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110th Congress                                              Exec. Rept.
                                 SENATE
 2d Session                                                      110-15

======================================================================



 
                      PROTOCOL AMENDING 1980 TAX 
                         CONVENTION WITH CANADA

                                _______
                                

               September 11, 2008.--Ordered to be printed

                                _______
                                

           Mr. Dodd, from the Committee on Foreign Relations,
                        submitted the following

                                 REPORT

                   [To accompany Treaty Doc. 110-15]

    The Committee on Foreign Relations, to which was referred 
the Protocol Amending the Convention between the United States 
of America and Canada with Respect to Taxes on Income and on 
Capital done at Washington on September 26, 1980, as amended by 
the Protocols done on June 14, 1983, March 28, 1984, March 17, 
1995, and July 29, 1997, signed on September 21, 2007, at 
Chelsea (the ``Protocol'') (Treaty Doc. 110-15), having 
considered the same, reports favorably thereon with one 
declaration and one condition, as indicated in the resolution 
of advice and consent, and recommends that the Senate give its 
advice and consent to ratification thereof, as set forth in 
this report and the accompanying resolution of advice and 
consent.

                                CONTENTS

                                                                   Page

  I. Purpose..........................................................1
 II. Background.......................................................2
III. Major Provisions.................................................2
 IV. Entry Into Force.................................................6
  V. Implementing Legislation.........................................6
 VI. Committee Action.................................................6
VII. Committee Recommendation and Comments............................7
VIII.Resolution of Advice and Consent to Ratification................10

 IX. Annex I.--Technical Explanation.................................13
  X. Annex II.--Treaty Hearing of July 10, 2008......................89

                               I. Purpose

    The purpose of the Protocol, along with the underlying 
treaty, is to promote and facilitate trade and investment 
between the United States and Canada. Principally, the Protocol 
would amend the existing tax treaty with Canada (the 
``Treaty'') in order to eliminate withholding taxes on cross-
border interest payments, coordinate the tax treatment of 
contributions to, and other benefits of, pension funds for 
cross-border workers, and provide for mandatory arbitration of 
certain cases before the competent authorities of both 
countries.

                             II. Background

    The United States has a tax treaty with Canada that is 
currently in force, which was concluded in 1980. This Protocol 
is the fifth protocol to the 1980 Treaty; it has been the 
subject of negotiations for approximately ten years.\1\ The 
Protocol was negotiated to address specific issues that have 
arisen in our tax treaty relations and changes in each 
country's domestic law and tax treaty policy.
---------------------------------------------------------------------------
    \1\The 1980 Canadian Tax Treaty has been amended by protocols done 
on June 14, 1983 (Treaty Doc. 98-7), March 28, 1984 (Treaty Doc. 98-
22), March 17, 1995 (Treaty Doc. 104-4), and July 29, 1997 (Treaty Doc. 
105-29).
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                         III. Major Provisions

    A detailed article-by-article analysis of the Protocol may 
be found in the Technical Explanation published by the 
Department of the Treasury on July 10, 2008, which is reprinted 
in Annex I. In addition, the staff of the Joint Committee on 
Taxation prepared an analysis of the Protocol, Document JCX-57-
08 (July 8, 2008), which was of great assistance to the 
committee in reviewing the Protocol. A summary of the key 
provisions of the Protocol is set forth below.

1. Arbitration

    Among the most important features of this new Protocol with 
Canada is a binding arbitration provision that would apply when 
the Canadian and U.S. competent authorities are unable to 
resolve a case in a timely fashion under the Mutual Agreement 
Procedure in the current tax treaty with Canada. See Article 
21. This type of provision is a relatively recent innovation 
and has only been included in two other U.S. bilateral income 
tax treaties, both of which were approved by the Senate last 
year: a tax protocol with Germany and a tax treaty with 
Belgium.\2\ The arbitration procedure is sometimes referred to 
as ``last best offer'' arbitration or ``baseball 
arbitration''\3\ because each of the competent authorities 
proposes one and only one figure for settlement and the 
arbitration board must select one of those figures as the 
award. The arbitration decision is binding on both countries if 
the decision is accepted by the taxpayer. The taxpayer,\4\ 
however, has the right to reject the decision and access, for 
example, the relevant country's court system. See Article 
21(7)(e).
---------------------------------------------------------------------------
    \2\The arbitration mechanism in the Canada Protocol is most like 
the mechanism found in the Germany Tax Treaty, Treaty Doc. 109-20, 
which is similarly limited in its application to certain articles of 
the treaty.
    \3\ Referring to the arbitration method first introduced in the 
1970 Collective Bargaining Agreement (CBA) of Major League Baseball and 
expanded in the 1973 CBA to include player salaries.
    \4\A taxpayer is referred to as a ``concerned person'' in the 
treaty.
---------------------------------------------------------------------------

2. Interest

    The Protocol would eliminate withholding taxes on certain 
cross-border interest payments. See Article 6. This provision 
comes into effect with respect to interest paid to unrelated 
parties on the first day of January of the year in which the 
proposed Protocol enters into force. The zero rate for interest 
paid to related persons would be phased in over a three-year 
period. See Article 27(3)(d).

3. Dual-Resident Corporations

    The Protocol would address the issue of so-called ``dual-
resident corporations.'' It provides that if such a company is 
created under the laws in force in one treaty country but not 
under the laws in force in the other treaty country, the 
company is deemed to be a resident only of the first treaty 
country. See Article 2(1). If that rule is inapplicable, the 
Protocol generally provides that the competent authorities of 
the United States and Canada shall endeavor to reach agreement 
on the treatment of such companies for purposes of the treaty. 
In the absence of such agreement, the company is not considered 
to be a resident of either treaty country for purposes of its 
claiming any benefits under the treaty.

4. Permanent Establishment

    In general, U.S. bilateral tax treaties attempt to ensure 
that a person or entity is not subject to undue and overly 
burdensome taxation in instances in which the taxpayer has 
minimal contacts with the taxing jurisdiction. This is 
accomplished in the Treaty through provisions under which the 
United States and Canada agree not to tax business income 
derived from sources within either country by residents of the 
other country unless the business activities in the taxing 
country are substantial enough to constitute a permanent 
establishment. See Article VII(1) of the Treaty. A permanent 
establishment is generally defined as ``a fixed place of 
business through which the business of a resident of a 
Contracting State is wholly or partly carried on.'' See Article 
V(1) of the Canada Tax Treaty. Examples include a place of 
management, an office, branch, or factory. See Article V(2).
    The Protocol, however, would amend Article V of the 
existing treaty with Canada and effectively expand the 
definition of a permanent establishment in a way that would 
affect enterprises that provide services. See Article 3. 
Specifically, an enterprise of one country would be deemed to 
have a permanent establishment in the other country if either 
(a) services are performed by an individual who is present in 
the other country for at least 183 days during any 12-month 
period and more than 50 percent of the enterprise's gross 
active business revenues during that time is income derived 
from those services or (b) the services are provided in the 
other country for at least 183 days during any 12-month period 
with respect to the same or a connected project for customers 
who are residents of that country or who have a permanent 
establishment there for which the services are provided. See 
Article 3(2). Thus, an enterprise that met either of these 
criteria would be deemed to have a permanent establishment in 
the treaty partner country, even if it did not have a fixed 
place of business in that country, and attributable business 
profits would be subject to tax by that country.
    As noted in relation to the Bulgaria Convention in 
Executive Report 110-16, the United States has included similar 
provisions in some of its tax treaties with developing nations, 
but this would be the first time that such a provision would be 
included in a tax treaty with a developed nation. The provision 
addresses an issue that has been the subject of litigation in 
Canada, and has the effect of reversing a case that effectively 
limited Canada's taxing authority's interpretation of 
``permanent establishment.''\5\
---------------------------------------------------------------------------
    \5\The provision effectively reverses the result of the Canadian 
Federal Court of Appeal decision in The Queen v. Dudney, 99 DTC 147 
(T.C.C.C.), aff'd, 2000 DTC 6169 (F.C.A.), in which a U.S. independent 
contractor was held not to have a Canadian ``fixed base'' (which the 
court recognized to have substantially the same meaning as ``permanent 
establishment''), even though the contractor spent substantial time at 
his customer's premises during the course of two consecutive calendar 
years.
---------------------------------------------------------------------------
    This special rule presents a number of administrative and 
compliance challenges. For example, a number of the terms used 
in this rule, such as what constitutes ``presence'' or a 
``connected project'' are ambiguous and require further 
clarification. In addition, when combined with Article XV of 
the Treaty, as amended by Article 10(2) of the Protocol, 
additional complexities arise. Article XV(1) of the Treaty, 
with certain exceptions, sets forth a general rule that if an 
employee who is a resident of one treaty country (the 
``residence country'') is working in the other treaty country 
(the ``employment country''), his or her salaries, wages, and 
other remuneration derived from the exercise of employment in 
that country may be taxed by that country (the employment 
country). Notwithstanding this general rule, Article XV(2) of 
the treaty provides that the remuneration derived by the 
employee from the exercise of employment in the employment 
country shall be taxed only by the residence country (and not 
the employment country) if (1) the employee's remuneration does 
not exceed $10,000; or (2) the employee is present in the 
employment country for 183 days or less in any 12-month period 
commencing or ending in the taxable year concerned; the 
remuneration is not paid by, or on behalf of, a person who is a 
resident of the employment country; and the remuneration is not 
``borne'' by a permanent establishment in the employment 
country. It is this final requirement (that the remuneration 
must not be ``borne'' by a permanent establishment that the 
employer has in the employment country), which interacts with 
the special rule in Article 3(2) of the Protocol in a way that 
is likely to create problems for some taxpayers.
    In other words, the salaries, wages, and other remuneration 
derived by an employee performing services through a permanent 
establishment arising under Article 3(2) of the Protocol would 
be subject, under Article XV of the Treaty to being taxed by 
the employment country, even if the other requirements of the 
exception in Article XV(2) had been met. Thus, the interaction 
of these two provisions increases the complexities associated 
with the special rule. For example, such a scenario would mean 
that an employer and the relevant employees would need to 
fulfill several tax-related obligations, including obtaining 
tax identification numbers and providing for the withholding of 
income taxes and other taxes as appropriate that would cover 
the period beginning on the first day such services were 
performed by such employee during the affected year, despite 
the fact that they may not know whether the enterprise will be 
deemed to have a permanent establishment under the treaty until 
perhaps 6 months into the relevant 12-month period, and will 
therefore be subject to various taxes, including employment 
taxes, by the employment country reaching back to the beginning 
of the relevant 12-month period.
    Another aspect of the rule that would appear to be 
difficult to manage is that the 12-month period is not tied to 
a fiscal or calendar year. Also, it is necessary to determine 
whether customers in the employment country are residents or 
have a permanent establishment in that country. Some of the 
issues that may arise result from the fact that an enterprise 
with a deemed permanent establishment in another country that 
is not an actual fixed base is unlikely to have the 
infrastructure in that other country to do the things necessary 
to comply with the rules of the provision. For example, such an 
enterprise is unlikely to keep in the employment country a full 
set of financial records, or records tracking employees' 
activities there.
    The committee asked the Treasury Department a number of 
questions regarding this provision in an attempt to gain 
greater insight about its operation. These questions and 
answers can be found in Annex II.

Fiscally Transparent and Hybrid Entities

    Article 2(2) of the Protocol would amend Article IV of the 
existing treaty to include a new paragraph 6 and 7, setting 
forth specific rules for the treatment of certain income, 
profit, or gain derived through or paid by fiscally transparent 
entities. The new paragraph 6 would set forth a ``positive'' 
rule, which identifies scenarios in which ``income, profit or 
gain shall be considered to be derived by a person who is a 
resident of a Contracting State.'' The new paragraph 7 would 
set forth a ``negative'' rule intended to prevent the use of 
such entities to claim the benefits where the investors are not 
subject to tax on the income in their state of residence. In 
particular, paragraph 7 is aimed largely at curtailing the use 
of certain legal entity structures that include hybrid fiscally 
transparent entities, which, when combined with the selective 
use of debt and equity, may facilitate the allowance of either 
(1) duplicated interest deductions in the United States and 
Canada, or (2) a single, internally generated, interest 
deduction in one country without offsetting interest income in 
the other country. As noted by the Joint Committee on Taxation 
in its explanation of the Protocol, commentators have raised a 
question as to whether subparagraph 7(b) is too broad, because 
it could prevent legitimate business structures that are not 
engaging in potentially abusive transactions from taking 
advantage of benefits that would otherwise be available to them 
under the treaty.
    The Treasury Department, in response to questions from the 
committee, noted as follows regarding subparagraph 7(b):


          Subparagraph 7(b) essentially denies benefits in cases in 
        which the residence country treats a payment differently than 
        the source country and other conditions are met. The rule is 
        broader than an analogous rule in Treasury regulations issued 
        pursuant to section 894 of the Internal Revenue Code. The 
        Treasury Department is aware that the scope of subparagraph 
        7(b) is potentially overbroad, especially in the case of non-
        deductible payments. The Treasury Department has been 
        discussing, and will continue to discuss with Canada, whether 
        to address this issue. The Treasury Department does not 
        contemplate incorporating such a rule in future tax treaties.


    Additional questions were asked by the committee of the 
Treasury Department regarding this provision. These questions 
and answers can be found in Annex II.

Pensions and Annuities

    The Protocol would amend Article XVIII of the existing 
treaty, mainly to address certain individual retirement 
accounts and cross-border pension contributions and benefits 
accruals. Many of the new rules are similar to those found in 
the U.S. Model Tax Treaty, but several reflect the uniquely 
large cross-border flow of personal services between Canada and 
the United States, including a large number of cross-border 
commuters. These rules are intended to remove barriers to the 
flow of personal services between the two countries that could 
otherwise result from discontinuities under the laws of each 
country regarding the deductibility of pension contributions 
and the taxation of a pension plan's earnings and accretions in 
value. In addition, the Protocol would add a new provision to 
address the source of certain annuity or life insurance 
payments made by branches of insurance companies.

Limitation on Benefits

    The Protocol would replace the Limitation on Benefits 
article in the existing treaty (Article XXIX A) with a new 
article that reflects the anti-treaty shopping provisions 
included in the U.S. Model treaty and more recent U.S. income 
tax treaties. The rules in the existing treaty are not 
reciprocal and can only be applied by the United States. The 
new rules are stronger and reciprocal.

Exchange of Information

    The Protocol would replace Article XXVII of the existing 
treaty, which deals with the exchange of tax information, with 
an article on the same subject that is similar to what appears 
in the 2006 U.S. Model Tax Treaty. The new rules generally 
provide that the two competent authorities will exchange such 
information as may be relevant in carrying out the provisions 
of the domestic laws of the United States and Canada concerning 
taxes to which the treaty applies, to the extent the taxation 
under those laws is not contrary to the treaty.

                          IV. Entry Into Force

    The United States and Canada shall notify each other in 
writing through diplomatic channels when their respective 
applicable procedures for the entry into force of this Protocol 
have been satisfied. This Protocol shall enter into force on 
the date of the later of these notifications. The various 
provisions of this Protocol will have effect as described in 
paragraphs 2 and 3 of Article 27.

                      V. Implementing Legislation

    As is the case generally with income tax treaties, the 
Protocol is self-executing and does not require implementing 
legislation for the United States.

                          VI. Committee Action

    The committee held a public hearing on the Protocol on July 
10, 2008. Testimony was received from Mr. Michael Mundaca, 
Deputy Assistant Secretary (International), Office of Tax 
Policy, U.S. Department of the Treasury and Ms. Emily S. 
McMahon, Deputy Chief of Staff to the Joint Committee on 
Taxation. A transcript of this hearing can be found in Annex 
II.
    On July 29, 2008, the committee considered the Protocol and 
ordered it favorably reported by voice vote, with a quorum 
present and without objection.

               VII. Committee Recommendation and Comments

    The Committee on Foreign Relations believes that the 
Protocol will stimulate increased trade and investment, 
substantially deny treaty-shoppers the benefits of this tax 
treaty, and promote closer co-operation between the United 
States and Canada. The committee therefore urges the Senate to 
act promptly to give advice and consent to ratification of the 
Protocol, as set forth in this report and the accompanying 
resolution of advice and consent.

          A. SPECIAL PERMANENT ESTABLISHMENT RULE FOR SERVICES

    As discussed in Section III, the Protocol includes a 
special rule that would effectively expand the standard 
definition of a permanent establishment in a way that affects 
enterprises that provide services. This provision also appears 
in the Tax Convention with Bulgaria that is before the Senate, 
and presents a number of serious administrative and compliance 
challenges to service enterprises that may be subject to the 
rule.
    The Treasury Department has made clear in testimony before 
the committee that the inclusion of this provision in the 
Convention and the Tax Protocol with Canada ``does not reflect 
a change in U.S. tax treaty policy, and inclusion of such a 
provision in the U.S. Model is not being considered.'' The 
committee welcomes this statement and urges the Treasury 
Department to avoid including such a provision in future tax 
treaties, but particularly in treaties with developed nations 
for which there is no articulated rationale for its inclusion.
    In addition, the Treasury Department indicated that there 
have been ongoing discussions with Canada ``regarding the 
interpretation and application of the new rule concerning the 
taxation of services'' and that ``additional guidance with 
respect to the services rule included in both the proposed 
Protocol with Canada and the Convention with Bulgaria is needed 
to provide more certainty to taxpayers.'' In the committee's 
view, such discussions are crucial, particularly given the 
significant cross-border trade with Canada and the impact that 
such an unwieldy rule can have on businesses operating in both 
countries. The committee urges the Treasury Department to 
produce guidance on the rule's application, including ways in 
which enterprises might approach their compliance, as soon as 
is feasible and to keep the committee posted on its progress.

