The dividend tax generally applies to Dutch source proceeds whether paid to individual or corporate residents or nonresidents.28 The dividend tax does not apply to a dividend paid to a foreign corporation residing in a European Communities ("EC") member country, if the dividend is subject to Dutch tax law provisions enacted in response to the so-called "parent-subsidiary directive" approved by the EC Council of Ministers on July 23, 1990.29 Moreover, the dividend tax does not apply (or applies at a reduced rate) to an amount paid to a nonresident eligible for the elimination or reduction of the dividend tax by treaty.

The dividend tax is creditable against the Dutch income or company tax imposed on a Dutch resident shareholder receiving the taxable amount (or in some cases a nonresident subject to Dutch income or corporate tax). An excess of the dividend tax over those taxes generally is refundable to a Dutch resident (or in some limited cases a nonresident subject to the Dutch income or corporate tax).

Like U.S. corporate tax law, Dutch tax law generally embodies the so-called "classical system" under which corporate income may be taxed at the corporate level, and then taxed again at the shareholder level upon a distribution, without a mechanism such as an imputation credit or a dividends paid deduction to integrate the two levels of tax. Also like U.S. tax law, Dutch law provides for special reduced corporate taxation in the case of certain Dutch resident corporations serving as investment vehicles. An investment organization that qualifies for such treatment is referred to as a "beleggingsinstelling" in Article 28 of the Netherlands Corporation Tax Act (Wet op de vennootschapsbelasting 1969). Its activities consist wholly or largely of stock, debt, or real estate investments, and it meets certain requirements concerning, among other things, stock ownership and the annual distribution of its profits. Generally, it is subject to a zero-percent corporate tax rate. Moreover, in a limited class of cases, the dividend tax does not apply to dividends paid by a beleggingsinstelling to Dutch residents.

Treaty reduction of dividend taxes

Under the proposed treaty, each country may tax dividends paid by its resident companies, but the rate of tax is limited by the proposed treaty if the beneficial owner of the dividends is a resident of the other country. Source country taxation generally is limited to 5 percent of the gross amount of the dividends if the beneficial owner of the dividends is a company which holds directly at least 10 percent of the voting shares of the payor corporation. The Understanding provides that a beneficial owner of dividends who holds depository receipts or trust certificates evidencing beneficial ownership of the shares in lieu of the shares themselves may also claim entitlement to this 5-percent rate under the proposed treaty. Under the present Dutch treaty, source country tax may be imposed at a 15-percent rate, rather than only a 5-percent rate, un

28 An exception applies to certain dividends paid to Dutch corporations holding at least 5 percent of the stock of the payor. This exemption mirrors the so-called "participation exemption" (discussed below in connection with Article 25) under which Dutch corporations are exempt from tax on dividends paid by corporations (Dutch or foreign) in which the recipient owns at least a 5-percent interest.

29 90/435/EEC.

less a higher ownership threshold is met (either 25-percent stock ownership by one recipient corporation residing in the other country, or 25-percent ownership by a group of recipient corporations resident in that country each of which owns at least 10 percent), and is met for the period ending on the date the dividend is paid and beginning at the start of the paying corporation's previous taxable year.

Under the proposed treaty, the tax generally is limited to 15 percent of the gross amount of the dividends in cases involving dividends paid to residents of the other country not described above in connection with the proposed treaty.

The Understanding provides that where a person loans shares (or other rights the income from which is subject to the same taxation treatment as income from shares) and receives from the borrower an obligation to pay an amount equivalent to any dividend distribution made with respect to the shares or other rights loaned during the term of the loan, the person will be treated as the beneficial owner of the dividend paid with respect to those shares or other rights for purposes of the application of this article to the equivalent amount. Thus the proposed treaty would permit the United States to impose withholding tax on substitute dividend payments.

