income earned by a U.S. citizen resident in Slovakia, the U.S. tax would not be limited by the rules contained in Article 14. Article 15. Dependent Personal Services Under the proposed treaty, income from services performed as an employee in one treaty country (the source country) by a resident of the other country generally would be taxable by both countries; however, only the country of residence could tax the income if three requirements are met: (1) the individual is present in the source country for fewer than 184 days during any 12-month period; (2) his or her employer is not a resident of the source country; and (3) the compensation is not borne (i.e., deducted by) by a permanent establishment or fixed base of the employer in the source country. Compensation derived by an employee in respect of employment as a member of the regular complement (i.e., a member of the permanent crew) of a ship or aircraft operated in international traffic by an enterprise of one of the treaty countries would be taxable only by that country. Under the U.S. model treaty, by contrast, only the country where the employee resides may tax the income. The provisions of this article would be modified in some respects for directors' fees (Article 16), pensions (Article 20) and compensation derived by students, trainees, teachers, and researchers (Article 21). The article on dependent personal services is subject to the provisions of the saving clause (Article 1, paragraph 3). Therefore, as a general rule, the United States may tax its citizens and residents on employment income without regard to the provisions contained in the proposed treaty. For example, in the case of such income earned by a U.S. citizen resident in Slovakia, the U.S. tax is not limited by the rules contained in Article 16. Article 16. Directors' Fees The proposed treaty contains a special rule for directors' fees. If an individual who is a resident of one treaty country serves as a member of the board of directors or another similar organ of a company that is a resident of the other country, the country of the company's residence would be allowed to tax the fees and similar payments paid to the individual for such services to the extent attributable to services performed in that country. This rule follows the OECD model, except that under the OECD model, the country of residence of the company could tax the fees or similar payments regardless of where the related services are performed. There is no corresponding rule in the U.S. model treaty. Article 17. Limitation on Benefits In general The proposed treaty contains a provision intended to limit the benefits of the treaty to persons who are entitled to them generally by reason of their residence in the United States or Slovakia. The proposed treaty is intended to limit double taxation caused by the interaction of the tax systems of the United States and Slovakia as they apply to residents of those two countries. At times, however, residents of third countries attempt to use a treaty. This use is known as "treaty shopping" and refers to the situation where a person who is not a resident of either treaty country seeks certain benefits under the income tax treaty between the two countries. Under certain circumstances, and without appropriate safeguards, the third-country resident may be able to secure these benefits indirectly by establishing a corporation (or other entity) in one of the treaty countries which entity, as a resident of that country, is entitled to the benefits of the treaty. Additionally, it may be possible for the third-country resident to reduce the income base of the treaty country resident by having the latter pay out interest, royalties, or other amounts under favorable conditions (i.e., it may be possible to reduce or eliminate taxes of the resident company by distributing its earnings through deductible payments or by avoiding withholding taxes on the distributions) either through relaxed tax provisions in the distributing country or by passing the funds through other treaty countries (essentially, continuing to treaty shop), until the funds can be repatriated under favorable terms. The proposed anti-treaty shopping article provides that a person that is a resident of either Slovakia or the United States and derives income from the other treaty country would be entitled to the benefits of the treaty only if that person is an individual, unless it satisfies an active business test, an ownership/base erosion" test, or a public company test, or unless it is itself one of the treaty countries or a political subdivision or local authority thereof, or else is a not-for-profit, tax-exempt organization that also satisfies an ownership test. Finally, a company that fails to satisfy any of the above tests would still be permitted to obtain benefits under the treaty if agreed to by the competent authority of the treaty country in which the income at issue arises. Active business test Under the active business test, if the income derived in the other country is derived in connection with, or is incidental to, the active conduct by such person of a trade or business in the country of residence (other than the business of making or managing investments by a person other than a bank or insurance company), then no limitation on treaty benefits would apply. Under this test, the income would not have to be attributable to a permanent establishment in the country in which the income arises. Rather, it only has to be derived by a resident of one of the countries in connection with, or incidental to, the active conduct of a trade or business in that country. The Technical Explanation provides that the first six examples in the Memorandum of Understanding Regarding the Scope of the Limitation on Benefits Article in the Convention Between the Federal Republic of Germany and the United States of America (i.e., the U.S.-German income tax treaty) illustrate the situations covered by the active business test of the proposed treaty. Ownership/base erosion test A person also would qualify for treaty benefits if it satisfies both an ownership test and a base erosion test. Under the ownership test, more than 50 percent of the beneficial interest (in the case of a company, more than 50 percent of the number of shares of each class of shares) in that entity must be owned (directly or indirectly) by any combination of one or more persons that meet any of the other limitation on benefits tests (other than the active business test). In order to satisfy the base erosion test, not more than 50 percent of the gross income of the entity may be used (directly or indirectly) to meet liabilities (including liabilities for interest or royalties) to persons other than those that meet any of the other limitation on benefits tests (other than the active business test). This provision would, for example, deny the benefits of the reduced U.S. withholding tax rates on dividends, interest and royalties to a Slovak company that is owned by individual residents of a third country. In applying the base erosion test, the proposed treaty specifies that the term "gross income" would mean gross receipts. Where the enterprise is engaged in a business which includes the manufacture or production of goods, that term would mean gross receipts reduced by the direct costs of labor and materials attributable to such manufacture or production and paid or payable out of such receipts. Public company test Under the public company test, a company resident in a treaty country that has substantial and regular trading in its principal class of stock on a recognized securities exchange (a term defined in the proposed treaty) would be entitled to the benefits of the treaty regardless of where its actual owners reside. In addition, the public company test would