The proposed treaty addresses the issue of interest charges not at arm's length between parties having a direct or indirect special relationship by providing that the amount of interest for purposes of the treaty would be the amount of arm's-length interest. The amount of interest in excess of the arm's-length interest would be taxable according to the laws of each country, taking into account the other provisions of the proposed treaty (e.g., if in excess of the arm's-length amount interest paid to a shareholder were treated as a dividend under local law, it, thus, would be entitled to the benefits of Article 10 of the proposed treaty). The article on interest would be subject to the provisions of the saving clause (Article 1, paragraph 3). Therefore, as a general rule, the United States would be permitted to tax its citizens and residents on interest income without regard to the provisions contained in the proposed treaty. Article 12. Royalties Internal royalty rules United States Under the same system that applies to dividends and interest, the United States imposes a 30-percent tax on U.S. source royalties paid to foreign persons. Royalties are from U.S. sources if they are for the use of property located in the United States. U.S. source royalties include royalties for the use of or the right to use intangible property in the United States. Such royalties include motion picture royalties. Slovakia Nonresident persons generally are subject to a gross-basis tax at a rate of 25 percent on royalties and rents arising from sources within Slovakia. The tax is collected by withholding. Taxation of royalties under the proposed treaty The U.S. model treaty exempts royalties from tax at source. The proposed treaty, conversely, would allow limited source country taxation of certain royalties. Generally, royalties from sources (under the royalty source rule discussed below) in one country that are beneficially owned by a resident of the other country would be taxable by both countries. As an exception to this general rule, royalties received in consideration for the use of, or for the right to use, any copyright of literary, artistic or scientific work, including cinematographic films or films or tapes and other means of image or sound reproduction would be taxable only by the country in which the recipient is a resident. All other royalties arising from sources in one treaty country and beneficially owned by a resident of the other country would be taxable in the source country at a rate not in excess of 10 percent of the gross amount of the royalties. The rate limitation and exemption in the proposed treaty would apply only if the royalty is beneficially owned by a resident of the other country; they would not apply if the recipient is a nominee for a nonresident. Definition of royalties Royalties would be defined to mean payments of any kind received in consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work, including cinematographic films or films or tapes and other means of image or sound reproduction. Royalties would also include payments for the use of, or the right to use, any patent, trademark, design or model, plan, secret formula or process, or other like right or property, or for industrial, commercial, or scientific equipment, or for information concerning industrial, commercial or scientific experience. The definition of the term "royalties" also would include payments derived from the alienation of any such right or property to the extent contingent on the productivity, use, or further disposition thereof. Similar gains that are not so contingent would be subject to the rules of the article on gains (Article 13). Source rules for royalties The proposed treaty provides special source rules for royalties. Generally under U.S. tax rules (secs. 861-862), royalty income is sourced where the property or right is being used. As a general rule under the proposed treaty, if the payor of a royalty is the government of one of the treaty countries (or a political subdivision or local authority thereof) or a resident of that country for purposes of its tax, the royalty would be sourced in that country. If the payor of a royalty (whether or not a resident of one of the countries) has a permanent establishment or fixed base in the United States or Slovakia in connection with which the liability to pay the royalty was incurred, and if the royalties are borne by the permanent establishment or fixed base, the royalties would be deemed to arise (for purposes of the proposed treaty) in the country in which the permanent establishment or fixed base is situated. Finally, in situations where the payor of a royalty is not a resident of either country and the royalty is not borne by a permanent establishment or a fixed base located in either country, but the royalty relates to the use of, or the right to use, in one of the countries, property described in the proposed treaty's definition of the term "royalty," the royalty would be sourced in that country of use. The proposed treaty's source rules for royalties detailed above would be applicable only for purposes of determining whether royalties are taxable in the country of source under Article 12. It is understood that these rules would not apply with respect to the determination of source for purposes of the permitting a foreign tax credit under the article for relief from double taxation (Article 24). Other rules Neither the reduced withholding tax rate nor the exemption would apply where the beneficial owner of the royalties carries on or has carried on business through a permanent establishment in the source country or performs or has performed personal services in an independent capacity from a fixed base in the source country, and the royalties are attributable to the permanent establishment or fixed base. In that event, the royalties would be taxed as business profits (Article 7) or income from the performance of independent personal services (Article 14). The proposed treaty provides that in the case of royalty payments between persons having a special relationship, only that portion of the payment that represents an arm's-length royalty would be treated as a royalty. Payments in excess of the arm's-length amount would be taxable according to the law of each country with due regard being given for the other provisions of the proposed treaty. Thus, for example, an excess amount might be treated as a dividend subject to the taxing limitations of Article 10. The article on royalties would be subject to the provisions of the saving clause (Article 1, paragraph 3). Therefore, as a general rule, the United States would be permitted to tax its citizens and residents on royalty income without regard to the provisions contained in the proposed treaty. Specifically, in the case of a royalty from a U.S. company accruing to a beneficial owner who is a U.S. citizen resident in Slovakia, the U.S. tax would not be limited by the source country withholding limits contained in Article 12. Article 13. Gains Internal capital gains rules United States Generally, gain realized by a nonresident alien or a foreign corporation from the sale of a capital asset is not subject to U.S. tax unless the gain is effectively connected with the conduct of a U.S. trade or business or, in the case of a nonresident alien, he or she is physically present in the United States for at least 183 days in the taxable year. However, under the Foreign Investment in Real Property Tax Act of 1980, as amended ("FIRPTA"), a nonresident alien or foreign