Under the present treaty, as, for example, under the U.S.-France income tax treaty, the prohibition on source country tax at a rate exceeding 5 percent does not apply in certain cases where more than 25 percent of the gross income of the dividend payor for the prior taxable year consisted of interest and dividends. The proposed treaty would eliminate this rule, and replace it with rules similar to those adopted in recent treaties and protocols that allow source country_tax in excess of 5 percent on direct investment dividends from a RIC or REIT.30

a

The proposed treaty allows the Netherlands to impose at least a 15-percent tax on any dividend paid by a beleggingsinstelling in the sense of Article 28 of the Netherlands Corporation Tax Act. There is no limit in the proposed treaty on the tax that may be imposed by the Netherlands on certain dividends paid by beleggingsinstelling if the company invests in real estate to the same extent as is required of a REIT under U.S. law. The staff understands that in order for the limitation to be lifted in this case, generally the beleggingsinstelling would have to meet a gross income test like that in Code section 865(c)(3) and an asset similar to that in section 865(c)(5). Such a dividend would thus be taxable by the Netherlands, assuming no change in present Dutch internal law, at the full 25-percent rate. The absence of treaty limitation in this case applies to a dividend that is beneficially owned by a U.S. resident individual holding a 25-percent or greater interest in the company. This absence of limitation also applies to Dutch withholding on a dividend the beneficial owner of which is a U.S. resident other than an individual, a RIC, or a REIT.

30 The Technical Explanation indicates that distributions by a REIT that are attributable to gains from the disposition of a U.S. real property interest are not treated as dividends under the proposed treaty. Such distributions are covered by the provisions of Article 14 (Capital Gains).

Similarly, the proposed treaty allows the United States to impose a 15-percent tax on a U.S. source dividend paid by a RIC to a Dutch company owning 10 percent or more of the voting shares of the RIC, or a U.S. source dividend paid by a REIT to a Ďutch company that is a beleggingsinstelling owning 10 percent or more of the voting shares of the REIT. In addition, there is no limitation in the proposed treaty on the tax that may be imposed by the United States on a dividend paid by a REIT that is beneficially owned by a Dutch resident, if the beneficial owner is either an individual holding a 25 percent or greater interest in the REIT, or a company that is not a beleggingsinstelling. Such a dividend thus would be taxable by the United States, assuming no change in present U.S. internal law, at the full 30-percent rate.

The limitations on source country taxation of dividends do not affect the taxation of the company in respect of the profits out of which the dividends are paid.

Definition of dividends

Unlike the U.S. and OECD model treaties, the present treaty provides no express definition of the term dividend. The proposed treaty provides a definition of dividends that is broader than the definition in the U.S. model treaty and some U.S. treaties. Similar to the U.S. model treaty, the proposed treaty generally defines "dividends" as income from shares or other rights participating in profits. Dividends also include income from other corporate rights that is subjected to the same tax treatment as income from shares by the source country-i.e., the country in which the distributing company is resident. The proposed treaty also provides (unlike the U.S. model treaty) that in the case of the United States, the term dividends includes income from debt obligations carrying the right to participate in profits. In the case of the Netherlands, the term includes income from profit sharing bonds from profit sharing bonds ("winstdelende obligaties").

Thus, for withholding purposes, the proposed treaty would expressly permit withholding under Article 10 on interest paid on a loan with an "equity kicker." This represents a change from the present treaty, under which there is no explicit definition of dividend, and withholding on interest generally is prohibited. It is understood that this language permits the United States to impose withholding tax on a U.S. source payment. The staff further understands that this language does not have the further effect, together with Article 25, of requiring the United States to give an indirect foreign tax credit, under Code section 902, with respect to interest received by a U.S. corporation on a note issued by its Dutch subsidiary, although the note may have equity features.

Because the Dutch dividend tax applies to payments that, were they derived from U.S. sources, would not be subject to U.S. withholding tax (either under the terms of present internal U.S. law or other provisions of the proposed treaty), the effect of the proposed treaty will be to permit the Netherlands to continue to impose source-country taxation in a case where the United States does not now impose tax. By the same token, however, if future U.S. legislation were to impose withholding taxes in some cases where such taxes are not now imposed under the Code, the proposed treaty

might accommodate such changes (depending on the scope of the legislation) without giving rise to a treaty-statute conflict (assuming the proposed treaty were then in force).

Special rules and exceptions

The proposed treaty's reduced rates of tax on dividends will not apply if the beneficial owner of the dividend carries on business through a permanent establishment (or fixed base in the case of an individual who performs independent personal services) in the source country and the holding on which the dividends are paid forms part of the business property of the permanent establishment (or fixed base). Dividends paid on such holdings of a permanent establishment would be taxed as business profits (Article 7). Dividends paid on such holdings of a fixed base would be taxed as income from the performance of independent personal services (Article 15). In such a case, the effect of the deferred payment rules for determining U.S.-effectively connected income under the Code (sec 864(c)(6)) on Dutch residents eligible for treaty benefits are dealt with in Article 24 (Basis of Taxation) of the proposed treaty.