                             B. ARBITRATION

Report on Arbitration

    The committee recognizes the potential value that the 
binding arbitration mechanism contained in the Protocol has 
with respect to the effective implementation and enforcement of 
the Tax Treaty with Canada and commends the Department's work 
in its development. Under the current treaty, disputes between 
the competent authorities have gone unresolved for extended 
periods of time, burdening taxpayers and encumbering capital 
that could be put to more productive use. Delays in resolving 
disputes can also have the consequence of slowing payments by 
taxpayers, thereby depriving the U.S. Treasury of revenue. The 
inclusion of such a provision is, however, a new development in 
tax treaties and thus, the committee has included a reporting 
requirement in the resolution of advice and consent that is 
intended to help the committee determine whether the mechanism 
is functioning as anticipated and hoped.
    The report required by the Resolution of advice and consent 
has two parts. The first part requires the Secretary of the 
Treasury to transmit to this committee, the Committee on 
Finance, and the Joint Committee on Taxation the texts of the 
rules of procedure that are ultimately developed and applicable 
to the arbitration boards established pursuant to the Canada, 
Germany, and Belgium tax treaties, including conflict of 
interest rules to be applied to members of the arbitration 
board. The second part requires specific data on the 
arbitrations conducted pursuant to the Canada, Germany, and 
Belgium tax treaties. This information, which will be provided 
by the Secretary of the Treasury on an annual basis for a total 
of six years, is designed to help the committee evaluate the 
operation of the mandatory arbitration mechanism set forth in 
the three tax treaties. Because this data is potentially 
subject to U.S. law that provides for the confidentiality of 
taxpayer returns and return information, the Resolution 
requires the report containing this data to be provided only to 
the Committee on Finance and to the Joint Committee on 
Taxation. The Resolution is itself intended to constitute a 
written request for taxpayer information in accordance with the 
requirements of 26 U.S.C. Sec. 6103(f)(1), but as a matter of 
practice, the Treasury Department should advise the chairman of 
the Committee on Finance and the chairman of the Joint 
Committee on Taxation when the reporting requirement is 
initially triggered (60 days after a determination has been 
reached by an arbitration board in the tenth arbitration 
proceeding conducted pursuant to either this Protocol, the 2006 
German Protocol, or the Belgium Convention) so that the 
chairmen can formalize the request in writing, in order to 
comply with taxpayer disclosure law. It is the committee's 
expectation that the report will help to inform the Joint 
Committee on Taxation's analysis of the operation of the 
arbitration mechanism, and that the analysis will then be 
shared with this committee in a manner consistent with U.S. 
taxpayer confidentiality law.
    Should this committee determine that it has a need to view 
the data contained in the report itself, it may avail itself of 
the statutory mechanism under 26 U.S.C. Sec. 6103(f)(3). It 
should also be understood that the committee and the Joint 
Committee on Taxation may request further information, beyond 
that included in the report, if it is needed to evaluate the 
arbitration mechanism.

Comments on Arbitration for the Future

    The committee made a number of comments regarding issues 
that might be addressed in future arbitration provisions by the 
Treasury Department in the committee's Executive Report on the 
Protocol Amending the Tax Convention with Germany, which are 
equally relevant to the arbitration mechanism in this 
Protocol.\6\ In particular, the committee offered specific 
comments regarding 1) Taxpayer Input; 2) Treaty Interpretation; 
and 3) the Selection of Arbiters.
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    \6\ See Exec. Rept. 110-5 at pp. 7-9.
---------------------------------------------------------------------------
    In response to committee questions regarding why these 
comments were not reflected in this Protocol, the Treasury 
Department testified that the arbitration provision in the 
Protocol with Canada had already been negotiated at the time 
the committee provided its comments to the Department and thus, 
it was not possible to take them into account in this Protocol. 
The Treasury Department further indicated that ``the 
committee's concerns have been and will continue to be 
considered in any arbitration negotiations the Treasury 
Department conducts.'' The committee expects that the next 
treaty with a mandatory arbitration mechanism will address the 
committee's comments and concerns.

          C. FISCALLY TRANSPARENT AND HYBRID ENTITY PROVISIONS

    As noted in Section III above, Article 2(2) of the Protocol 
would amend Article IV of the existing treaty to include a new 
paragraph 6 and 7, setting forth specific rules for the 
treatment of certain income, profit, or gain derived through or 
paid by fiscally transparent entities. The new paragraph 7 is 
intended to prevent the use of fiscally transparent entities to 
claim the benefits when the investors are not subject to tax on 
the income in their state of residence. As discussed above and 
described at length in questions for the record included in 
Annex II, the scope of paragraph 7(b) is potentially overbroad, 
especially in the case of non-deductible payments, so that in 
some circumstances a legitimate business structure that is not 
engaging in potentially abusive transactions would be prevented 
from taking advantage of benefits that should be available to 
them under the treaty. The Treasury Department noted in 
testimony before the committee that it ``has been discussing, 
and will continue to discuss with Canada, whether to address 
this issue. The Treasury Department does not contemplate 
incorporating such a rule in future tax treaties.'' The 
committee welcomes this statement and urges the Treasury 
Department to address this issue with Canada as soon as 
possible.

                     D. DUAL-RESIDENT CORPORATIONS

    As noted in Section III above, the Protocol would address 
the issue of so-called ``dual-resident corporations'' by 
providing that if such a company is created under the laws in 
force in one treaty country but not under the laws in force in 
the other treaty country, the company is deemed to be a 
resident only of the first treaty country. See Article 2(1). If 
that rule is inapplicable, the Protocol generally provides that 
the competent authorities of the United States and Canada shall 
endeavor to reach agreement on the treatment of such companies 
for purposes of the treaty. In the absence of such agreement, 
the company is not considered to be a resident of either treaty 
country for purposes of its claiming any benefits under the 
treaty.
    The committee recognizes that the new rule is likely to be 
helpful in addressing abuse of the existing treaty by certain 
companies. Nevertheless, the rule appears to have some 
drawbacks. For example, application of the dual-residency rule 
in the Protocol would not be equitable with respect to a 
corporation that was organized under the laws of the United 
States many years ago and has long since ceased to have 
significant contacts with the United States, but instead is 
managed and controlled in Canada. In response to questions from 
the committee on this point, the Treasury Department noted that 
it ``[i]t has been a longstanding treaty policy of the United 
States to place significant weight on the place of 
incorporation when addressing questions of dual corporate 
residence. However, we have included in other agreements, for 
example in our agreement with the United Kingdom and the 
proposed Bulgaria and Iceland agreements, provisions directing 
the Competent Authorities to endeavor to determine for treaty 
purposes the residence of dual resident corporations.'' The 
committee supports the Treasury Department's efforts to cut 
down on treaty abuse, but recommends that when including such a 
rule in future, the Competent Authorities be afforded the 
discretion to override a strict application of the rule when 
the result would be inequitable.

                             E. RESOLUTION

    The committee has included in the resolutions of advice and 
consent one condition, which is a report on the arbitration 
mechanism in the Protocol and in the Belgium and German Tax 
treaties, which is discussed above, and one declaration, which 
is the same for each treaty and is discussed below.

Declaration

    The committee has included a proposed declaration, which 
states that the Protocol is self-executing, as is the case 
generally with income tax treaties. The committee has in the 
past included such a statement in the committee's report, but 
in light of the recent Supreme Court decision, Medellin v. 
Texas, 128 S. Ct. 1346 (2008), the committee has determined 
that a clear statement in the Resolution is warranted. A 
further discussion of the committee's views on this matter can 
be found in Section VIII of Executive Report 110-12.

         VIII. Resolution of Advice and Consent to Ratification

    Resolved (two-thirds of the Senators present concurring 
therein),

SECTION 1. SENATE ADVICE AND CONSENT SUBJECT TO A DECLARATION AND A 
                    CONDITION

    The Senate advises and consents to the ratification of the 
Protocol Amending the Convention between the United States of 
America and Canada with Respect to Taxes on Income and on 
Capital done at Washington on September 26, 1980, as Amended by 
the Protocols done on June 14, 1983, March 28, 1984, March 17, 
1995, and July 29, 1997, signed on September 21, 2007, at 
Chelsea (the ``Protocol'') (Treaty Doc. 110-15), subject to the 
declaration of section 2 and the condition of section 3.

SECTION 2. DECLARATION

    The advice and consent of the Senate under section 1 is 
subject to the following declaration:
          This Convention is self-executing.

SECTION 3. CONDITION

    The advice and consent of the Senate under section 1 is 
subject to the following condition:

Report.

  1. Not later than two years from the date on which this 
Protocol enters into force and prior to the first arbitration 
conducted pursuant to the binding arbitration mechanism 
provided for in this Protocol, the Secretary of Treasury shall 
transmit the text of the rules of procedure applicable to 
arbitration boards, including conflict of interest rules to be 
applied to members of the arbitration board, to the committees 
on Finance and Foreign Relations of the Senate and the Joint 
Committee on Taxation.
  The Secretary of Treasury shall also, prior to the first 
arbitration conducted pursuant to the binding arbitration 
mechanism provided for in the 2006 Protocol Amending the 
Convention between the United States of America and the Federal 
Republic of Germany for the Avoidance of Double Taxation and 
the Prevention of Fiscal Evasion with Respect to Taxes on 
Income and Capital and to Certain Other Taxes (the ``2006 
German Protocol'') (Treaty Doc. 109-20) and the Convention 
between the Government of the United States of America and the 
Government of the Kingdom of Belgium for the Avoidance of 
Double Taxation and the Prevention of Fiscal Evasion with 
Respect to Taxes on Income, and accompanying protocol (the 
``Belgium Convention'') (Treaty Doc. 110-3), transmit the text 
of the rules of procedure applicable to the first arbitration 
board agreed to under each treaty to the committees on Finance 
and Foreign Relations of the Senate and the Joint Committee on 
Taxation.
  2. 60 days after a determination has been reached by an 
arbitration board in the tenth arbitration proceeding conducted 
pursuant to either this Protocol, the 2006 German Protocol, or 
the Belgium Convention, the Secretary of Treasury shall prepare 
and submit a detailed report to the Joint Committee on Taxation 
and the Committee on Finance of the Senate, subject to law 
relating to taxpayer confidentiality, regarding the operation 
and application of the arbitration mechanism contained in the 
aforementioned treaties. The report shall include the following 
information:
          I. The aggregate number, for each treaty, of cases 
        pending on the respective dates of entry into force of 
        this Protocol, the 2006 German Protocol, or the Belgium 
        Convention, along with the following additional 
        information regarding these cases:
                  a. The number of such cases by treaty 
                article(s) at issue;
                  b. The number of such cases that have been 
                resolved by the competent authorities through a 
                mutual agreement as of the date of the report; 
                and
                  c. The number of such cases for which 
                arbitration proceedings have commenced as of 
                the date of the report.
          II. A list of every case presented to the competent 
        authorities after the entry into force of this 
        Protocol, the 2006 German Protocol, or the Belgium 
        Convention, with the following information regarding 
        each and every case:
                  a. The commencement date of the case for 
                purposes of determining when arbitration is 
                available;
                  b. Whether the adjustment triggering the 
                case, if any, was made by the United States or 
                the relevant treaty partner and which competent 
                authority initiated the case;
                  c. Which treaty the case relates to;
                  d. The treaty article(s) at issue in the 
                case;
                  e. The date the case was resolved by the 
                competent authorities through a mutual 
                agreement, if so resolved;
                  f. The date on which an arbitration 
                proceeding commenced, if an arbitration 
                proceeding commenced; and
                  g. The date on which a determination was 
                reached by the arbitration board, if a 
                determination was reached, and an indication as 
                to whether the board found in favor of the 
                United States or the relevant treaty partner.
          III. With respect to each dispute submitted to 
        arbitration and for which a determination was reached 
        by the arbitration board pursuant to this Protocol, the 
        2006 German Protocol, or the Belgium Convention, the 
        following information shall be included:
                  a. An indication as to whether the 
                determination of the arbitration board was 
                accepted by each concerned person;
                  b. The amount of income, expense, or taxation 
                at issue in the case as determined by reference 
                to the filings that were sufficient to set the 
                commencement date of the case for purposes of 
                determining when arbitration is available; and
                  c. The proposed resolutions (income, expense, 
                or taxation) submitted by each competent 
                authority to the arbitration board.
    3. The Secretary of Treasury shall, in addition, prepare 
and submit the detailed report described in paragraph (2) on 
March 1 of the year following the year in which the first 
report is submitted to the Joint Committee on Taxation and the 
Committee on Finance of the Senate, and on an annual basis 
thereafter for a period of five years. In each such report, 
disputes that were resolved, either by a mutual agreement 
between the relevant competent authorities or by a 
determination of an arbitration board, and noted as such in 
prior reports may be omitted.
                  IX. Annex I.--Technical Explanation


TECHNICAL EXPLANATION OF THE PROTOCOL DONE AT CHELSEA ON SEPTEMBER 21, 
 2007 AMENDING THE CONVENTION BETWEEN THE UNITED STATES OF AMERICA AND 
     CANADA WITH RESPECT TO TAXES ON INCOME AND ON CAPITAL DONE AT 
 WASHINGTON ON SEPTEMBER 26, 1980, AS AMENDED BY THE PROTOCOLS DONE ON 
    JUNE 14, 1983, MARCH 28, 1994, MARCH 17, 1995, AND JULY 29, 1997

                              INTRODUCTION

    This is a Technical Explanation of the Protocol signed at 
Chelsea on September 21, 2007 (the ``Protocol''), amending the 
Convention between the United States of America and Canada with 
Respect to Taxes on Income and on Capital done at Washington on 
September 26, 1980, as amended by the Protocols done on June 
14, 1983, March 28, 1994, March 17, 1995, and July 29, 1997 
(the ``existing Convention''). The existing Convention as 
modified by the Protocol shall be referred to as the 
``Convention.''
    Negotiation of the Protocol took into account the U.S. 
Treasury Department's current tax treaty policy and the 
Treasury Department's Model Income Tax Convention, published on 
November 15, 2006 (the ``U.S. Model''). Negotiations also took 
into account the Model Tax Convention on Income and on Capital, 
published by the Organisation for Economic Cooperation and 
Development (the ``OECD Model''), and recent tax treaties 
concluded by both countries.
    The Technical Explanation is an official United States 
guide to the Protocol. The Government of Canada has reviewed 
this document and subscribes to its contents. In the view of 
both governments, this document accurately reflects the 
policies behind particular Protocol provisions, as well as 
understandings reached with respect to the application and 
interpretation of the Protocol and the Convention.
    References made to the ``existing Convention'' are intended 
to put various provisions of the Protocol into context. The 
Technical Explanation does not, however, provide a complete 
comparison between the provisions of the existing Convention 
and the amendments made by the Protocol. The Technical 
Explanation is not intended to provide a complete guide to the 
existing Convention as amended by the Protocol. To the extent 
that the existing Convention has not been amended by the 
Protocol, the prior technical explanations of the Convention 
remain the official explanations. References in this Technical 
Explanation to ``he'' or ``his'' should be read to mean ``he or 
she'' or ``his or her.'' References to the ``Code'' are to the 
Internal Revenue Code.
    On the date of signing of the Protocol, the United States 
and Canada exchanged two sets of diplomatic notes. Each of 
these notes sets forth provisions and understandings related to 
the Protocol and the Convention, and comprises an integral part 
of the overall agreement between the United States and Canada. 
The first note, the ``Arbitration Note,'' relates to the 
implementation of new paragraphs 6 and 7 of Article XXVI 
(Mutual Agreement Procedure), which provide for binding 
arbitration of certain disputes between the competent 
authorities. The second note, the ``General Note,'' relates 
more generally to issues of interpretation or application of 
various provisions of the Protocol.

                               ARTICLE 1

    Article 1 of the Protocol adds subparagraph 1(k) to Article 
III (General Definitions) to address the definition of 
``national'' of a Contracting State as used in the Convention. 
The Contracting States recognize that Canadian tax law does not 
draw distinctions based on nationality as such. Nevertheless, 
at the request of the United States, the definition was added 
and contains references to both citizenship and nationality. 
The definition includes any individual possessing the 
citizenship or nationality of a Contracting State and any legal 
person, partnership or association whose status is determined 
by reference to the laws in force in a Contracting State. The 
existing Convention contains one reference to the term 
``national'' in paragraph 1 of Article XXVI (Mutual Agreement 
Procedure). The Protocol adds another reference in paragraph 1 
of Article XXV (Non-Discrimination) to ensure that nationals of 
the United States are covered by the non-discrimination 
provisions of the Convention. The definition added by the 
Protocol is consistent with the definition provided in other 
U.S. tax treaties.
    The General Note provides that for purposes of paragraph 2 
of Article III, as regards the application at any time of the 
Convention, any term not defined in the Convention shall, 
unless the context otherwise requires or the competent 
authorities otherwise agree to a common meaning pursuant to 
Article XXVI (Mutual Agreement Procedure), have the meaning 
which it has at that time under the law of that State for the 
purposes of the taxes to which the Convention apply, any 
meaning under the applicable tax laws of that State prevailing 
over a meaning given to the term under other laws of that 
State.

                               ARTICLE 2

    Article 2 of the Protocol replaces paragraph 3 of Article 
IV (Residence) of the existing Convention to address the 
treatment of so-called dual resident companies. Article 2 of 
the Protocol also adds new paragraphs 6 and 7 to Article IV to 
determine whether income is considered to be derived by a 
resident of a Contracting State when such income is derived 
through a fiscally transparent entity.