be satisfied if the company is wholly owned (directly or indirectly) by a resident of the same treaty country in whose principal class of shares there is such substantial and regular trading on a recognized securities exchange. Under the proposed treaty, the term "recognized stock exchange" means the NASDAQ System owned by the National Association of Securities Dealers, Inc. and any stock exchange registered with the Securities and Exchange Commission as a national securities exchange for the purposes of the Securities Exchange Act of 1934; the Slovak stock exchange (Burza Cennych Papierov Bratislava, A.S.) and any other stock exchange approved by the authorities of that country; and any other stock exchange, located in a treaty country, that is agreed upon by the competent authorities of the two countries. Tax-exempt entity An entity that is a not-for-profit organization (including a pension fund or private foundation) and that, by virtue of that status, generally is exempt from income taxation in its residence country, provided that more than half of the beneficiaries, members, or participants, if any, in such an organization are entitled to benefits under the treaty, would qualify for treaty benefits. Competent authority relief An alternative would be provided for persons that do not satisfy any of the tests previously discussed. Under this alternative, such a person would be granted treaty benefits if the competent authority of the treaty country in which the income at issue arises so determines. Article 18. Artistes and Sportsmen The proposed treaty contains an additional set of rules which apply to the taxation of income earned by entertainers (such as theater, motion picture, radio or television "artistes" or musicians) and sportsmen (e.g., athletes). These rules apply notwithstanding the other provisions dealing with the taxation of income from personal services (Articles 14 and 15) and are intended, in part, to prevent entertainers and sportsmen from using the treaty to avoid paying any tax on their income earned in one of the countries. Under the proposed treaty, one treaty country would be allowed to tax an entertainer or sportsman who is a resident of the other country on the income from his or her personal activities as an entertainer or sportsman in that country during any year unless the gross receipts that he or she derives from such activities, including reimbursed expenses, do not exceed $20,000 or its equivalent in Slovak crowns for the taxable year. (The U.S. model treaty contains an identical $20,000 threshold.) Thus, if a Slovak entertainer maintained no fixed base in the United States and performed (as an independent contractor) for two days in one taxable year in the United States for total compensation of $20,000, the United States could not tax that income. If, however, that entertainer's total compensation were $30,000, the full $30,000 (less appropriate deductions) would be subject to U.S. tax. As in the case of the other provisions dealing with personal services income, this provision would not bar the country of residence from also taxing that income. Failure to exceed the $20,000 threshold would not preclude the source country from imposing withholding taxes on income of artistes and sportsmen, if such imposition is sanctioned under that country's domestic laws. To the extent that the amount of tax withheld in such a case exceeds the actual amount of tax due, such excess would be refunded to the taxpayer. In addition, the proposed treaty provides that where income in respect of personal services performed by an entertainer or sportsman accrues not to that person but rather to another person or entity, that income would be taxable by the country in which the services are performed in any situation where the entertainer or sportsman shares directly or indirectly in the profits of the person or entity receiving the income. (This provision would apply notwithstanding Articles 7 and 14.) For this purpose, participation in the profits of the recipient of the income would include the receipt of deferred compensation, bonuses, fees, dividends, partnership distributions, or other distributions. The provision would not apply if it is established that neither the entertainer or sportsman, nor related persons, participate directly or indirectly in the profits of the person or entity receiving the income in any manner. This provision is intended to prevent highly paid performers and sportsmen from avoiding tax in the country in which they perform by routing the compensation for their services through a third person such as a personal holding company or trust located in a country that would not tax the income. Notwithstanding the above provisions, the proposed treaty provides that income derived by a resident of one of the countries as an entertainer or sportsman would be exempt from tax by the other country if the person's visit to the other country is substantially supported by public funds of his or her country of residence (or of a political subdivision or local authority thereof) or if made pursuant to a specific arrangement agreed to by the governments of the two countries. The artistes and sportsmen article would be subject to the provisions of the saving clause (Article 1, paragraph 3). Therefore, as a general rule, the United States could tax its citizens and residents on income earned as an entertainer or sportsman without regard to the provisions contained in the proposed treaty. For example, in the case of such income earned by a U.S. citizen resident in Slovakia, the U.S. tax on that income would not be limited by the rules contained in Article 18. Article 19. Pensions, Annuities, Alimony, and Child Support Pensions Under the proposed treaty, pensions and other similar remuneration derived and beneficially owned by a resident of a treaty country in consideration of past employment by that person (or by another individual resident of the same country) would be subject to tax only in that country. (A different rule would apply in the case of pensions that are paid to citizens of one country attributable to services performed by the individual for government entities of the other (Article 20 (Governmental Service)). The saving clause would allow each country to continue to tax its citizens who are residents of the other country on pensions and similar remuneration. Payments under the Social Security legislation of a treaty country and similar public pension payments made to a resident of the other country or to a U.S. citizen would be taxable only by the country making such payments. The staff understands that this rule would cover benefits under the social security programs of both the United States and Slovakia, as well as certain U.S. Railroad Retirement benefits. This provision would not be subject to the proposed treaty's saving clause. Annuities The proposed treaty also provides that (subject to the saving clause) annuities would be taxed by only the country of residence of the person who derives and beneficially owns them. Annuities would be defined as stated sums paid periodically at stated times during a specific number of years, under an obligation to make the payments in return for adequate and full consideration (other than services rendered). Alimony The proposed treaty provides that deductible alimony paid to a resident of one of the treaty countries generally would be taxable only by that country.22 The proposed treaty would define alimony to mean periodic payments made pursuant to a written separation agreement or decree of divorce, separate maintenance, or compulsory support that are taxable to the recipient under the laws of his or her country of residence. The saving clause generally would 22 Under U.S. law, the payment of alimony generally is deductible. |