to the extent that the person, property, or activity to which the treaty is being applied is connected with such exploration or exploitation. The term "United States" means the United States of America, but does not include Puerto Rico, the Virgin Islands, Guam or any other U.S. possession or territory. When used in a geographical sense, it means the states and the District of Columbia. Under Code section 638, where the term is used in a geographical sense, it also includes the continental shelf: that is, the seabed and subsoil of those submarine areas which are adjacent to the territorial waters of the United States and over which the United States has exclusive rights, in accordance with international law, with respect to the exploration and exploitation of natural resources. Under the proposed treaty, these same areas are considered part of the United States for treaty purposes, but only to the extent that the person, property, or activity to which the treaty is being applied is connected with such exploration or exploitation. The term "person" includes an individual, an estate, a trust, a company, and any other body of persons. The Technical Explanation states that the negotiators agreed that the term "person" would be understood to include a partnership. A "company" is any body corporate or any entity which is treated as a body corporate for tax purposes. An enterprise of a country is defined as an enterprise carried on by a resident of that country. The treaty does not define the term "enterprise." Under the proposed treaty, a person is considered a national of one of the treaty countries if the person is an individual possessing citizenship or nationality of that country, or a legal person, partnership, or association deriving its status as such from the law in force in that country. The proposed treaty defines "international traffic" as any transport by a ship or aircraft operated by an enterprise of one of the treaty countries, except when the ship or aircraft is operated solely between places in one of the treaty countries. Accordingly, with respect to a Dutch enterprise, purely domestic transport in the United States is excluded. Moreover, as under the OECD, model but unlike the definition in the U.S. model, transport by a resident of a third country also is excluded. The Dutch competent authority is the Minister of Finance or his duly authorized representative. The U.S. competent authority is the Secretary of the Treasury or his delegate. In fact, the U.S. competent authority function has been delegated to the Commissioner of Internal Revenue, who has redelegated the authority to the Assistant Commissioner (International) of the IRS. On interpretative issues, the latter acts with the concurrence of the Associate Chief Counsel (International) of the IRS. The proposed treaty also contains the standard provision that, unless the context otherwise requires or the competent authorities of the two countries establish a common meaning, all terms not defined in the treaty are to have the meanings which they have under the laws of the country applying the treaty. Article 4. Residence In general The assignment of a country of residence is important because the benefits of the proposed treaty generally are available only to a resident of one of the treaty countries as that term is defined in the treaty. Furthermore, double taxation is often avoided by the treaty assigning a single treaty country as the country of residence when, under the internal laws of the treaty countries, a person is a resident of both. Under U.S. law, residence of an individual is important because a resident alien is taxed on his or her worldwide income, while a nonresident alien is taxed only on his or her U.S. source income and on his or her income that is effectively connected with a U.S. trade or business. An individual who spends substantial time in the United States in any year or over a three-year period generally is a U.S. resident (Code sec. 7701(b)). A permanent resident for immigration purposes (i.e., a green card holder) also is a U.S. resident. The standards for determining residence provided in the Code do not alone determine the residence of a U.S. citizen for the purpose of any U.S. tax treaty (such as a treaty that benefits residents, rather than citizens, of the United States.) Under the Code, a company is domestic, and therefore taxable on its worldwide income, if it is organized in the United States or under the laws of the United States, a State, or the District of Columbia. The proposed treaty generally defines "resident of one of the States" to mean any person who, under the laws of that country, is liable to tax therein by reason of his domicile, residence, place of management, place of incorporation, or any other criterion of a similar nature. Also included in the term is an exempt pension trust or an exempt organization that is treated as a resident of a treaty country under that country's internal law. As provided in |