Paragraph 3 of Article IV--Dual resident companies

    Paragraph 3, which addresses companies that are otherwise 
considered resident in each of the Contracting States, is 
replaced. The provisions of paragraph 3, and the date upon 
which these provisions are effective, are consistent with an 
understanding reached between the United States and Canada on 
September 18, 2000, to clarify the residence of a company under 
the Convention when the company has engaged in a so-called 
corporate ``continuance'' transaction. The paragraph applies 
only where, by reason of the rules set forth in paragraph 1 of 
Article IV (Residence), a company is a resident of both 
Contracting States.
    Subparagraph 3(a) provides a rule to address the situation 
when a company is a resident of both Contracting States but is 
created under the laws in force in only one of the Contracting 
States. In such a case, the rule provides that the company is a 
resident only of the Contracting State under which it is 
created. For example, if a company is incorporated in the 
United States but the company is also otherwise considered a 
resident of Canada because the company is managed in Canada, 
subparagraph 3(a) provides that the company shall be considered 
a resident only of the United States for purposes of the 
Convention. Subparagraph 3(a) is intended to operate in a 
manner similar to the first sentence of former paragraph 3. 
However, subparagraph 3(a) clarifies that such a company must 
be considered created in only one of the Contracting States to 
fall within the scope of subparagraph 3(a). In some cases, a 
company may engage in a corporate continuance transaction and 
retain its charter in the Contracting State from which it 
continued, while also being considered as created in the State 
to which the company continued. In such cases, the provisions 
of subparagraph 3(a) shall not apply because the company would 
be considered created in both of the Contracting States.
    Subparagraph 3(b) addresses all cases involving a dual 
resident company that are not addressed in subparagraph 3(a). 
Thus, subparagraph 3(b) applies to continuance transactions 
occurring between the Contracting States if, as a result, a 
company otherwise would be considered created under the laws of 
each Contracting State, e.g., because the corporation retained 
its charter in the first State. Subparagraph 3(b) would also 
address so-called serial continuance transactions where, for 
example, a company continues from one of the Contracting States 
to a third country and then continues into the other 
Contracting State without having ceased to be treated as 
resident in the first Contracting State.
    Subparagraph 3(b) provides that if a company is considered 
to be a resident of both Contracting States, and the residence 
of such company is not resolved by subparagraph 3(a), then the 
competent authorities of the Contracting States shall endeavor 
to settle the question of residency by a mutual agreement 
procedure and determine the mode of application of the 
Convention to such company. Subparagraph 3(b) also provides 
that in the absence of such agreement, the company shall not be 
considered a resident of either Contracting State for purposes 
of claiming any benefits under the Convention.

Paragraphs 6 and 7 of Article IV--income, profit, or gain derived 
        through fiscally transparent entities

    New paragraphs 6 and 7 are added to Article IV to provide 
specific rules for the treatment of amounts of income, profit 
or gain derived through or paid by fiscally transparent 
entities such as partnerships and certain trusts. Fiscally 
transparent entities, as explained more fully below, are in 
general entities the income of which is taxed at the 
beneficiary, member, or participant level. Entities that are 
subject to tax, but with respect to which tax may be relieved 
under an integrated system, are not considered fiscally 
transparent entities. Entities that are fiscally transparent 
for U.S. tax purposes include partnerships, common investment 
trusts under section 584, grantor trusts, and business entities 
such as a limited liability company (``LLC'') that is treated 
as a partnership or is disregarded as an entity separate from 
its owner for U.S. tax purposes. Entities falling within this 
description in Canada are (except to the extent the law 
provides otherwise) partnerships and what are known as ``bare'' 
trusts.
    United States tax law also considers a corporation that has 
made a valid election to be taxed under Subchapter S of Chapter 
1 of the Internal Revenue Code (an ``S corporation'') to be 
fiscally transparent within the meaning explained below. Thus, 
if a U.S. resident derives income from Canada through an S 
corporation, the U.S. resident will under new paragraph 6 be 
considered for purposes of the Convention as the person who 
derived the income. Exceptionally, because Canada will 
ordinarily accept that an S corporation is itself resident in 
the United States for purposes of the Convention, Canada will 
allow benefits under the Convention to the S corporation in its 
own right. In a reverse case, however--that is, where the S 
corporation is owned by a resident of Canada and has U. S.-
source income, profits or gains--the Canadian resident will not 
be considered as deriving the income by virtue of subparagraph 
7 (a) as Canada does not see the S corporation as fiscally 
transparent.
    Under both paragraph 6 and paragraph 7, it is relevant 
whether the treatment of an amount of income, profit or gain 
derived by a person through an entity under the tax law of the 
residence State is ``the same as its treatment would be if that 
amount had been derived directly.'' For purposes of paragraphs 
6 and 7, whether the treatment of an amount derived by a person 
through an entity under the tax law of the residence State is 
the same as its treatment would be if that amount had been 
derived directly by that person shall be determined in 
accordance with the principles set forth in Code section 894 
and the regulations under that section concerning whether an 
entity will be treated as fiscally transparent with respect to 
an item of income received by the entity. Treas. Reg. section 
1.894-1(d)(3)(iii) provides that an entity will be fiscally 
transparent under the laws of an interest holder's jurisdiction 
with respect to an item of income to the extent that the laws 
of that jurisdiction require the interest holder resident in 
that jurisdiction to separately take into account on a current 
basis the interest holder's respective share of the item of 
income paid to the entity, whether or not distributed to the 
interest holder, and the character and source of the item in 
the hands of the interest holder are determined as if such item 
were realized directly from the source from which realized by 
the entity. Although Canada does not have analogous provisions 
in its domestic law, it is anticipated that principles 
comparable to those described above will apply.

Paragraph 6

    Under paragraph 6, an amount of income, profit or gain is 
considered to be derived by a resident of a Contracting State 
(residence State) if 1) the amount is derived by that person 
through an entity (other than an entity that is a resident of 
the other Contracting State (source State), and 2) by reason of 
that entity being considered fiscally transparent under the 
laws of the residence State, the treatment of the amount under 
the tax law of the residence State is the same as its treatment 
would be if that amount had been derived directly by that 
person. These two requirements are set forth in subparagraphs 
6(a) and 6(b), respectively.
    For example, if a U.S. resident owns a French entity that 
earns Canadian-source dividends and the entity is considered 
fiscally transparent under U.S. tax law, the U.S. resident is 
considered to derive the Canadian-source dividends for purposes 
of Article IV (and thus, the dividends are considered as being 
``paid to'' the resident) because the U.S. resident is 
considered under the tax law of the United States to have 
derived the dividend through the French entity and, because the 
entity is treated as fiscally transparent under U.S. tax law, 
the treatment of the income under U.S. tax law is the same as 
its treatment would be if that amount had been derived directly 
by the U.S. resident. This result obtains even if the French 
entity is viewed differently under the tax laws of Canada or of 
France (i.e., the French entity is treated under Canadian law 
or under French tax law as not fiscally transparent).
    Similarly, if a Canadian resident derives U. S.-source 
income, profit or gain through an entity created under Canadian 
law that is considered a partnership for Canadian tax purposes 
but a corporation for U.S. tax purposes, U. S.-source income, 
profit or gain derived through such entity by the Canadian 
resident will be considered to be derived by the Canadian 
resident in considering the application of the Convention.

Application of paragraph 6 and related treaty provisions by Canada

    In determining the entitlement of a resident of the United 
States to the benefits of the Convention, Canada shall apply 
the Convention within its own legal framework.
    For example, assume that from the perspective of Canadian 
law an amount of income is seen as being paid from a source in 
Canada to USLLC, an entity that is entirely owned by U.S. 
persons and is fiscally transparent for U.S. tax purposes, but 
that Canada considers a corporation and, thus, under Canadian 
law, a taxpayer in its own right. Since USLLC is not itself 
taxable in the United States, it is not considered to be a U.S. 
resident under the Convention; but for new paragraph 6 Canada 
would not apply the Convention in taxing the income.
    If new paragraph 6 applies in respect of an amount of 
income, profit or gain, such amount is considered as having 
been derived by one or more U.S. resident shareholders of 
USLLC, and Canada shall grant benefits of the Convention to the 
payment to USLLC and eliminate or reduce Canadian tax as 
provided in the Convention. The effect of the rule is to 
suppress Canadian taxation of USLLC to give effect to the 
benefits available under the Convention to the U.S. residents 
in respect of the particular amount of income, profit or gain.
    However, for Canadian tax purposes, USLLC remains the only 
``visible'' taxpayer in relation to this amount. In other 
words, the Canadian tax treatment of this taxpayer (USLLC) is 
modified because of the entitlement of its U.S. resident 
shareholders to benefits under the Convention, but this does 
not alter USLLC's status under Canadian law. Canada does not, 
for example, treat USLLC as though it did not exist, 
substituting the shareholders for it in the role of taxpayer 
under Canada's system.
    Some of the implications of this are as follows. First, 
Canada will not require the shareholders of USLLC to file 
Canadian tax returns in respect of income that benefits from 
new paragraph 6. Instead, USLLC itself will file a Canadian tax 
return in which it will claim the benefit of the paragraph and 
supply any documentation required to support the claim. (The 
Canada Revenue Agency will supply additional practical guidance 
in this regard, including instructions for seeking to establish 
entitlement to Convention benefits in advance of payment.) 
Second, as is explained in greater detail below, if the income 
in question is business profits, it will be necessary to 
determine whether the income was earned through a permanent 
establishment in Canada. This determination will be based on 
the presence and activities in Canada of USLLC itself, not of 
its shareholders acting in their own right.

Determination of the existence of a permanent establishment from the 
        business activities of a fiscally transparent entity

    New paragraph 6 applies not only in respect of amounts of 
dividends, interest and royalties, but also profit (business 
income), gains and other income. It may thus be relevant in 
cases where a resident of one Contracting State carries on 
business in the other State through an entity that has a 
different characterization in each of the two Contracting 
States.
    Application of new paragraph 6 and the provisions of 
Article V (Permanent Establishment) by CanadaAssume, for 
instance, that a resident of the United States is part owner of 
a U.S. limited liability company (USLLC) that is treated in the 
United States as a fiscally transparent entity, but in Canada 
as a corporation. Assume one of the other two shareholders of 
USLLC is resident in a country that does not have a tax treaty 
with Canada and that the remaining shareholder is resident in a 
country with which Canada does have a tax treaty, but that the 
treaty does not include a provision analogous to paragraph 6.
    Assume further that USLLC carries on business in Canada, 
but does not do so through a permanent establishment there. 
(Note that from the Canadian perspective, the presence or 
absence of a permanent establishment is evaluated with respect 
to USLLC only, which Canada sees as a potentially taxable 
entity in its own right.) Regarding Canada's application of the 
provisions of the Convention, the portion of USLLC's profits 
that belongs to the U.S. resident shareholder will not be 
taxable in Canada, provided that the U.S. resident meets the 
Convention's limitation on benefits provisions. Under paragraph 
6, that portion is seen as having been derived by the U.S. 
resident shareholder, who is entitled to rely on Article VII 
(Business Profits). The balance of USLLC's profits will, 
however, remain taxable in Canada. Since USLLC is not itself 
resident in the United States for purposes of the Convention, 
in respect of that portion of its profits that is not 
considered to have been derived by a U.S. resident (or a 
resident of another country whose treaty with Canada includes a 
rule comparable to paragraph 6) it is not relevant whether or 
not it has a permanent establishment in Canada.
    Another example would be the situation where a USLLC that 
is wholly owned by a resident of the U.S. carries on business 
in Canada through a permanent establishment. If the USLLC is 
fiscally transparent for U.S. tax purposes (and therefore, the 
conditions for the application of paragraph 6 are satisfied) 
then the USLLC's profits will be treated as having been derived 
by its U.S. resident owner inclusive of all attributes of that 
income (e.g., such as having been earned through a permanent 
establishment). However, since the USLLC remains the only 
``visible'' taxpayer for Canadian tax purposes, it is the 
USLLC, and not the U.S. shareholder, that is subject to tax on 
the profits that are attributable to the permanent 
establishment.

Application of new paragraph 6 and the provisions of Article V 
        (Permanent Establishment) by the United States

    It should be noted that in the situation where a person is 
considered to derive income through an entity, the United 
States looks in addition to such person's activities in order 
to determine whether he has a permanent establishment. Assume 
that a Canadian resident and a resident in a country that does 
not have a tax treaty with the United States are owners of 
CanLP. Assume further that Can LP is an entity that is 
considered fiscally transparent for Canadian tax purposes but 
is not considered fiscally transparent for U.S. tax purposes, 
and that CanLP carries on business in the United States. If 
CanLP carries on the business through a permanent 
establishment, that permanent establishment may be attributed 
to the partners. Moreover, in determining whether there is a 
permanent establishment, the activities of both the entity and 
its partners will be considered. If CanLP does not carry on the 
business through a permanent establishment, the Canadian 
resident, who derives income through the partnership, may claim 
the benefits of Article VII (Business Profits) of the 
Convention with respect to such income, assuming that the 
income is not otherwise attributable to a permanent 
establishment of the partner. In any case, the third country 
partner cannot claim the benefits of Article VII of the 
Convention between the United States and Canada.

Paragraph 7

    Paragraph 7 addresses situations where an item of income, 
profit or gain is considered not to be paid to or derived by a 
person who is a resident of a Contracting State. The paragraph 
is divided into two subparagraphs.
    Under subparagraph 7(a), an amount of income, profit or 
gain is considered not to be paid to or derived by a person who 
is a resident of a Contracting State (the residence State) if 
(1) the other Contracting State (the source State) views the 
person as deriving the amount through an entity that is not a 
resident of the residence State, and (2) by reason of the 
entity not being treated as fiscally transparent under the laws 
of the residence State, the treatment of the amount under the 
tax law of the residence State is not the same as its treatment 
would be if that amount had been derived directly by the 
person.
    For example, assume USCo, a company resident in the United 
States, is a part owner of CanLP, an entity that is considered 
fiscally transparent for Canadian tax purposes, but is not 
considered fiscally transparent for U.S. tax purposes. CanLP 
receives a dividend from a Canadian company in which it owns 
stock. Under Canadian tax law USCo is viewed as deriving a 
Canadian-source dividend through CanLP. For U.S. tax purposes, 
CanLP, and not USCo, is viewed as deriving the dividend. 
Because the treatment of the dividend under U.S. tax law in 
this case is not the same as the treatment under U.S. law if 
USCo derived the dividend directly, subparagraph 7(a) provides 
that USCo will not be considered as having derived the 
dividend. The result would be the same if CanLP were a third-
country entity that was viewed by the United States as not 
fiscally transparent, but was viewed by Canada as fiscally 
transparent. Similarly, income from U.S. sources received by an 
entity organized under the laws of the United States that is 
treated for Canadian tax purposes as a corporation and is owned 
by shareholders who are residents of Canada is not considered 
derived by the shareholders of that U.S. entity even if, under 
U.S. tax law, the entity is treated as fiscally transparent.
    Subparagraph 7(b) provides that an amount of income, profit 
or gain is not considered to be paid to or derived by a person 
who is a resident of a Contracting State (the residence State) 
where the person is considered under the tax law of the other 
Contracting State (the source State) to have received the 
amount from an entity that is a resident of that other State 
(the source State), but by reason of the entity being treated 
as fiscally transparent under the laws of the Contracting State 
of which the person is resident (the residence State), the 
treatment of such amount under the tax law of that State (the 
residence State) is not the same as the treatment would be if 
that entity were not treated as fiscally transparent under the 
laws of that State (the residence State).
    That is, under subparagraph 7(b), an amount of income, 
profit or gain is not considered to be paid to or derived by a 
resident of a Contracting State (the residence State) if: (1) 
the other Contracting State (the source State) views such 
person as receiving the amount from an entity resident in the 
source State; (2) the entity is viewed as fiscally transparent 
under the laws of the residence State; and (3) by reason of the 
entity being treated as fiscally transparent under the laws of 
the residence State, the treatment of the amount received by 
that person under the tax law of the residence State is not the 
same as its treatment would be if the entity were not treated 
as fiscally transparent under the laws of the residence State.
    For example, assume that USCo, a company resident in the 
United States is the sole owner of CanCo, an entity that is 
considered under Canadian tax law to be a corporation that is 
resident in Canada but is considered under U.S. tax law to be 
disregarded as an entity separate from its owner. Assume 
further that USCo is considered under Canadian tax law to have 
received a dividend from CanCo.
    In such a case, Canada, the source State, views USCo as 
receiving income (i.e., a dividend) from a corporation that is 
a resident of Canada (CanCo), CanCo is viewed as fiscally 
transparent under the laws of the United States, the residence 
State, and by reason of CanCo being disregarded under U.S. tax 
law, the treatment under U.S. tax law of the payment is not the 
same as its treatment would be if the entity were regarded as a 
corporation under U.S. tax law. That is, the payment is 
disregarded for U.S. tax purposes, whereas if U.S. tax law 
regarded CanCo as a corporation, the payment would be treated 
as a dividend. Therefore, subparagraph 7(b) would apply to 
provide that the income is not considered to be paid to or 
derived by USCo.
    The same result obtains if, in the above example, USCo is 
considered under Canadian tax law to have received an interest 
or royalty payment (instead of a dividend) from CanCo. Under 
U.S. law, because CanCo is disregarded as an entity separate 
from its owner, the payment is disregarded, whereas if CanCo 
were treated as not fiscally transparent, the payment would be 
treated as interest or a royalty, as the case may be. 
Therefore, subparagraph 7(b) would apply to provide that such 
amount is not considered to be paid to or derived by USCo.
    The application of subparagraph 7(b) differs if, in the 
above example, USCo (as well as other persons) are owners of 
CanCo, a Canadian entity that is considered under Canadian tax 
law to be a corporation that is resident in Canada but is 
considered under U.S. tax law to be a partnership (as opposed 
to being disregarded). Assume that USCo is considered under 
Canadian tax law to have received a dividend from CanCo. Such 
payment is viewed under Canadian tax law as a dividend, but 
under U.S. tax law is viewed as a partnership distribution. In 
such a case, Canada views USCo as receiving income (i.e., a 
dividend) from an entity that is a resident of Canada (CanCo), 
CanCo is viewed as fiscally transparent under the laws of the 
United States, the residence State, and by reason of CanCo 
being treated as a partnership under U.S. tax law, the 
treatment under U.S. tax law of the payment (as a partnership 
distribution) is not the same as the treatment would be if 
CanCo were not fiscally transparent under U.S. tax law (as a 
dividend). As a result, subparagraph 7(b) would apply to 
provide that such amount is not considered paid to or derived 
by the U.S. resident.
    As another example, assume that CanCo, a company resident 
in Canada, is the owner of USLP, an entity that is considered 
under U.S. tax law (by virtue of an election) to be a 
corporation resident in the United States, but that is 
considered under Canadian tax law to be a branch of CanCo. 
Assume further that CanCo is considered under U.S. tax law to 
have received a dividend from USLP. In this case, the United 
States views CanCo as receiving income (i.e., a dividend) from 
an entity that is resident in the United States (USLP), but by 
reason of USLP being a branch under Canadian tax law, the 
treatment under Canadian tax law of the payment is not the same 
as its treatment would be if USLP were a company under Canadian 
tax law. That is, the payment is treated as a branch remittance 
for Canadian tax purposes, whereas if Canadian tax law regarded 
USLP as a corporation, the payment would be treated as a 
dividend. Therefore, subparagraph 7(b) would apply to provide 
that the income is not considered to be paid to or derived by 
CanCo. The same result would obtain in the case of interest or 
royalties paid by USLP to CanCo.
    Paragraphs 6 and 7 apply to determine whether an amount is 
considered to be derived by (or paid to) a person who is a 
resident of Canada or the United States. If, as a result of 
paragraph 7, a person is not considered to have derived or 
received an amount of income, profit or gain, that person shall 
not be entitled to the benefits of the Convention with respect 
to such amount. Additionally, for purposes of application of 
the Convention by the United States, the treatment of such 
payments under Code section 894(c) and the regulations 
thereunder would not be relevant.
    New paragraphs 6 and 7 are not an exception to the saving 
clause of paragraph 2 of Article XXIX (Miscellaneous Rules). 
Accordingly, subparagraph 7(b) does not prevent a Contracting 
State from taxing an entity that is treated as a resident of 
that State under its tax law. For example, if a U.S. 
partnership with members who are residents of Canada elects to 
be taxed as a corporation for U.S. tax purposes, the United 
States will tax that partnership on its worldwide income on a 
net basis, even if Canada views the partnership as fiscally 
transparent.