The proposed treaty contains a general limitation on the taxation of dividends paid by corporations that are not residents of the taxing country. Under this provision, the Netherlands may not, except in two cases, impose any taxes on dividends paid by a U.S. resident company that derives profits or income from the Netherlands, even if the dividends represent Dutch profits or income. The first exception is the case where the dividends are paid to Dutch residents. The second is the case where the holding in respect of which the dividends are paid forms part of the business property of a Dutch permanent establishment or pertains to a fixed base in the Netherlands. Similarly, the United States may not impose any tax on dividends paid by a Dutch corporation that derives U.S. profits or income (regardless whether the dividends represent U.S. earnings) unless the dividends are paid to a U.S. resident or the holding in respect of which the dividends are paid forms part of the business property of a U.S. permanent establishment or pertains to a U.S. fixed base. This rule is somewhat less restrictive of the United States' taxing jurisdiction than the corresponding rule in the present treaty. The latter provides that dividends paid by a Dutch corporation are exempt from U.S. tax in any case where the recipient is not a U.S. citizen, resident, or corporation.

Finally, the dividend article of the proposed treaty prohibits any tax by one treaty country on the undistributed profits of a company resident in the other treaty country, except as provided in the branch tax article (Article 11). The staff understands that this language is not intended to impair the right of the source country to impose corporate income tax otherwise permitted under the business profits article.

Article 11. Branch Tax

The proposed treaty would expressly permit the United States to collect the branch profits tax from a Dutch company, but only with respect to earnings of the latter accumulated during periods when the proposed treaty is in effect.

U.S. branch profits tax rules

A foreign corporation engaged in the conduct of a trade or business in the United States is subject under the Code to a flat 30percent branch profits tax on its "dividend equivalent amount," which is a measure of the accumulated U.S. effectively connected earnings of the corporation that are removed in any year from the conduct of its U.S. trade or business. This provision was added to the Code in 1986. Under the Code, the dividend equivalent amount is limited by (among other things) aggregate earnings and profits accumulated in taxable years beginning after December 31, 1986. The Code provides that no U.S. treaty shall exempt any foreign corporation from the branch profits tax (or reduce the amount thereof) unless the foreign corporation is a "qualified resident" of the treaty country.

The Code defines a "qualified resident" as any foreign corporation which is a resident of a treaty country if can meet at least one of the following tests. First, any foreign corporation resident in a treaty country is a qualified resident of that country unless 50 percent or more (by value) of the stock of the corporation is owned (directly or indirectly within the meaning of Code section 883(c)(4)) by individuals who are not residents of the treaty country and who are neither U.S. citizens nor resident aliens, or 50 percent or more of its income is used (directly or indirectly) to meet liabilities to persons who are residents of neither the treaty country nor the United States. Second, a foreign corporation resident in a treaty country is a qualified resident if the stock of the corporation is primarily and regularly traded on an established securities market in the treaty country, or if the corporation is wholly owned (either directly or indirectly) by another foreign corporation which is organized in the treaty country and the stock of which is so traded, or is wholly owned by a U.S. corporation whose stock is primarily and regularly traded on an established securities market in the United States.

Proposed treaty rules

The proposed treaty would allow the United States to impose the branch profits tax (as opposed to the branch level excess interest tax (Code sec. 884(f)), described below) on a Dutch resident corporation that either has a permanent establishment in the United States, or is subject to tax on a net basis in the United States on income from real property or gains from the disposition of real property interests. (The treaty would also allow the Netherlands to impose a branch profits tax on similar items earned by a U.S. corporation, but no such tax is currently imposed under Dutch internal law.) As is generally true of treaties negotiated or modified since the enactment of the branch profits tax in 1986, the proposed treaty would permit at most a 5-percent branch profits tax rate, and, in cases where a foreign corporation conducts a trade or business in the United States, but not through a permanent establishment, the proposed treaty would completely eliminate the branch. profits tax that the Code imposes on such corporation. The proposed treaty adds an additional limitation not found in other post1986-Act U.S. tax treaties: under the proposed treaty, the dividend equivalent amount is computed with reference only to profits accumulated in years for which the proposed treaty is in effect.