corporation is taxed by the United States on gain from the sale of a U.S. real property interest as if the gain were effectively connected with a trade or business conducted in the United States. "U.S. real property interests" include interests in certain corporations holding U.S. real property. Slovakia As a general rule, it is understood that tax is not imposed on capital gains realized by foreign persons; e.g., no tax is levied on gains resulting from the disposition of shares of Slovak corporations. Treatment of gains under the proposed treaty Under the proposed treaty, only certain gains would be taxable in the source country. Gains derived by a resident of one treaty country from the alienation of real property would be taxable in the country where the real property is situated. For this purpose, real property situated in the other country would include real property as defined in Article 6 (Income from Real Property (Immovable Property)) which is situated in that other country. It also would include shares of stock of a company the property of which consists at least 50 percent of property situated in that other country, as well as an interest in a partnership, trust or estate to the extent that the assets of that entity consist of real property situated in that other country.20 According to the Technical Explanation, real property situated in the United States under the proposed treaty would include in all cases a United States real property interest as defined in Code section 897(c). This definition would allow the United States to tax any transaction of a Slovak resident that is taxable under FIRPTA. Gains from the alienation of personal (movable) property which are attributable to a permanent establishment which an enterprise of a treaty country has or had in the other country, or which are attributable to a fixed base which is or was available to a resident of a treaty country in the other country for the purpose of performing independent personal services, and gains from the alienation of such a permanent establishment (alone or with the whole enterprise) or such a fixed base, would be taxable in that other country. Gains derived by an enterprise of one country from the sale or exchange of ships, aircraft or containers used in international traffic would be taxable only by the country of the enterprise's residence. The ships, aircraft, and containers whose disposition would be exempt from source country gains tax under this provision corresponds to the property the profits from which would be exempt from source country tax under the article on shipping and air transport (Article 8). Gains contingent on the productivity, use, or further disposition of rights or property, and therefore described as royalties under Article 12 (Royalties), would be taxable only in accordance with the provisions of that article. Gains from the alienation of any property other than property discussed above would be taxable under the proposed treaty only in the country where the alienator is a resident. The article on gains would be subject to the provisions of the saving clause (Article 1, paragraph 3). Therefore, as a general rule, the United States would be allowed to tax its citizens and residents on gains without regard to the provisions contained in the proposed treaty. For example, in the case of a gain from the alienation of ships, aircraft, or containers, recognized by a U.S. citizen resident in Slovakia, the United States would not be limited in its ability to tax such gain by the provisions contained in Article 13. Article 14. Independent Personal Services Internal rules regarding services income in general United States The United States taxes the income of a nonresident alien at the regular graduated rates if the income is effectively connected with the conduct of a trade or business in the United States by the individual. (See discussion of U.S. taxation of business profits under Article 7 (Business Profits).) The performance of personal services within the United States can constitute a trade or business within the United States (Code sec. 864(b)). 20 In other treaties, the 50-percent (or other similar) test is based on "real property." By contrast, the language of the Slovak treaty omits the word "real." The staff understands that the treaty is intended to operate like other treaties in this respect; that is, the use of the word "property" for purposes of this computation refers to real property. Under the Code, the income of a nonresident alien individual from the performance of personal services in the United States is excluded from U.S. source income, and therefore is not taxed by the United States in the absence of a U.S. trade or business, if certain criteria are met. The criteria are: (1) the individual is not in the United States for over 90 days during a taxable year, (2) the compensation does not exceed $3,000, and (3) the services are performed as an employee of or under a contract with a foreign person not engaged in a trade or business in the United States, or they are performed for a foreign office or place of business of a U.S. person. If these criteria are not satisfied, then the income is taxed at the regular graduated rates that apply to U.S. persons. Slovakia Nonresident persons generally are subject to income tax in Slovakia on their income derived from the performance of personal services in that country. The rate of income tax on individuals ranges from 15 to 47 percent. Treatment of independent personal services under the proposed treaty The proposed treaty would limit the right of a treaty country to tax income from the performance of personal services by a resident of the other country. Under the proposed treaty, income from the performance of independent personal services would be treated separately from income from the performance of personal services as an employee (which is dealt with in Article 15 (Dependent Personal Services)). Income from the performance of independent personal services in one country (the "source country") by a resident of the other country would be exempt from tax in the source country, unless either of two thresholds is met. Under the first, the source country could tax such income if the individual has or had a fixed base regularly available to him or her in that country for the purpose of performing the services.21 In such case, the source country could tax only that portion of the individual's income that is attributable to the fixed base. Under the second, the source country could tax such income if the individual is present there for a period or periods exceeding in the aggregate 183 days in any twelve month period. Independent personal services would include especially independent scientific, literary, artistic, educational, and teaching activities, as well as independent services of physicians, lawyers, engineers, architects, dentists, and accountants. The foregoing list is not exhaustive. The article on independent personal services would be subject to the provisions of the saving clause (Article 1, paragraph 3). Therefore, as a general rule, the United States would be permitted to tax its citizens and residents on income derived from the performance of independent personal services without regard to the provisions contained in the proposed treaty. For example, in the case of such 21 This rule would incorporate the concept of Code section 864(c)(6) with respect to deferred payments (which also is reflected in Articles 7 (Business Profits), 11 (Interest), 12 (Royalties), and 22 (Other Income)). |