Interaction of paragraphs 6 and 7 with the determination of 
        ``beneficial ownership''

    With respect to payments of income, profits or gain arising 
in a Contracting State and derived directly by a resident of 
the other Contracting State (and not through a fiscally 
transparent entity), the term ``beneficial owner'' is defined 
under the internal law of the country imposing tax (i.e., the 
source State). Thus, if the payment arising in a Contracting 
State is derived by a resident of the other State who under the 
laws of the first-mentioned State is determined to be a nominee 
or agent acting on behalf of a person that is not a resident of 
that other State, the payment will not be entitled to the 
benefits of the Convention. However, payments arising in a 
Contracting State and derived by a nominee on behalf of a 
resident of that other State would be entitled to benefits. 
These limitations are confirmed by paragraph 12 of the 
Commentary to Article 10 of the OECD Model.
    Special rules apply in the case of income, profits or gains 
derived through a fiscally transparent entity, as described in 
new paragraph 6 of Article IV. Residence State principles 
determine who derives the income, profits or gains, to assure 
that the income, profits or gains for which the source State 
grants benefits of the Convention will be taken into account 
for tax purposes by a resident of the residence State. Source 
country principles of beneficial ownership apply to determine 
whether the person who derives the income, profits or gains, or 
another resident of the other Contracting State, is the 
beneficial owner of the income, profits or gains. The source 
State may conclude that the person who derives the income, 
profits or gains in the residence State is a mere nominee, 
agent, conduit, etc., for a third country resident and deny 
benefits of the Convention. If the person who derives the 
income, profits or gains under paragraph 6 of Article IV would 
not be treated under the source State's principles for 
determining beneficial ownership as a nominee, agent, 
custodian, conduit, etc., that person will be treated as the 
beneficial owner of the income, profits or gains for purposes 
of the Convention.
    Assume, for instance, that interest arising in the United 
States is paid to CanLP, an entity established in Canada which 
is treated as fiscally transparent for Canadian tax purposes 
but is treated as a company for U.S. tax purposes. CanCo, a 
company incorporated in Canada, is the sole interest holder in 
CanLP. Paragraph 6 of Article IV provides that CanCo derives 
the interest. However, if under the laws of the United States 
regarding payments to nominees, agents, custodians and 
conduits, CanCo is found be a nominee, agent, custodian or 
conduit for a person who is not a resident of Canada, CanCo 
will not be considered the beneficial owner of the interest and 
will not be entitled to the benefits of Article XI with respect 
to such interest. The payment may be entitled to benefits, 
however, if CanCo is found to be a nominee, agent, custodian or 
conduit for a person who is a resident of Canada.
    With respect to Canadian-source income, profit or gains, 
beneficial ownership is to be determined under Canadian law. 
For example, assume that LLC, an entity that is treated as 
fiscally transparent for U.S. tax purposes, but as a 
corporation for Canadian tax purposes, is owned by USCo, a U.S. 
resident company. LLC receives Canadian-source income. The 
question of the beneficial ownership of the income received by 
LLC is determined under Canadian law. If LLC is considered the 
beneficial owner of the income under Canadian law, paragraph 6 
shall apply to extend benefits of the Convention to the income 
received by LLC to the extent that the Canadian-source income 
is derived by U.S. resident members of LLC.

                               ARTICLE 3

    Article 3 of the Protocol amends Article V (Permanent 
Establishment) of the Convention. Paragraph 1 of Article 3 of 
the Protocol adds a reference in Paragraph 6 of Article IV to 
new paragraph 9 of Article V. Paragraph 2 of Article 3 of the 
Protocol sets forth new paragraphs 9 and 10 of Article V.

Paragraph 9 of Article V

    New paragraph 9 provides a special rule (subject to the 
provisions of paragraph 3) for an enterprise of a Contracting 
State that provides services in the other Contracting State, 
but that does not have a permanent establishment by virtue of 
the preceding paragraphs of the Article. If (and only if) such 
an enterprise meets either of two tests as provided in 
subparagraphs 9(a) and 9(b), the enterprise will be deemed to 
provide those services through a permanent establishment in the 
other State.
    The first test as provided in subparagraph 9(a) has two 
parts. First, the services must be performed in the other State 
by an individual who is present in that other State for a 
period or periods aggregating 183 days or more in any twelve-
month period. Second, during that period or periods, more than 
50 percent of the gross active business revenues of the 
enterprise (including revenue from active business activities 
unrelated to the provision of services) must consist of income 
derived from the services performed in that State by that 
individual. If the enterprise meets both of these tests, the 
enterprise will be deemed to provide the services through a 
permanent establishment. This test is employed to determine 
whether an enterprise is deemed to have a permanent 
establishment by virtue of the presence of a single individual 
(i.e., a natural person).
    For the purposes of subparagraph 9(a), the term ``gross 
active business revenues'' shall mean the gross revenues 
attributable to active business activities that the enterprise 
has charged or should charge for its active business 
activities, regardless of when the actual billing will occur or 
of domestic law rules concerning when such revenues should be 
taken into account for tax purposes. Such active business 
activities are not restricted to the activities related to the 
provision of services. However, the term does not include 
income from passive investment activities.
    As an example of the application of subparagraph 9(a), 
assume that Mr. X, an individual resident in the United States, 
is one of the two shareholders and employees of USCo, a company 
resident in the United States that provides engineering 
services. During the 12-month period beginning December 20 of 
Year 1 and ending December 19 of Year 2, Mr. X is present in 
Canada for periods totaling 190 days, and during those periods, 
70 percent of all of the gross active business revenues of USCo 
attributable to business activities are derived from the 
services that Mr. X performs in Canada. Because both of the 
criteria of subparagraph 9(a) are satisfied, USCo will be 
deemed to have a permanent establishment in Canada by virtue of 
that subparagraph.
    The second test as provided in subparagraph 9(b) provides 
that an enterprise will have a permanent establishment if the 
services are provided in the other State for an aggregate of 
183 days or more in any twelve-month period with respect to the 
same or connected projects for customers who either are 
residents of the other State or maintain a permanent 
establishment in the other State with respect to which the 
services are provided. The various conditions that have to be 
satisfied in order for subparagraph 9(b) to have application 
are described in detail below.
    In addition to meeting the 183-day threshold, the services 
must be provided for customers who either are residents of the 
other State or maintain a permanent establishment in that 
State. The intent of this requirement is to reinforce the 
concept that unless there is a customer in the other State, 
such enterprise will not be deemed as participating 
sufficiently in the economic life of that other State to 
warrant being deemed to have a permanent establishment.
    Assume for example, that CanCo, a Canadian company, wishes 
to acquire USCo, a company in the United States. In preparation 
for the acquisition, CanCo hires Canlaw, a Canadian law firm, 
to conduct a due diligence evaluation of USCo's legal and 
financial standing in the United States. Canlaw sends a staff 
attorney to the United States to perform the due diligence 
analysis of USCo. That attorney is present and working in the 
United States for greater than 183 days. If the remuneration 
paid to Canlaw for the attorney's services does not constitute 
more than 50 percent of Canlaw's gross active business revenues 
for the period during which the attorney is present in the 
United States, Canlaw will not be deemed to provide the 
services through a permanent establishment in the United States 
by virtue of subparagraph 9(a). Additionally, because the 
services are being provided for a customer (CanCo) who neither 
is a resident of the United States nor maintains a permanent 
establishment in the United States to which the services are 
provided, Canlaw will also not have a permanent establishment 
in the United States by virtue of subparagraph 9(b).
    Paragraph 9 applies only to the provision of services, and 
only to services provided by an enterprise to third parties. 
Thus, the provision does not have the effect of deeming an 
enterprise to have a permanent establishment merely because 
services are provided to that enterprise. Paragraph 9 only 
applies to services that are performed or provided by an 
enterprise of a Contracting State within the other Contracting 
State. It is therefore not sufficient that the relevant 
services be merely furnished to a resident of the other 
Contracting State. Where, for example, an enterprise provides 
customer support or other services by telephone or computer to 
customers located in the other State, those would not be 
covered by paragraph 9 because they are not performed or 
provided by that enterprise within the other State. Another 
example would be that of an architect who is hired to design 
blueprints for the construction of a building in the other 
State. As part of completing the project, the architect must 
make site visits to that other State, and his days of presence 
there would be counted for purposes of determining whether the 
183-day threshold is satisfied. However, the days that the 
architect spends working on the blueprint in his home office 
shall not count for purposes of the 183-day threshold, because 
the architect is not performing or providing those services 
within the other State.
    For purposes of determining whether the time threshold has 
been met, subparagraph 9(b) permits the aggregation of services 
that are provided with respect to connected projects. Paragraph 
2 of the General Note provides that for purposes of 
subparagraph 9(b), projects shall be considered to be connected 
if they constitute a coherent whole, commercially and 
geographically. The determination of whether projects are 
connected should be determined from the point of view of the 
enterprise (not that of the customer), and will depend on the 
facts and circumstances of each case. In determining the 
existence of commercial coherence, factors that would be 
relevant include: 1) whether the projects would, in the absence 
of tax planning considerations, have been concluded pursuant to 
a single contract; 2) whether the nature of the work involved 
under different projects is the same; and 3) whether the same 
individuals are providing the services under the different 
projects. Whether the work provided is covered by one or 
multiple contracts may be relevant, but not determinative, in 
finding that projects are commercially coherent.
    The aggregation rule addresses, for example, potentially 
abusive situations in which work has been artificially divided 
into separate components in order to avoid meeting the 183-day 
threshold. Assume for example, that a technology consultant has 
been hired to install a new computer system for a company in 
the other country. The work will take ten months to complete. 
However, the consultant purports to divide the work into two 
five-month projects with the intention of circumventing the 
rule in subparagraph 9(b). In such case, even if the two 
projects were considered separate, they will be considered to 
be commercially coherent. Accordingly, subject to the 
additional requirement of geographic coherence, the two 
projects could be considered to be connected, and could 
therefore be aggregated for purposes of subparagraph 9(b). In 
contrast, assume that the technology consultant is contracted 
to install a particular computer system for a company, and is 
also hired by that same company, pursuant to a separate 
contract, to train its employees on the use of another computer 
software that is unrelated to the first system. In this second 
case, even though the contracts are both concluded between the 
same two parties, there is no commercial coherence to the two 
projects, and the time spent fulfilling the two contracts may 
not be aggregated for purposes of subparagraph 9(b). Another 
example of projects that do not have commercial coherence would 
be the case of a law firm which, as one project provides tax 
advice to a customer from one portion of its staff, and as 
another project provides trade advice from another portion of 
its staff, both to the same customer.
    Additionally, projects, in order to be considered 
connected, must also constitute a geographic whole. An example 
of projects that lack geographic coherence would be a case in 
which a consultant is hired to execute separate auditing 
projects at different branches of a bank located in different 
cities pursuant to a single contract. In such an example, while 
the consultant's projects are commercially coherent, they are 
not geographically coherent and accordingly the services 
provided in the various branches shall not be aggregated for 
purposes of applying subparagraph 9(b). The services provided 
in each branch should be considered separately for purposes of 
subparagraph 9(b).
    The method of counting days for purposes of subparagraph 
9(a) differs slightly from the method for subparagraph 9(b). 
Subparagraph 9(a) refers to days in which an individual is 
present in the other country. Accordingly, physical presence 
during a day is sufficient. In contrast, subparagraph 9(b) 
refers to days during which services are provided by the 
enterprise in the other country. Accordingly, non-working days 
such as weekends or holidays would not count for purposes of 
subparagraph 9(b), as long as no services are actually being 
provided while in the other country on those days. For the 
purposes of both subparagraphs, even if the enterprise sends 
many individuals simultaneously to the other country to provide 
services, their collective presence during one calendar day 
will count for only one day of the enterprise's presence in the 
other country. For instance, if an enterprise sends 20 
employees to the other country to provide services to a client 
in the other country for 10 days, the enterprise will be 
considered present in the other country only for 10 days, not 
200 days (20 employees x 10 days).
    By deeming the enterprise to provide services through a 
permanent establishment in the other Contracting State, 
paragraph 9 allows the application of Article VII (Business 
Profits), and accordingly, the taxation of the services shall 
be on a net-basis. Such taxation is also limited to the profits 
attributable to the activities carried on in performing the 
relevant services. It will be important to ensure that only the 
profits properly attributable to the functions performed and 
risks assumed by provision of the services will be attributed 
to the deemed permanent establishment.
    In addition to new paragraph 9, Article 3 of the Protocol 
amends paragraph 6 of Article V of the Convention to include a 
reference to paragraph 9. Therefore, in no case will paragraph 
9 apply to deem services to be provided through a permanent 
establishment if the services are limited to those mentioned in 
paragraph 6 which, if performed through a fixed place of 
business, would not make the fixed place of business a 
permanent establishment under the provisions of that paragraph.
    The competent authorities are encouraged to consider 
adopting rules to reduce the potential for excess withholding 
or estimated tax payments with respect to employee wages that 
may result from the application of this paragraph. Further, 
because paragraph 6 of Article V applies notwithstanding 
paragraph 9, days spent on preparatory or auxiliary activities 
shall not be taken into account for purposes of applying 
subparagraph 9(b).

Paragraph 10 of Article V

    Paragraph 2 of Article 3 of the Protocol also sets forth 
new paragraph 10 of Article V. The provisions of new paragraph 
10 are identical to paragraph 9 of Article V as it existed 
prior to the Protocol. New paragraph 10 provides that the 
provisions of Article V shall be applied in determining whether 
any person has a permanent establishment in any State.

                               ARTICLE 4

Article 4 of the Protocol replaces paragraph 2 of Article VII (Business 
        Profits).

    New paragraph 2 provides that where a resident of either 
Canada or the United States carries on (or has carried on) 
business in the other Contracting State through a permanent 
establishment in that other State, both Canada and the United 
States shall attribute to permanent establishments in their 
respective states those business profits which the permanent 
establishment might be expected to make if it were a distinct 
and separate person engaged in the same or similar activities 
under the same or similar conditions and dealing wholly 
independently with the resident and with any other person 
related to the resident. The term ``related to the resident'' 
is to be interpreted in accordance with paragraph 2 of Article 
IX (Related Persons). The reference to other related persons is 
intended to make clear that the test of paragraph 2 is not 
restricted to independence between a permanent establishment 
and a home office.
    New paragraph 2 is substantially similar to paragraph 2 as 
it existed before the Protocol. However, in addition to the 
reference to a resident of a Contracting State who ``carries 
on'' business in the other Contracting State, the Protocol 
incorporates into the Convention the rule of Code section 
864(c)(6) by adding ``or has carried on'' to address 
circumstances where, as a result of timing, income may be 
attributable to a permanent establishment that no longer exists 
in one of the Contracting States. In such cases, the income is 
properly within the scope of Article VII. Conforming changes 
are also made in the Protocol to Articles X (Dividends), XI 
(Interest), and XII (Royalties) of the Convention where Article 
VII would apply. As is explained in paragraph 5 of the General 
Note, these revisions to the Convention are only intended to 
clarify the application of the existing provisions of the 
Convention.
    The following example illustrates the application of 
paragraph 2. Assume a company that is a resident of Canada and 
that maintains a permanent establishment in the United States 
winds up the permanent establishment's business and sells the 
permanent establishment's inventory and assets to a U.S. buyer 
at the end of year 1 in exchange for an installment obligation 
payable in full at the end of year 3. Despite the fact that the 
company has no permanent establishment in the United States in 
year 3, the United States may tax the deferred income payment 
recognized by the company in year 3.
    The ``attributable to'' concept of paragraph 2 provides an 
alternative to the analogous but somewhat different 
``effectively connected'' concept in Code section 864(c). 
Depending on the circumstances, the amount of income 
``attributable to'' a permanent establishment under Article VII 
may be greater or less than the amount of income that would be 
treated as ``effectively connected'' to a U.S. trade or 
business under Code section 864. In particular, in the case of 
financial institutions, the use of internal dealings to 
allocate income within an enterprise may produce results under 
Article VII that are significantly different than the results 
under the effectively connected income rules. For example, 
income from interbranch notional principal contracts may be 
taken into account under Article VII, notwithstanding that such 
transactions may be ignored for purposes of U.S. domestic law. 
A taxpayer may use the treaty to reduce its taxable income, but 
may not use both treaty and Code rules where doing so would 
thwart the intent of either set of rules.  See  Rev. Rul. 84-
17, 1984-1 C.B. 308.
    The profits attributable to a permanent establishment may 
be from sources within or without a Contracting State. However, 
as stated in the General Note, the business profits 
attributable to a permanent establishment include only those 
profits derived from the assets used, risks assumed, and 
activities performed by the permanent establishment.
    The language of paragraph 2, when combined with paragraph 3 
dealing with the allowance of deductions for expenses incurred 
for the purposes of earning the profits, incorporates the arm's 
length standard for purposes of determining the profits 
attributable to a permanent establishment. The United States 
and Canada generally interpret the arm's length standard in a 
manner consistent with the OECD Transfer Pricing Guidelines.
    Paragraph 9 of the General Note confirms that the arm's 
length method of paragraphs 2 and 3 consists of applying the 
OECD Transfer Pricing Guidelines, but taking into account the 
different economic and legal circumstances of a single legal 
entity (as opposed to separate but associated enterprises). 
Thus, any of the methods used in the Transfer Pricing 
Guidelines, including profits methods, may be used as 
appropriate and in accordance with the Transfer Pricing 
Guidelines. However, the use of the Transfer Pricing Guidelines 
applies only for purposes of attributing profits within the 
legal entity. It does not create legal obligations or other tax 
consequences that would result from transactions having 
independent legal significance. Thus, the Contracting States 
agree that the notional payments used to compute the profits 
that are attributable to a permanent establishment will not be 
taxed as if they were actual payments for purposes of other 
taxing provisions of the Convention, for example, for purposes 
of taxing a notional royalty under Article XII (Royalties).
    One example of the different circumstances of a single 
legal entity is that an entity that operates through branches 
rather than separate subsidiaries generally will have lower 
capital requirements because all of the assets of the entity 
are available to support all of the entity's liabilities (with 
some exceptions attributable to local regulatory restrictions). 
This is the reason that most commercial banks and some 
insurance companies operate through branches rather than 
subsidiaries. The benefit that comes from such lower capital 
costs must be allocated among the branches in an appropriate 
manner. This issue does not arise in the case of an enterprise 
that operates through separate entities, since each entity will 
have to be separately capitalized or will have to compensate 
another entity for providing capital (usually through a 
guarantee).
    Under U.S. domestic regulations, internal ``transactions'' 
generally are not recognized because they do not have legal 
significance. In contrast, the rule provided by the General 
Note is that such internal dealings may be used to attribute 
income to a permanent establishment in cases where the dealings 
accurately reflect the allocation of risk within the 
enterprise. One example is that of global trading in 
securities. In many cases, banks use internal swap transactions 
to transfer risk from one branch to a central location where 
traders have the expertise to manage that particular type of 
risk. Under paragraph 2 as set forth in the Protocol, such a 
bank may also use such swap transactions as a means of 
attributing income between the branches, if use of that method 
is the ``best method'' within the meaning of regulation section 
1.482-1(c). The books of a branch will not be respected, 
however, when the results are inconsistent with a functional 
analysis. So, for example, income from a transaction that is 
booked in a particular branch (or home office) will not be 
treated as attributable to that location if the sales and risk 
management functions that generate the income are performed in 
another location.
    The understanding in the General Note also affects the 
interpretation of paragraph 3 of Article VII. Paragraph 3 
provides that in determining the business profits of a 
permanent establishment, deductions shall be allowed for the 
expenses incurred for the purposes of the permanent 
establishment, ensuring that business profits will be taxed on 
a net basis. This rule is not limited to expenses incurred 
exclusively for the purposes of the permanent establishment, 
but includes expenses incurred for the purposes of the 
enterprise as a whole, or that part of the enterprise that 
includes the permanent establishment. Deductions are to be 
allowed regardless of which accounting unit of the enterprise 
books the expenses, so long as they are incurred for the 
purposes of the permanent establishment. For example, a portion 
of the interest expense recorded on the books of the home 
office in one State may be deducted by a permanent 
establishment in the other. The amount of the expense that must 
be allowed as a deduction is determined by applying the arm's 
length principle.
    As noted above, paragraph 9 of the General Note provides 
that the OECD Transfer Pricing Guidelines apply, by analogy, in 
determining the profits attributable to a permanent 
establishment. Accordingly, a permanent establishment may 
deduct payments made to its head office or another branch in 
compensation for services performed for the benefit of the 
branch. The method to be used in calculating that amount will 
depend on the terms of the arrangements between the branches 
and head office. For example, the enterprise could have a 
policy, expressed in writing, under which each business unit 
could use the services of lawyers employed by the head office. 
At the end of each year, the costs of employing the lawyers 
would be charged to each business unit according to the amount 
of services used by that business unit during the year. Since 
this has the characteristics of a cost-sharing arrangement and 
the allocation of costs is based on the benefits received by 
each business unit, such a cost allocation would be an 
acceptable means of determining a permanent establishment's 
deduction for legal expenses. Alternatively, the head office 
could agree to employ lawyers at its own risk, and to charge an 
arm's length price for legal services performed for a 
particular business unit. If the lawyers were under-utilized, 
and the ``fees'' received from the business units were less 
than the cost of employing the lawyers, then the head office 
would bear the excess cost. If the ``fees'' exceeded the cost 
of employing the lawyers, then the head office would keep the 
excess to compensate it for assuming the risk of employing the 
lawyers. If the enterprise acted in accordance with this 
agreement, this method would be an acceptable alternative 
method for calculating a permanent establishment's deduction 
for legal expenses.
    The General Note also makes clear that a permanent 
establishment cannot be funded entirely with debt, but must 
have sufficient capital to carry on its activities as if it 
were a distinct and separate enterprise. To the extent that the 
permanent establishment has not been attributed capital for 
profit attribution purposes, a Contracting State may attribute 
such capital to the permanent establishment, in accordance with 
the arm's length principle, and deny an interest deduction to 
the extent necessary to reflect that capital attribution. The 
method prescribed by U.S. domestic law for making this 
attribution is found in Treas. Reg. section 1.882-5. Both 
section 1.882-5 and the method prescribed in the General Note 
start from the premise that all of the capital of the 
enterprise supports all of the assets and risks of the 
enterprise, and therefore the entire capital of the enterprise 
must be allocated to its various businesses and offices.
    However, section 1.882-5 does not take into account the 
fact that some assets create more risk for the enterprise than 
do other assets. An independent enterprise would need less 
capital to support a perfectly-hedged U.S. Treasury security 
than it would need to support an equity security or other asset 
with significant market and/or credit risk. Accordingly, in 
some cases section 1.882-5 would require a taxpayer to allocate 
more capital to the United States, and therefore would reduce 
the taxpayer's interest deduction more, than is appropriate. To 
address these cases, the General Note allows a taxpayer to 
apply a more flexible approach that takes into account the 
relative risk of its assets in the various jurisdictions in 
which it does business. In particular, in the case of financial 
institutions other than insurance companies, the amount of 
capital attributable to a permanent establishment is determined 
by allocating the institution's total equity between its 
various offices on the basis of the proportion of the financial 
institution's risk-weighted assets attributable to each of 
them. This recognizes the fact that financial institutions are 
in many cases required to risk-weight their assets for 
regulatory purposes and, in other cases, will do so for 
business reasons even if not required to do so by regulators. 
However, risk-weighting is more complicated than the method 
prescribed by section 1.882-5. Accordingly, to ease this 
administrative burden, taxpayers may choose to apply the 
principles of Treas. Reg. section 1.882-5(c) to determine the 
amount of capital allocable to its U.S. permanent 
establishment, in lieu of determining its allocable capital 
under the risk-weighted capital allocation method provided by 
the General Note, even if it has otherwise chosen the 
principles of Article VII rather than the effectively connected 
income rules of U.S. domestic law. It is understood that this 
election is not binding for purposes of Canadian taxation 
unless the result is in accordance with the arm's length 
principle.
    As noted in the Convention, nothing in paragraph 3 requires 
a Contracting State to allow the deduction of any expenditure 
which, by reason of its nature, is not generally allowed as a 
deduction under the tax laws in that State.

                               ARTICLE 5

    Article 5 makes a number of amendments to Article X 
(Dividends) of the existing Convention. As with other benefits 
of the Convention, the benefits of Article X are available to a 
resident of a Contracting State only if that resident is 
entitled to those benefits under the provisions of Article XXIX 
A (Limitation on Benefits).
     See the Technical Explanation for new paragraphs 6 and 7 
of Article IV (Residence) for discussion regarding the 
interaction between domestic law concepts of beneficial 
ownership and the treaty rules to determine when a person is 
considered to derive an item of income for purposes of 
obtaining benefits of the Convention such as withholding rate 
reductions.

Paragraph 1

    Paragraph 1 of Article 5 of the Protocol replaces 
subparagraph 2(a) of Article X of the Convention. In general, 
paragraph 2 limits the amount of tax that may be imposed on 
dividends by the Contracting State in which the company paying 
the dividends is resident if the beneficial owner of the 
dividends is a resident of the other Contracting State. 
Subparagraph 2(a) limits the rate to 5 percent of the gross 
amount of the dividends if the beneficial owner is a company 
that owns 10 percent or more of the voting stock of the company 
paying the dividends.
    The Protocol adds a parenthetical to address the 
determination of the requisite ownership set forth in 
subparagraph 2(a) when the beneficial owner of dividends 
receives the dividends through an entity that is considered 
fiscally transparent in the beneficial owner's Contracting 
State. The added parenthetical stipulates that voting stock in 
a company paying the dividends that is indirectly held through 
an entity that is considered fiscally transparent in the 
beneficial owner's Contracting State is taken into account, 
provided the entity is not a resident of the other Contracting 
State. The United States views the new parenthetical as merely 
a clarification.
    For example, assume USCo, a U.S. corporation, directly owns 
2 percent of the voting stock of CanCo, a Canadian company that 
is considered a corporation in the United States and Canada. 
Further, assume that USCo owns 18 percent of the interests in 
LLC, an entity that in turn owns 50 percent of the voting stock 
of CanCo. CanCo pays a dividend to each of its shareholders. 
Provided that LLC is fiscally transparent in the United States 
and not considered a resident of Canada, USCo's 9 percent 
ownership in CanCo through LLC (50 percent x 18 percent) is 
taken into account in determining whether USCo meets the 10 
percent ownership threshold set forth in subparagraph 2(a). In 
this example, USCo may aggregate its voting stock interests in 
CanCo that it owns directly and through LLC to determine if it 
satisfies the ownership requirement of subparagraph 2(a). 
Accordingly, USCo will be entitled to the 5 percent rate of 
withholding on dividends paid with respect to both its voting 
stock held through LLC and its voting stock held directly. 
Alternatively, if, for example, all of the shareholders of LLC 
were natural persons, the 5 percent rate would not apply.

Paragraph 2

    Paragraph 2 of Article 5 of the Protocol replaces the 
definition of the term ``dividends'' provided in paragraph 3 of 
Article X of the Convention. The new definition conforms to the 
U.S. Model formulation. Paragraph 3 defines the term dividends 
broadly and flexibly. The definition is intended to cover all 
arrangements that yield a return on an equity investment in a 
corporation as determined under the tax law of the source 
State, as well as arrangements that might be developed in the 
future.
    The term dividends includes income from shares, or other 
corporate rights that are not treated as debt under the law of 
the source State, that participate in the profits of the 
company. The term also includes income that is subjected to the 
same tax treatment as income from shares by the law of the 
source State. Thus, for example, a constructive dividend that 
results from a non-arm's length transaction between a 
corporation and a related party is a dividend. In the case of 
the United States the term ``dividend'' includes amounts 
treated as a dividend under U.S. law upon the sale or 
redemption of shares or upon a transfer of shares in a 
reorganization. See, e.g., Rev. Rul. 92-85, 1992-2 C.B. 69 
(sale of foreign subsidiary's stock to U.S. sister company is a 
deemed dividend to extent of the subsidiary's and sister 
company's earnings and profits). Further, a distribution from a 
U.S. publicly traded limited partnership that is taxed as a 
corporation under U.S. law is a dividend for purposes of 
Article X. However, a distribution by a limited liability 
company is not considered by the United States to be a dividend 
for purposes of Article X, provided the limited liability 
company is not characterized as an association taxable as a 
corporation under U.S. law.
    Paragraph 3 of the General Note states that distributions 
from Canadian income trusts and royalty trusts that are treated 
as dividends as a result of changes to Canada's taxation of 
income and royalty trusts enacted in 2007 (S.C. 2007, c. 29) 
shall be treated as dividends for the purposes of Article X.
    Additionally, a payment denominated as interest that is 
made by a thinly capitalized corporation may be treated as a 
dividend to the extent that the debt is recharacterized as 
equity under the laws of the source State. At the time the 
Protocol was signed, interest payments subject to Canada's 
thin-capitalization rules were not recharacterized as 
dividends.

Paragraph 3

    Paragraph 3 of Article 5 of the Protocol replaces paragraph 
4 of Article X. New paragraph 4 is substantially similar to 
paragraph 4 as it existed prior to the Protocol. New paragraph 
4, however, adds clarifying language consistent with the 
changes made in Articles 4, 6, and 7 of the Protocol with 
respect to income attributable to a permanent establishment 
that has ceased to exist. Paragraph 4 provides that the 
limitations of paragraph 2 do not apply if the beneficial owner 
of the dividends carries on or has carried on business in the 
State in which the company paying the dividends is a resident 
through a permanent establishment situated there, and the 
stockholding in respect of which the dividends are paid is 
effectively connected to such permanent establishment. In such 
a case, the dividends are taxable pursuant to the provisions of 
Article VII (Business Profits). Thus, dividends paid in respect 
of holdings forming part of the assets of a permanent 
establishment or which are otherwise effectively connected to 
such permanent establishment will be taxed on a net basis using 
the rates and rules of taxation generally applicable to 
residents of the State in which the permanent establishment is 
situated.
    To conform with Article 9 of the Protocol, which deletes 
Article XIV (Independent Personal Services) of the Convention, 
paragraph 4 of Article 5 of the Protocol also amends paragraph 
5 of Article X by omitting the reference to a ``fixed base.''

Paragraph 4

    To conform with Article 9 of the Protocol, which deletes 
Article XIV (Independent Personal Services) of the Convention, 
paragraph 4 of Article 5 of the Protocol amends paragraph 5 of 
Article X by omitting the reference to a ``fixed base.''

Paragraph 5

    Paragraph 5 of Article 5 of the Protocol replaces 
subparagraph 7(c) of Article X of the existing Convention. 
Consistent with current U.S. tax treaty policy, new 
subparagraph 7(c) provides rules that expand the application of 
subparagraph 2(b) for the treatment of dividends paid by a Real 
Estate Investment Trust (REIT). New subparagraph 7(c) maintains 
the rule of the existing Convention that dividends paid by a 
REIT are not eligible for the 5 percent maximum rate of 
withholding tax of subparagraph 2(a), and provides that the 15 
percent maximum rate of withholding tax of subparagraph 2(b) 
applies to dividends paid by REITs only if one of three 
conditions is met.
    First, the dividend will qualify for the 15 percent maximum 
rate if the beneficial owner of the dividend is an individual 
holding an interest of not more than 10 percent in the REIT. 
For this purpose, subparagraph 7(c) also provides that where an 
estate or testamentary trust acquired its interest in a REIT as 
a consequence of the death of an individual, the estate or 
trust will be treated as an individual for the five-year period 
following the death. Thus, dividends paid to an estate or 
testamentary trust in respect of a holding of less than a 10 
percent interest in the REIT also will be entitled to the 15 
percent rate of withholding, but only for up to five years 
after the death.
    Second, the dividend will qualify for the 15 percent 
maximum rate if it is paid with respect to a class of stock 
that is publicly traded and the beneficial owner of the 
dividend is a person holding an interest of not more than 5 
percent of any class of the REIT's stock.
    Third, the dividend will qualify for the 15 percent maximum 
rate if the beneficial owner of the dividend holds an interest 
in the REIT of 10 percent or less and the REIT is 
``diversified.'' A REIT is diversified if the gross value of no 
single interest in real property held by the REIT exceeds 10 
percent of the gross value of the REIT's total interest in real 
property. For purposes of this diversification test, 
foreclosure property is not considered an interest in real 
property, and a REIT holding a partnership interest is treated 
as owning its proportionate share of any interest in real 
property held by the partnership.
    A resident of Canada directly holding U.S. real property 
would pay U.S. tax either at a 30 percent rate of withholding 
tax on the gross income or at graduated rates on the net 
income. By placing the real property in a REIT, the investor 
absent a special rule could transform real estate income into 
dividend income, taxable at the rates provided in Article X, 
significantly reducing the U.S. tax that otherwise would be 
imposed. Subparagraph 7(c) prevents this result and thereby 
avoids a disparity between the taxation of direct real estate 
investments and real estate investments made through REIT 
conduits. In the cases in which subparagraph 7(c) allows a 
dividend from a REIT to be eligible for the 15 percent maximum 
rate of withholding tax, the holding in the REIT is not 
considered the equivalent of a direct holding in the underlying 
real property.

Article 6

    Article 6 of the Protocol replaces Article XI (Interest) of 
the existing Convention. Article XI specifies the taxing 
jurisdictions over interest income of the States of source and 
residence and defines the terms necessary to apply Article XI. 
As with other benefits of the Convention, the benefits of 
Article XI are available to a resident of a Contracting State 
only if that resident is entitled to those benefits under the 
provisions of Article XXIX A (Limitation on Benefits).

Paragraph 1 of Article XI

    New paragraph 1 generally grants to the residence State the 
exclusive right to tax interest beneficially owned by its 
residents and arising in the other Contracting State. See the 
Technical Explanation for new paragraphs 6 and 7 of Article IV 
(Residence) for discussion regarding the interaction between 
domestic law concepts of beneficial ownership and the treaty 
rules to determine when a person is considered to derive an 
item of income for purposes of obtaining benefits under the 
Convention such as withholding rate reductions.
    Subparagraph 3(d) of Article 27 of the Protocol provides an 
additional rule regarding the application of paragraph 1 during 
the first two years that end after the Protocol's entry into 
force. This rule is described in detail in the Technical 
Explanation to Article 27.

Paragraph 2 of Article XI

    Paragraph 2 of new Article XI is substantially identical to 
paragraph 4 of Article XI of the existing Convention.
    Paragraph 2 defines the term ``interest'' as used in 
Article XI to include, inter alia, income from debt claims of 
every kind, whether or not secured by a mortgage. Interest that 
is paid or accrued subject to a contingency is within the ambit 
of Article XI. This includes income from a debt obligation 
carrying the right to participate in profits. The term does 
not, however, include amounts that are treated as dividends 
under Article X (Dividends).
    The term ``interest'' also includes amounts subject to the 
same tax treatment as income from money lent under the law of 
the State in which the income arises. Thus, for purposes of the 
Convention, amounts that the United States will treat as 
interest include (i) the difference between the issue price and 
the stated redemption price at maturity of a debt instrument 
(i.e., original issue discount (OID)), which may be wholly or 
partially realized on the disposition of a debt instrument 
(section 1273), (ii) amounts that are imputed interest on a 
deferred sales contract (section 483), (iii) amounts treated as 
interest or OID under the stripped bond rules (section 1286), 
(iv) amounts treated as original issue discount under the 
below-market interest rate rules (section 7872), (v) a 
partner's distributive share of a partnership's interest income 
(section 702), (vi) the interest portion of periodic payments 
made under a ``finance lease'' or similar contractual 
arrangement that in substance is a borrowing by the nominal 
lessee to finance the acquisition of property, (vii) amounts 
included in the income of a holder of a residual interest in a 
real estate mortgage investment conduit (REMIC) (section 860E), 
because these amounts generally are subject to the same 
taxation treatment as interest under U.S. tax law, and (viii) 
interest with respect to notional principal contracts that are 
re-characterized as loans because of a ``substantial non-
periodic payment.''
    Paragraph 3 is in all material respects the same as 
paragraph 5 of Article XI of the existing Convention. New 
paragraph 3 adds clarifying language consistent with the 
changes made in Articles 4, 5, and 7 of the Protocol with 
respect to income attributable to a permanent establishment 
that has ceased to exist. Also, consistent with the changes 
described in Article 9 of the Protocol, discussed below, 
paragraph 3 does not contain references to the performance of 
independent personal services through a fixed base.
    Paragraph 3 provides an exception to the exclusive 
residence taxation rule of paragraph 1 in cases where the 
beneficial owner of the interest carries on business through a 
permanent establishment in the State of source and the interest 
is effectively connected to that permanent establishment. In 
such cases the provisions of Article VII (Business Profits) 
will apply and the source State will retain the right to impose 
tax on such interest income.

Paragraph 4 of Article XI

    Paragraph 4 is in all material respects the same as 
paragraph 6 of Article XI of the existing Convention. The only 
difference is that, consistent with the changes described below 
with respect to Article 9 of the Protocol, paragraph 4 does not 
contain references to a fixed base.
    Paragraph 4 establishes the source of interest for purposes 
of Article XI. Interest is considered to arise in a Contracting 
State if the payer is that State, or a political subdivision, 
local authority, or resident of that State. However, in cases 
where the person paying the interest, whether a resident of a 
Contracting State or of a third State, has in a State other 
than that of which he is a resident a permanent establishment 
in connection with which the indebtedness on which the interest 
was paid was incurred, and such interest is borne by the 
permanent establishment, then such interest is deemed to arise 
in the State in which the permanent establishment is situated 
and not in the State of the payer's residence. Furthermore, 
pursuant to paragraphs 1 and 4, and Article XXII (Other 
Income), Canadian tax will not be imposed on interest paid to a 
U.S. resident by a company resident in Canada if the 
indebtedness is incurred in connection with, and the interest 
is borne by, a permanent establishment of the company situated 
in a third State. For the purposes of this Article, ``borne 
by'' means allowable as a deduction in computing taxable 
income.

Paragraph 5 of Article XI

    Paragraph 5 is identical to paragraph 7 of Article XI of 
the existing Convention.
    Paragraph 5 provides that in cases involving special 
relationships between the payer and the beneficial owner of 
interest income or between both of them and some other person, 
Article XI applies only to that portion of the total interest 
payments that would have been made absent such special 
relationships (i.e., an arm's-length interest payment). Any 
excess amount of interest paid remains taxable according to the 
laws of the United States and Canada, respectively, with due 
regard to the other provisions of the Convention.
    New paragraph 6 provides anti-abuse exceptions to exclusive 
residence State taxation in paragraph 1 for two classes of 
interest payments.
    The first class of interest, dealt with in subparagraphs 
6(a) and 6(b), is so-called ``contingent interest.'' With 
respect to interest arising in the United States, subparagraph 
6(a) refers to contingent interest of a type that does not 
qualify as portfolio interest under U.S. domestic law. The 
cross-reference to the U.S. definition of contingent interest, 
which is found in Code section 871(h)(4), is intended to ensure 
that the exceptions of Code section 871 (h)(4)(C) will apply. 
With respect to Canada, such interest is defined in 
subparagraph 6(b) as any interest arising in Canada that is 
determined by reference to the receipts, sales, income, profits 
or other cash flow of the debtor or a related person, to any 
change in the value of any property of the debtor or a related 
person or to any dividend, partnership distribution or similar 
payment made by the debtor or a related person.1 Any such 
interest may be taxed in Canada according to the laws of 
Canada.
    Under subparagraph 6(a) or 6(b), if the beneficial owner is 
a resident of the other Contracting State, the gross amount of 
the ``contingent interest'' may be taxed at a rate not 
exceeding 15 percent.
    The second class of interest is dealt with in subparagraph 
6(c). This exception is consistent with the policy of Code 
sections 860E(e) and 860G(b) that excess inclusions with 
respect to a real estate mortgage investment conduit (REMIC) 
should bear full U.S. tax in all cases. Without a full tax at 
source, foreign purchasers of residual interests would have a 
competitive advantage over U.S. purchasers at the time these 
interests are initially offered. Also, absent this rule, the 
U.S. fisc would suffer a revenue loss with respect to mortgages 
held in a REMIC because of opportunities for tax avoidance 
created by differences in the timing of taxable and economic 
income produced by these interests.
    Therefore, subparagraph 6(c) provides a bilateral provision 
that interest that is an excess inclusion with respect to a 
residual interest in a REMIC may be taxed by each State in 
accordance with its domestic law. While the provision is 
written reciprocally, at the time the Protocol was signed, the 
provision had no application in respect of Canadian-source 
interest, as Canada did not have REMICs.

Paragraph 7 of Article XI

    Paragraph 7 is in all material respects the same as 
paragraph 8 of Article XI of the existing Convention. The only 
difference is that, consistent with the changes made in Article 
9 of the Protocol, paragraph 7 removes the references to a 
fixed base.
    Paragraph 7 restricts the right of a Contracting State to 
impose tax on interest paid by a resident of the other 
Contracting State. The first State may not impose any tax on 
such interest except insofar as the interest is paid to a 
resident of that State or arises in that State or the debt 
claim in respect of which the interest is paid is effectively 
connected with a permanent establishment situated in that 
State.
    1 New subparagraph 6(b) of Article XI erroneously refers to 
a ``similar payment made by the debtor to a related person.'' 
The correct formulation, which the Contracting States agree to 
apply, is ``similar payment made by the debtor or a related 
person.''

Relationship to other Articles

    Notwithstanding the foregoing limitations on source State 
taxation of interest, the saving clause of paragraph 2 of 
Article XXIX (Miscellaneous Rules) permits the United States to 
tax its residents and citizens, subject to the special foreign 
tax credit rules of paragraph 5 of Article XXIV (Elimination of 
Double Taxation), as if the Convention had not come into force.

                               ARTICLE 7

    Article 7 of the Protocol amends Article XII (Royalties) of 
the existing Convention. As with other benefits of the 
Convention, the benefits of Article XII are available to a 
resident of a Contracting State only if that resident is 
entitled to those benefits under the provisions of Article XXIX 
A (Limitation on Benefits).
     See the Technical Explanation for new paragraphs 6 and 7 
of Article IV (Residence) for discussion regarding the 
interaction between domestic law concepts of beneficial 
ownership and the treaty rules to determine when a person is 
considered to derive an item of income for purposes of 
obtaining benefits of the Convention such as withholding rate 
reductions.

Paragraph 1

    Paragraph 1 of Article 7 of the Protocol replaces paragraph 
5 of Article XII of the Convention. In all material respects, 
new paragraph 5 is the same as paragraph 5 of Article XII of 
the existing Convention. However, new paragraph 5 adds 
clarifying language consistent with the changes made in 
Articles 4, 5, and 6 of the Protocol with respect to income 
attributable to a permanent establishment that has ceased to 
exist. To conform with Article 9 of the Protocol, which deletes 
Article XIV (Independent Personal Services) of the Convention, 
paragraph 1 of Article 7 of the Protocol also amends paragraph 
5 of Article XII by omitting the reference to a ``fixed base.''
    New paragraph 5 provides that the 10 percent limitation on 
tax in the source State provided by paragraph 2, and the 
exemption in the source State for certain royalties provided by 
paragraph 3, do not apply if the beneficial owner of the 
royalties carries on or has carried on business in the source 
State through a permanent establishment and the right or 
property in respect of which the royalties are paid is 
attributable to such permanent establishment. In such case, the 
royalty income would be taxable by the source State under the 
provisions of Article VII (Business Profits).

Paragraph 2

    Paragraph 2 of Article 7 of the Protocol sets forth a new 
subparagraph 6(a) of Article XII that is in all material 
respects the same as subparagraph 6(a) of Article XII of the 
existing Convention. The only difference is that, consistent 
with the changes made in Article 9 of the Protocol, new 
subparagraph 6(a) omits references to a ``fixed base.''

Paragraph 3

    Paragraph 3 of Article 7 of Protocol amends paragraph 8 of 
Article XII of the Convention to remove references to a ``fixed 
base.'' In addition, paragraph 8 of the General Note confirms 
the intent of the Contracting States that the reference in 
subparagraph 3(c) of Article XII of the Convention to 
information provided in connection with a franchise agreement 
generally refers only to information that governs or otherwise 
deals with the operation (whether by the payer or by another 
person) of the franchise, and not to other information 
concerning industrial, commercial or scientific experience that 
is held for resale or license.

                               ARTICLE 8

Paragraph 1

    Paragraph 1 of Article 8 of the Protocol replaces paragraph 
2 of Article XIII (Gains) of the existing Convention. 
Consistent with Article 9 of the Protocol, new paragraph 2 does 
not contain any reference to property pertaining to a fixed 
base or to the performance of independent personal services.
    New paragraph 2 of Article XIII provides that the 
Contracting State in which a resident of the other Contracting 
State has or had a permanent establishment may tax gains from 
the alienation of personal property constituting business 
property if such gains are attributable to such permanent 
establishment. Unlike paragraph 1 of Article VII (Business 
Profits), paragraph 2 limits the right of the source State to 
tax such gains to a twelve-month period following the 
termination of the permanent establishment.

Paragraph 2

    Paragraph 2 of Article 8 of the Protocol replaces paragraph 
5 of Article XIII of the existing Convention. In general, new 
paragraph 5 provides an exception to the general rule stated in 
paragraph 4 that gains from the alienation of any property, 
other than property referred to in paragraphs 1, 2, and 3, 
shall be taxable only in the Contracting State of which the 
alienator is a resident. Paragraph 5 provides that a 
Contracting State may, according to its domestic law, impose 
tax on gains derived by an individual who is a resident of the 
other Contracting State if such individual was a resident of 
the first-mentioned State for 120 months (whether or not 
consecutive) during any period of 20 consecutive years 
preceding the alienation of the property, and was a resident of 
that State at any time during the 10-year period immediately 
preceding the alienation of the property. Further, the property 
(or property received in substitution in a tax-free transaction 
in the first-mentioned State) must have been owned by the 
individual at the time he ceased to be a resident of the first-
mentioned State and must not have been property that the 
individual was treated as having alienated by reason of ceasing 
to be a resident of the first-mentioned State and becoming a 
resident of the other Contracting State.
    The provisions of new paragraph 5 are substantially similar 
to paragraph 5 of Article XIII of the existing Convention. 
However, the Protocol adds a new requirement to paragraph 5 
that the property not be ``a property that the individual was 
treated as having alienated by reason of ceasing to be a 
resident of the first-mentioned State and becoming a resident 
of the other Contracting State.'' This new requirement reflects 
the fact that the main purpose of paragraph 5--ensuring that 
gains that accrue while an individual is resident in a 
Contracting State remain taxable for the stated time after the 
individual has moved to the other State--is met if that pre-
departure gain is taxed in the first State immediately before 
the individual's emigration. This rule applies whether or not 
the individual makes the election provided by paragraph 7 of 
Article XIII, as amended, which is described below.

Paragraph 3

    Paragraph 3 of Article 8 of the Protocol replaces paragraph 
7 of Article XIII.
    The purpose of paragraph 7, in both its former and revised 
form, is to provide a rule to coordinate U.S. and Canadian 
taxation of gains in the case of a timing mismatch. Such a 
mismatch may occur, for example, where a Canadian resident is 
deemed, for Canadian tax purposes, to recognize capital gain 
upon emigrating from Canada to the United States, or in the 
case of a gift that Canada deems to be an income producing 
event for its tax purposes but with respect to which the United 
States defers taxation while assigning the donor's basis to the 
donee. The former paragraph 7 resolved the timing mismatch of 
taxable events by allowing the individual to elect to be liable 
to tax in the deferring Contracting State as if he had sold and 
repurchased the property for an amount equal to its fair market 
value at a time immediately prior to the deemed alienation.
    The election under former paragraph 7 was not available to 
certain non-U.S. citizens subject to tax in Canada by virtue of 
a deemed alienation because such individuals could not elect to 
be liable to tax in the United States. To address this problem, 
the Protocol replaces the election provided in former paragraph 
7, with an election by the taxpayer to be treated by a 
Contracting State as having sold and repurchased the property 
for its fair market value immediately before the taxable event 
in the other Contracting State. The election in new paragraph 7 
therefore will be available to any individual who emigrates 
from Canada to the United States, without regard to whether the 
person is a U.S. citizen immediately before ceasing to be a 
resident of Canada. If the individual is not subject to U.S. 
tax at that time, the effect of the election will be to give 
the individual an adjusted basis for U.S. tax purposes equal to 
the fair market value of the property as of the date of the 
deemed alienation in Canada, with the result that only post-
emigration gain will be subject to U.S. tax when there is an 
actual alienation. If the Canadian resident is also a U.S. 
citizen at the time of his emigration from Canada, then the 
provisions of new paragraph 7 would allow the U.S. citizen to 
accelerate the tax under U.S. tax law and allow tax credits to 
be used to avoid double taxation. This would also be the case 
if the person, while not a U.S. citizen, would otherwise be 
subject to taxation in the United States on a disposition of 
the property.
    In the case of Canadian taxation of appreciated property 
given as a gift, absent paragraph 7, the donor could be subject 
to tax in Canada upon making the gift, and the donee may be 
subject to tax in the United States upon a later disposition of 
the property on all or a portion of the same gain in the 
property without the availability of any foreign tax credit for 
the tax paid to Canada. Under new paragraph 7, the election 
will be available to any individual who pays taxes in Canada on 
a gain arising from the individual's gifting of a property, 
without regard to whether the person is a U.S. taxpayer at the 
time of the gift. The effect of the election in such case will 
be to give the donee an adjusted basis for U.S. tax purposes 
equal to the fair market value as of the date of the gift. If 
the donor is a U.S. taxpayer, the effect of the election will 
be the realization of gain or loss for U.S. purposes 
immediately before the gift. The acceleration of the U.S. tax 
liability by reason of the election in such case enables the 
donor to utilize foreign tax credits and avoid double taxation 
with respect to the disposition of the property.
    Generally, the rule does not apply in the case of death. 
Note, however, that Article XXIX B (Taxes Imposed by Reason of 
Death) of the Convention provides rules that coordinate the 
income tax that Canada imposes by reason of death with the U.S. 
estate tax.
    If in one Contracting State there are losses and gains from 
deemed alienations of different properties, then paragraph 7 
must be applied consistently in the other Contracting State 
within the taxable period with respect to all such properties. 
Paragraph 7 only applies, however, if the deemed alienations of 
the properties result in a net gain.
    Taxpayers may make the election provided by new paragraph 7 
only with respect to property that is subject to a Contracting 
State's deemed disposition rules and with respect to which gain 
on a deemed alienation is recognized for that Contracting 
State's tax purposes in the taxable year of the deemed 
alienation. At the time the Protocol was signed, the following 
were the main types of property that were excluded from the 
deemed disposition rules in the case of individuals (including 
trusts) who cease to be residents of Canada: real property 
situated in Canada; interests and rights in respect of 
pensions; life insurance policies (other than segregated fund 
(investment) policies); rights in respect of annuities; 
interests in testamentary trusts, unless acquired for 
consideration; employee stock options; property used in a 
business carried on through a permanent establishment in Canada 
(including intangibles and inventory); interests in most 
Canadian personal trusts; Canadian resource property; and 
timber resource property.

Paragraph 4

    Consistent with the provisions of Article 9 of the 
Protocol, paragraph 4 of Article 8 of the Protocol amends 
subparagraph 9(c) of Article XIII of the existing Convention to 
remove the words ``or pertained to a fixed base.''

Relationship to other Articles

    The changes to Article XIII set forth in paragraph 3 were 
announced in a press release issued by the Treasury Department 
on September 18, 2000. Consistent with that press release, 
subparagraph 3(e) of Article 27 of the Protocol provides that 
the changes, jointly effectuated by paragraphs 2 and 3, will be 
generally effective for alienations of property that occur 
after September 17, 2000.

                               ARTICLE 9

    To conform with the current U.S. and OECD Model 
Conventions, Article 9 of the Protocol deletes Article XIV 
(Independent Personal Services) of the Convention. The 
subsequent articles of the Convention are not renumbered. 
Paragraph 4 of the General Note elaborates that current tax 
treaty practice omits separate articles for independent 
personal services because a determination of the existence of a 
fixed base is qualitatively the same as the determination of 
the existence of a permanent establishment. Accordingly, the 
taxation of income from independent personal services is 
adequately governed by the provisions of Articles V (Permanent 
Establishment) and VII (Business Profits).

                               ARTICLE 10

    Article 10 of the Protocol renames Article XV of the 
Convention as ``Income from Employment'' to conform with the 
current U.S. and OECD Model Conventions, and replaces 
paragraphs 1 and 2 of that renamed article consistent with the 
OECD Model Convention.

Paragraph 1

    New paragraph 1 of Article XV provides that, in general, 
salaries, wages, and other remuneration derived by a resident 
of a Contracting State in respect of an employment are taxable 
only in that State unless the employment is exercised in the 
other Contracting State. If the employment is exercised in the 
other Contracting State, the entire remuneration derived 
therefrom may be taxed in that other State, subject to the 
provisions of paragraph 2.
    New paragraph 1 of Article XV does not contain a reference 
to ``similar'' remuneration. This change was intended to 
clarify that Article XV applies to any form of compensation for 
employment, including payments in kind. This interpretation is 
consistent with paragraph 2.1 of the Commentary to Article 15 
(Income from Employment) of the OECD Model and the Technical 
Explanation of the 2006 U.S. Model.

Paragraph 2

    New paragraph 2 of Article XV provides two limitations on 
the right of a source State to tax remuneration for services 
rendered in that State. New paragraph 2 is divided into two 
subparagraphs that each sets forth a rule which, 
notwithstanding any contrary result due to the application of 
paragraph 1 of Article XV, prevents the source State from 
taxing income from employment in that State.
    First, subparagraph 2(a) provides a safe harbor rule that 
the remuneration may not be taxed in the source State if such 
remuneration is $10,000 or less in the currency of the source 
State. This rule is identical to the rule in subparagraph 2(a) 
of Article XV of the existing Convention. It is understood 
that, consistent with the prior rule, the safe harbor will 
apply on a calendar-year basis.
    Second, if the remuneration is not exempt from tax in the 
source State by virtue of subparagraph 2(a), subparagraph 2(b) 
provides an additional rule that the source State may not tax 
remuneration for services rendered in that State if the 
recipient is present in the source State for a period (or 
periods) that does not exceed in the aggregate 183 days in any 
twelve-month period commencing or ending in the fiscal year 
concerned, and the remuneration is not paid by or on behalf of 
a person who is a resident of that other State or borne by a 
permanent establishment in that other State. For purposes of 
this article, ``borne by'' means allowable as a deduction in 
computing taxable income.
    Assume, for example, that Mr. X, an individual resident in 
Canada, is an employee of the Canadian permanent establishment 
of USCo, a U.S. company. Mr. X is sent to the United States to 
perform services and is present in the United States for less 
than 183 days. Mr. X receives more than $10,000 (U.S.) in the 
calendar year(s) in question. The remuneration paid to Mr. X 
for such services is not exempt from U.S. tax under paragraph 
1, because his employer, USCo, is a resident of the United 
States and pays his remuneration. If instead Mr. X received 
less than $10,000 (U.S.), such earnings would be exempt from 
tax in the United States, because in all cases where an 
employee earns less than $10,000 in the currency of the source 
State, such earnings are exempt from tax in the source State.
    As another example, assume Ms. Y, an individual resident in 
the United States is employed by USCo, a U.S. company. Ms. Y is 
sent to Canada to provide services in the Canadian permanent 
establishment of USCo. Ms. Y is present in Canada for less than 
183 days. Ms. Y receives more than $10,000 (Canadian) in the 
calendar year(s) in question. USCo charges the Canadian 
permanent establishment for Ms. Y's remuneration, which the 
permanent establishment takes as a deduction in computing its 
taxable income. The remuneration paid to Ms. Y for such 
services is not exempt from Canadian tax under paragraph 1, 
because her remuneration is borne by the Canadian permanent 
establishment.
    New subparagraph 2(b) refers to remuneration that is paid 
by or on behalf of a ``person'' who is a resident of the other 
Contracting State, as opposed to an ``employer.'' This change 
is intended only to clarify that both the United States and 
Canada understand that in certain abusive cases, substance over 
form principles may be applied to recharacterize an employment 
relationship, as prescribed in paragraph 8 of the Commentary to 
Article 15 (Income from Employment) of the OECD Model. 
Subparagraph 2(b) is intended to have the same meaning as the 
analogous provisions in the U.S. and OECD Models.

Paragraph 6 of the General Note

    Paragraph 6 of the General Note contains special rules 
regarding employee stock options. There are no similar rules in 
the U.S. Model or the OECD Model, although the issue is 
discussed in detail in paragraph 12 of the Commentary to 
Article 15 (Income from Employment) of the OECD Model.
    The General Note sets forth principles that apply for 
purposes of applying Article XV and Article XXIV (Elimination 
of Double Taxation) to income of an individual in connection 
with the exercise or other disposal (including a deemed 
exercise or disposal) of an option that was granted to the 
individual as an employee of a corporation or mutual fund trust 
to acquire shares or units (``securities'') of the employer in 
respect of services rendered or to be rendered by such 
individual, or in connection with the disposal (including a 
deemed disposal) of a security acquired under such an option. 
For this purpose, the term ``employer'' is considered to 
include any entity related to the service recipient. The 
reference to a disposal (or deemed disposal) reflects the fact 
that under Canadian law and under certain provisions of U.S. 
law, income or gain attributable to the granting or exercising 
of the option may, in some cases, not be recognized until 
disposition of the securities.
    Subparagraph 6(a) of the General Note provides a specific 
rule to address situations where, under the domestic law of the 
Contracting States, an employee would be taxable by both 
Contracting States in respect of the income in connection with 
the exercise or disposal of the option. The rule provides an 
allocation of taxing rights where (1) an employee has been 
granted a stock option in the course of employment in one of 
the Contracting States, and (2) his principal place of 
employment has been situated in one or both of the Contracting 
States during the period between grant and exercise (or 
disposal) of the option. In this situation, each Contracting 
State may tax as Contracting State of source only that 
proportion of the income that relates to the period or periods 
between the grant and the exercise (or disposal) of the option 
during which the individual's principal place of employment was 
situated in that Contracting State. The proportion attributable 
to a Contracting State is determined by multiplying the income 
by a fraction, the numerator of which is the number of days 
between the grant and exercise (or disposal) of the option 
during which the employee's principal place of employment was 
situated in that Contracting State and the denominator of which 
is the total number of days between grant and exercise (or 
disposal) of the option that the employee was employed by the 
employer.
    If the individual is a resident of one of the Contracting 
States at the time he exercises the option, that Contracting 
State will have the right, as the State of residence, to tax 
all of the income under the first sentence of paragraph 1 of 
Article XV. However, to the extent that the employee renders 
his employment in the other Contracting State for some period 
of time between the date of the grant of the option and the 
date of the exercise (or disposal) of the option, the 
proportion of the income that is allocated to the other 
Contracting State under subparagraph 6(a) of the General Note 
will, subject to paragraph 2, be taxable by that other State 
under the second sentence of paragraph 1 of Article XV of the 
Convention. For this purpose, the tests of paragraph 2 of 
Article XV are applied to the year or years in which the 
relevant services were performed in the other Contracting State 
(and not to the year in which the option is exercised or 
disposed). To the extent the same income is subject to taxation 
in both Contracting States after application of Article XV, 
double taxation will be alleviated under the rules of Article 
XXIV (Elimination of Double Taxation).
    Subparagraph 6(b) of the General Note provides that 
notwithstanding subparagraph 6(a), if the competent authorities 
of both Contracting States agree that the terms of the option 
were such that the grant of the option is appropriately treated 
as transfer of ownership of the securities (e.g., because the 
options were in-the-money or not subject to a substantial 
vesting period), then they may agree to attribute income 
accordingly.

                               ARTICLE 11

    Consistent with Article 9 and paragraph 1 of Article 10 of 
the Protocol, paragraphs 1, 2, and 3 of Article 11 of the 
Protocol revise paragraphs 1, 2, and 4 of Article XVI (Artistes 
and Athletes) of the existing Convention by deleting references 
to former Article XIV (Independent Personal Services) of the 
Convention and deleting and replacing other language in 
acknowledgement of the renaming of Article XV (Income from 
Employment).

                               ARTICLE 12

    Article 12 of the Protocol deletes Article XVII 
(Withholding of Taxes in Respect of Personal Services) from the 
Convention. However, the subsequent Articles are not 
renumbered.

                               ARTICLE 13

    Article 13 of the Protocol replaces paragraphs 3, 4, and 7 
and adds paragraphs 8 through 17 to Article XVIII (Pensions and 
Annuities) of the Convention.

Paragraph 1--Roth IRAs

    Paragraph 1 of Article 13 of the Protocol separates the 
provisions of paragraph 3 of Article XVIII into two 
subparagraphs. Subparagraph 3(a) contains the existing 
definition of the term ``pensions,'' while subparagraph 3(b) 
adds a new rule to address the treatment of Roth IRAs or 
similar plan (as described below).
    Subparagraph 3(a) of Article XVIII provides that the term 
``pensions'' for purposes of the Convention includes any 
payment under a superannuation, pension, or other retirement 
arrangement, Armed-Forces retirement pay, war veterans pensions 
and allowances, and amounts paid under a sickness, accident, or 
disability plan, but does not include payments under an income-
averaging annuity contract (which are subject to Article XXII 
(Other Income)) or social security benefits, including social 
security benefits in respect of government services (which are 
subject to paragraph 5 of Article XVIII). Thus, the term 
``pensions'' includes pensions paid by private employers 
(including pre-tax and Roth 401(k) arrangements) as well as any 
pension paid in respect of government services. Further, the 
definition of ``pensions'' includes, for example, payments from 
individual retirement accounts (IRAs) in the United States and 
from registered retirement savings plans (RRSPs) and registered 
retirement income funds (RRIFs) in Canada.
    Subparagraph 3(b) of Article XVIII provides that the term 
``pensions'' generally includes a Roth IRA, within the meaning 
of Code section 408A (or a similar plan described below). 
Consequently, under paragraph 1 of Article XVIII, distributions 
from a Roth IRA to a resident of Canada generally continue to 
be exempt from Canadian tax to the extent they would have been 
exempt from U.S. tax if paid to a resident of the United 
States. In addition, residents of Canada generally may make an 
election under paragraph 7 of Article XVIII to defer any 
taxation in Canada with respect to income accrued in a Roth IRA 
but not distributed by the Roth IRA, until such time as and to 
the extent that a distribution is made from the Roth IRA or any 
plan substituted therefore. Because distributions will be 
exempt from Canadian tax to the extent they would have been 
exempt from U.S. tax if paid to a resident of the United 
States, the effect of these rules is that, in most cases, no 
portion of the Roth IRA will be subject to taxation in Canada.
    However, subparagraph 3(b) also provides that if an 
individual who is a resident of Canada makes contributions to 
his or her Roth IRA while a resident of Canada, other than 
rollover contributions from another Roth IRA (or a similar plan 
described below), the Roth IRA will cease to be considered a 
pension at that time with respect to contributions and 
accretions from such time and accretions from such time will be 
subject to tax in Canada in the year of accrual. Thus, the Roth 
IRA will in effect be bifurcated into a ``frozen'' pension that 
continues to be subject to the rules of Article XVIII and a 
savings account that is not subject to the rules of Article 
XVIII. It is understood by the Contracting States that, 
following a rollover contribution from a Roth 401(k) 
arrangement to a Roth IRA, the Roth IRA will continue to be 
treated as a pension subject to the rules of Article XVIII.
    Assume, for example, that Mr. X moves to Canada on July 1, 
2008. Mr. X has a Roth IRA with a balance of 1,100 on July 1, 
2008. Mr. X elects under paragraph 7 of Article XVIII to defer 
any taxation in Canada with respect to income accrued in his 
Roth IRA while he is a resident of Canada. Mr. X makes no 
additional contributions to his Roth IRA until July 1, 2010, 
when he makes an after-tax contribution of 100. There are 
accretions of 20 during the period July 1, 2008 through June 
30, 2010, which are not taxed in Canada by reason of the 
election under paragraph 7 of Article XVIII. There are 
additional accretions of 50 during the period July 1, 2010 
through June 30, 2015, which are subject to tax in Canada in 
the year of accrual. On July 1, 2015, while Mr. X is still a 
resident of Canada, Mr. X receives a lump-sum distribution of 
1,270 from his Roth IRA. The 1,120 that was in the Roth IRA on 
June 30, 2010 is treated as a distribution from a pension plan 
that, pursuant to paragraph 1 of Article XVIII, is exempt from 
tax in Canada provided it would be exempt from tax in the 
United States under the Internal Revenue Code if paid to a 
resident of the United States. The remaining 150 comprises the 
after-tax contribution of 100 in 2010 and accretions of 50 that 
were subject to Canadian tax in the year of accrual.
    The rules of new subparagraph 3(b) of Article XVIII also 
will apply to any plan or arrangement created pursuant to 
legislation enacted by either Contracting State after September 
21, 2007 (the date of signature of the Protocol) that the 
competent authorities agree is similar to a Roth IRA.
    Source of payments under life insurance and annuity 
contracts
    Paragraph 1 of Article 13 also replaces paragraph 4 of 
Article XVIII. Subparagraph 4(a) contains the existing 
definition of annuity, while subparagraph 4(b) adds a source 
rule to address the treatment of certain payments by branches 
of insurance companies.
    Subparagraph 4(a) provides that, for purposes of the 
Convention, the term ``annuity'' means a stated sum paid 
periodically at stated times during life or during a specified 
number of years, under an obligation to make the payments in 
return for adequate and full consideration other than services 
rendered. The term does not include a payment that is not 
periodic or any annuity the cost of which was deductible for 
tax purposes in the Contracting State where the annuity was 
acquired. Items excluded from the definition of ``annuity'' and 
not dealt with under another Article of the Convention are 
subject to the rules of Article XXII (Other Income).
    Under the existing Convention, payments under life 
insurance and annuity contracts to a resident of Canada by a 
Canadian branch of a U.S. insurance company are subject to 
either a 15-percent withholding tax under subparagraph 2(b) of 
Article XVIII or, unless dealt with under another Article of 
the Convention, an unreduced 30-percent withholding tax under 
paragraph 1 of Article XXII, depending on whether the payments 
constitute annuities within the meaning of paragraph 4 of 
Article XVIII.
    On July 12, 2004, the Internal Revenue Service issued 
Revenue Ruling 2004-75, 2004-2 C.B. 109, which provides in 
relevant part that annuity payments under, and withdrawals of 
cash value from, life insurance or annuity contracts issued by 
a foreign branch of a U.S. life insurance company are U.S.-
source income that, when paid to a nonresident alien 
individual, is generally subject to a 30-percent withholding 
tax under Code sections 871(a) and 1441. Revenue Ruling 2004-
97, 2004-2 C.B. 516, provided that Revenue Ruling 2004-75 would 
not be applied to payments that were made before January 1, 
2005, provided that such payments were made pursuant to binding 
life insurance or annuity contracts issued on or before July 
12, 2004.
    Under new subparagraph 4(b) of Article XVIII, an annuity or 
other amount paid in respect of a life insurance or annuity 
contract (including a withdrawal in respect of the cash value 
thereof), will generally be deemed to arise in the Contracting 
State where the person paying the annuity or other amount (the 
``payer'') is resident. However, if the payer, whether a 
resident of a Contracting State or not, has a permanent 
establishment in a Contracting State other than a Contracting 
State in which the payer is a resident, the payment will be 
deemed to arise in the Contracting State in which the permanent 
establishment is situated if both of the following requirements 
are satisfied: (i) the obligation giving rise to the annuity or 
other amount must have been incurred in connection with the 
permanent establishment, and (ii) the annuity or other amount 
must be borne by the permanent establishment. When these 
requirements are satisfied, payments by a Canadian branch of a 
U.S. insurance company will be deemed to arise in Canada.

Paragraph 2

    Paragraph 2 of Article 13 of the Protocol replaces 
paragraph 7 of Article XVIII of the existing Convention. 
Paragraph 7 continues to provide a rule with respect to the 
taxation of a natural person on income accrued in a pension or 
employee benefit plan in the other Contracting State. Thus, 
paragraph 7 applies where an individual is a citizen or 
resident of a Contracting State and is a beneficiary of a 
trust, company, organization, or other arrangement that is a 
resident of the other Contracting State, where such trust, 
company, organization, or other arrangement is generally exempt 
from income taxation in that other State, and is operated 
exclusively to provide pension, or employee benefits. In such 
cases, the beneficiary may elect to defer taxation in his State 
of residence on income accrued in the plan until it is 
distributed from the plan (or from another plan in that other 
Contracting State to which the income is transferred pursuant 
to the domestic law of that other Contracting State).
    Paragraph 2 of Article 13 of the Protocol makes two changes 
to paragraph 7 of Article XVIII of the existing Convention. The 
first change is that the phrase ``pension, retirement or 
employee benefits'' is changed to ``pension or employee 
benefits'' solely to reflect the fact that in certain cases, 
discussed above, Roth IRAs will not be treated as pensions for 
purposes of Article XVIII. The second change is that ``under'' 
is changed to ``subject to'' to make it clear that an election 
to defer taxation with respect to undistributed income accrued 
in a plan may be made whether or not the competent authority of 
the first-mentioned State has prescribed rules for making an 
election. For the U.S. rules, see Revenue Procedure 2002-23, 
2002-1 C.B. 744. As of the date the Protocol was signed, the 
competent authority of Canada had not prescribed rules.

Paragraph 3

    Paragraph 3 of Article 13 of the Protocol adds paragraphs 8 
through 17 to Article XVIII to deal with cross-border pension 
contributions. These paragraphs are intended to remove barriers 
to the flow of personal services between the Contracting States 
that could otherwise result from discontinuities in the laws of 
the Contracting States regarding the deductibility of pension 
contributions. Such discontinuities may arise where a country 
allows deductions or exclusions to its residents for 
contributions, made by them or on their behalf, to resident 
pension plans, but does not allow deductions or exclusions for 
payments made to plans resident in another country, even if the 
structure and legal requirements of such plans in the two 
countries are similar.
    There is no comparable set of rules in the OECD Model, 
although the issue is discussed in detail in the Commentary to 
Article 18 (Pensions). The 2006 U.S. Model deals with this 
issue in paragraphs 2 through 4 of Article 18 (Pension Funds).

Workers on short-term assignments in the other Contracting State

    Paragraphs 8 and 9 of Article XVIII address the case of a 
short-term assignment where an individual who is participating 
in a ``qualifying retirement plan'' (as defined in paragraph 15 
of Article XVIII) in one Contracting State (the ``home State'') 
performs services as an employee for a limited period of time 
in the other Contracting State (the ``host State''). If certain 
requirements are satisfied, contributions made to, or benefits 
accrued under, the plan by or on behalf of the individual will 
be deductible or excludible in computing the individual's 
income in the host State. In addition, contributions made to 
the plan by the individual's employer will be allowed as a 
deduction in computing the employer's profits in the host 
State.
    In order for paragraph 8 to apply, the remuneration that 
the individual receives with respect to the services performed 
in the host State must be taxable in the host State. This 
means, for example, that where the United States is the host 
State, paragraph 8 would not apply if the remuneration that the 
individual receives with respect to the services performed in 
the United States is exempt from taxation in the United States 
under Code section 893.
    The individual also must have been participating in the 
plan, or in another similar plan for which the plan was 
substituted, immediately before he began performing services in 
the host State. The rule regarding a successor plan would apply 
if, for example, the employer has been acquired by another 
corporation that replaces the existing plan with its own plan, 
transferring membership in the old plan over into the new plan.
    In addition, the individual must not have been a resident 
(as determined under Article IV (Residence)) of the host State 
immediately before he began performing services in the host 
State. It is irrelevant for purposes of paragraph 8 whether the 
individual becomes a resident of the host State while he 
performs services there. A citizen of the United States who has 
been a resident of Canada may be entitled to benefits under 
paragraph 8 if (a) he performs services in the United States 
for a limited period of time and (b) he was a resident of 
Canada immediately before he began performing such services.
    Benefits are available under paragraph 8 only for so long 
as the individual has not performed services in the host State 
for the same employer (or a related employer) for more than 60 
of the 120 months preceding the individual's current taxable 
year. The purpose of this rule is to limit the period of time 
for which the host State will be required to provide benefits 
for contributions to a plan from which it is unlikely to be 
able to tax the distributions. If the individual continues to 
perform services in the host State beyond this time limit, he 
is expected to become a participant in a plan in the host 
State. Canada's domestic law provides preferential tax 
treatment for employer contributions to foreign pension plans 
in respect of services rendered in Canada by short-term 
residents, but such treatment ceases once the individual has 
been resident in Canada for at least 60 of the preceding 72 
months.
    The contributions and benefits must be attributable to 
services performed by the individual in the host State, and 
must be made or accrued during the period in which the 
individual performs those services. This rule prevents 
individuals who render services in the host State for a very 
short period of time from making disproportionately large 
contributions to home State plans in order to offset the tax 
liability associated with the income earned in the host State. 
In the case where the United States is the host State, 
contributions will be deemed to have been made on the last day 
of the preceding taxable year if the payment is on account of 
such taxable year and is treated under U.S. law as a 
contribution made on the last day of the preceding taxable 
year.
    If an individual receives benefits in the host State with 
respect to contributions to a plan in the home State, the 
services to which the contributions relate may not be taken 
into account for purposes of determining the individual's 
entitlement to benefits under any trust, company, organization, 
or other arrangement that is a resident of the host State, 
generally exempt from income taxation in that State and 
operated to provide pension or retirement benefits. The purpose 
of this rule is to prevent double benefits for contributions to 
both a home State plan and a host State plan with respect to 
the same services. Thus, for example, an individual who is 
working temporarily in the United States and making 
contributions to a qualifying retirement plan in Canada with 
respect to services performed in the United States may not make 
contributions to an individual retirement account (within the 
meaning of Code section 40 8(a)) in the United States with 
respect to the same services.
    Paragraph 8 states that it applies only to the extent that 
the contributions or benefits would qualify for tax relief in 
the home State if the individual were a resident of and 
performed services in that State. Thus, benefits would be 
limited in the same fashion as if the individual continued to 
be a resident of the home State. However, paragraph 9 provides 
that if the host State is the United States and the individual 
is a citizen of the United States, the benefits granted to the 
individual under paragraph 8 may not exceed the benefits that 
would be allowed by the United States to its residents for 
contributions to, or benefits otherwise accrued under, a 
generally corresponding pension or retirement plan established 
in and recognized for tax purposes by the United States. Thus, 
the lower of the two limits applies. This rule ensures that 
U.S. citizens working temporarily in the United States and 
participating in a Canadian plan will not get more favorable 
U.S. tax treatment than U.S. citizens participating in a U.S. 
plan.
    Where the United States is the home State, the amount of 
contributions that may be excluded from the employee's income 
under paragraph 8 for Canadian purposes is limited to the U.S. 
dollar amount specified in Code section 415 or the U.S. dollar 
amount specified in Code section 402(g)(1) to the extent 
contributions are made from the employee's compensation. For 
this purpose, the dollar limit specified in Code section 
402(g)(1) means the amount applicable under Code section 
402(g)(1) (including the age 50 catch-up amount in Code section 
402(g)(1)(C)) or, if applicable, the parallel dollar limit 
applicable under Code section 457(e)(15) plus the age 50 catch-
up amount under Code section 414(v)(2)(B)(i) for a Code section 
457(g) trust.
    Where Canada is the home State, the amount of contributions 
that may be excluded from the employee's income under paragraph 
8 for U.S. purposes is subject to the limitations specified in 
subsections 146(5), 147(8), 147.1(8) and (9) and 147.2(1) and 
(4) of the Income Tax Act and paragraph 8503(4)(a) of the 
Income Tax Regulations, as applicable. If the employee is a 
citizen of the United States, then the amount of contributions 
that may be excluded is the lesser of the amounts determined 
under the limitations specified in the previous sentence and 
the amounts specified in the previous paragraph.
    The provisions described above provide benefits to 
employees. Paragraph 8 also provides that contributions made to 
the home State plan by an individual's employer will be allowed 
as a deduction in computing the employer's profits in the host 
State, even though such a deduction might not be allowable 
under the domestic law of the host State. This rule applies 
whether the employer is a resident of the host State or a 
permanent establishment that the employer has in the host 
State. The rule also applies to contributions by a person 
related to the individual's employer, such as contributions by 
a parent corporation for its subsidiary, that are treated under 
the law of the host State as contributions by the individual's 
employer. For example, if an individual who is participating in 
a qualifying retirement plan in Canada performs services for a 
limited period of time in the United States for a U.S. 
subsidiary of a Canadian company, a contribution to the 
Canadian plan by the parent company in Canada that is treated 
under U.S. law as a contribution by the U.S. subsidiary would 
be covered by the rule.
    The amount of the allowable deduction is to be determined 
under the laws of the home State. Thus, where the United States 
is the home State, the amount of the deduction that is 
allowable in Canada will be subject to the limitations of Code 
section 404 (including the Code section 401(a)(17) and 415 
limitations). Where Canada is the home State, the amount of the 
deduction that is allowable in the United States is subject to 
the limitations specified in subsections 147(8), 147.1(8) and 
(9) and 147.2(1) of the Income Tax Act, as applicable.

Cross-border commuters

    Paragraphs 10, 11, and 12 of Article XVIII address the case 
of a commuter who is a resident of one Contracting State (the 
``residence State'') and performs services as an employee in 
the other Contracting State (the ``services State'') and is a 
member of a ``qualifying retirement plan'' (as defined in 
paragraph 15 of Article XVIII) in the services State. If 
certain requirements are satisfied, contributions made to, or 
benefits accrued under, the qualifying retirement plan by or on 
behalf of the individual will be deductible or excludible in 
computing the individual's income in the residence State.
    In order for paragraph 10 to apply, the individual must 
perform services as an employee in the services State the 
remuneration from which is taxable in the services State and is 
borne by either an employer who is a resident of the services 
State or by a permanent establishment that the employer has in 
the services State. The contributions and benefits must be 
attributable to those services and must be made or accrued 
during the period in which the individual performs those 
services. In the case where the United States is the residence 
State, contributions will be deemed to have been made on the 
last day of the preceding taxable year if the payment is on 
account of such taxable year and is treated under U.S. law as a 
contribution made on the last day of the preceding taxable 
year.
    Paragraph 10 states that it applies only to the extent that 
the contributions or benefits qualify for tax relief in the 
services State. Thus, the benefits granted in the residence 
State are available only to the extent that the contributions 
or benefits accrued qualify for relief in the services State. 
Where the United States is the services State, the amount of 
contributions that may be excluded under paragraph 10 is the 
U.S. dollar amount specified in Code section 415 or the U.S. 
dollar amount specified in Code section 402(g)(1) (as defined 
above) to the extent contributions are made from the employee's 
compensation. Where Canada is the services State, the amount of 
contributions that may be excluded from the employee's income 
under paragraph 10 is subject to the limitations specified in 
subsections 146(5), 147(8), 147.1(8) and (9) and 147.2(1) and 
(4) of the Income Tax Act and paragraph 8503(4)(a) of the 
Income Tax Regulations, as applicable.
    However, paragraphs 11 and 12 further provide that the 
benefits granted under paragraph 10 by the residence State may 
not exceed certain benefits that would be allowable under the 
domestic law of the residence State.
    Paragraph 11 provides that where Canada is the residence 
State, the amount of contributions otherwise allowable as a 
deduction under paragraph 10 may not exceed the individual's 
deduction limit for contributions to registered retirement 
savings plans (RRSPs) remaining after taking into account the 
amount of contributions to RRSPs deducted by the individual 
under the law of Canada for the year. The amount deducted by 
the individual under paragraph 10 will be taken into account in 
computing the individual's deduction limit for subsequent 
taxation years for contributions to RRSPs. This rule prevents 
double benefits for contributions to both an RRSP and a 
qualifying retirement plan in the United States with respect to 
the same services.
    Paragraph 12 provides that if the United States is the 
residence State, the benefits granted to an individual under 
paragraph 10 may not exceed the benefits that would be allowed 
by the United States to its residents for contributions to, or 
benefits otherwise accrued under, a generally corresponding 
pension or retirement plan established in and recognized for 
tax purposes by the United States. For purposes of determining 
an individual's eligibility to participate in and receive tax 
benefits with respect to a pension or retirement plan or other 
retirement arrangement in the United States, contributions made 
to, or benefits accrued under, a qualifying retirement plan in 
Canada by or on behalf of the individual are treated as 
contributions or benefits under a generally corresponding 
pension or retirement plan established in and recognized for 
tax purposes by the United States. Thus, for example, the 
qualifying retirement plan in Canada would be taken into 
account for purposes of determining whether the individual is 
an ``active participant'' within the meaning of Code section 21 
9(g)(5), with the result that the individual's ability to make 
deductible contributions to an individual retirement account in 
the United States would be limited.
    Paragraph 10 does not address employer deductions because 
the employer is located in the services State and is already 
eligible for deductions under the domestic law of the services 
State.

U.S. citizens resident in Canada

    Paragraphs 13 and 14 of Article XVIII address the special 
case of a U.S. citizen who is a resident of Canada (as 
determined under Article IV (Residence)) and who performs 
services as an employee in Canada and participates in a 
qualifying retirement plan (as defined in paragraph 15 of 
Article XVIII) in Canada. If certain requirements are 
satisfied, contributions made to, or benefits accrued under, a 
qualifying retirement plan in Canada by or on behalf of the 
U.S. citizen will be deductible or excludible in computing his 
or her taxable income in the United States. These provisions 
are generally consistent with paragraph 4 of Article 18 of the 
U.S. Model treaty.
    In order for paragraph 13 to apply, the U.S. citizen must 
perform services as an employee in Canada the remuneration from 
which is taxable in Canada and is borne by an employer who is a 
resident of Canada or by a permanent establishment that the 
employer has in Canada. The contributions and benefits must be 
attributable to those services and must be made or accrued 
during the period in which the U.S. citizen performs those 
services. Contributions will be deemed to have been made on the 
last day of the preceding taxable year if the payment is on 
account of such taxable year and is treated under U.S. law as a 
contribution made on the last day of the preceding taxable 
year.
    Paragraph 13 states that it applies only to the extent the 
contributions or benefits qualify for tax relief in Canada. 
However, paragraph 14 provides that the benefits granted under 
paragraph 13 may not exceed the benefits that would be allowed 
by the United States to its residents for contributions to, or 
benefits otherwise accrued under, a generally corresponding 
pension or retirement plan established in and recognized for 
tax purposes by the United States. Thus, the lower of the two 
limits applies. This rule ensures that a U.S. citizen living 
and working in Canada does not receive better U.S. treatment 
than a U.S. citizen living and working in the United States. 
The amount of contributions that may be excluded from the 
employee's income under paragraph 13 is the U.S. dollar amount 
specified in Code section 415 or the U.S. dollar amount 
specified in Code section 402(g)(1) (as defined above) to the 
extent contributions are made from the employee's compensation. 
In addition, pursuant to Code section 91 1(d)(6), an individual 
may not claim benefits under paragraph 13 with respect to 
services the remuneration for which is excluded from the 
individual's gross income under Code section 911(a).
    For purposes of determining the individual's eligibility to 
participate in and receive tax benefits with respect to a 
pension or retirement plan or other retirement arrangement 
established in and recognized for tax purposes by the United 
States, contributions made to, or benefits accrued under, a 
qualifying retirement plan in Canada by or on behalf of the 
individual are treated as contributions or benefits under a 
generally corresponding pension or retirement plan established 
in and recognized for tax purposes by the United States. Thus, 
for example, the qualifying retirement plan in Canada would be 
taken into account for purposes of determining whether the 
individual is an ``active participant'' within the meaning of 
Code section 21 9(g)(5), with the result that the individual's 
ability to make deductible contributions to an individual 
retirement account in the United States would be limited.
    Paragraph 13 does not address employer deductions because 
the employer is located in Canada and is already eligible for 
deductions under the domestic law of Canada.

Definition of ``qualifying retirement plan''

    Paragraph 15 of Article XVIII provides that for purposes of 
paragraphs 8 through 14, a ``qualifying retirement plan'' in a 
Contracting State is a trust, company, organization, or other 
arrangement that (a) is a resident of that State, generally 
exempt from income taxation in that State and operated 
primarily to provide pension or retirement benefits; (b) is not 
an individual arrangement in respect of which the individual's 
employer has no involvement; and (c) the competent authority of 
the other Contracting State agrees generally corresponds to a 
pension or retirement plan established in and recognized for 
tax purposes in that State. Thus, U.S. individual retirement 
accounts (IRAs) and Canadian registered retirement savings 
plans (RRSPs) are not treated as qualifying retirement plans 
unless addressed in paragraph 10 of the General Note (as 
discussed below). In addition, a Canadian retirement 
compensation arrangement (RCA) is not a qualifying retirement 
plan because it is not considered to be generally exempt from 
income taxation in Canada.
    Paragraph 10 of the General Note provides that the types of 
Canadian plans that constitute qualifying retirement plans for 
purposes of paragraph 15 include the following and any 
identical or substantially similar plan that is established 
pursuant to legislation introduced after the date of signature 
of the Protocol (September 21, 2007): registered pension plans 
under section 147.1 of the Income Tax Act, registered 
retirement savings plans under section 146 that are part of a 
group arrangement described in subsection 204.2(1.32), deferred 
profit sharing plans under section 147, and any registered 
retirement savings plan under section 146, or registered 
retirement income fund under section 146.3, that is funded 
exclusively by rollover contributions from one or more of the 
preceding plans.
    Paragraph 10 of the General Note also provides that the 
types of U.S. plans that constitute qualifying retirement plans 
for purposes of paragraph 15 include the following and any 
identical or substantially similar plan that is established 
pursuant to legislation introduced after the date of signature 
of the Protocol (September 21, 2007): qualified plans under 
Code section 401(a) (including Code section 401(k) 
arrangements), individual retirement plans that are part of a 
simplified employee pension plan that satisfies Code section 
408(k), Code section 408(p) simple retirement accounts, Code 
section 403(a) qualified annuity plans, Code section 403(b) 
plans, Code section 457(g) trusts providing benefits under Code 
section 457(b) plans, the Thrift Savings Fund (Code section 
7701(j)), and any individual retirement account under Code 
section 408(a) that is funded exclusively by rollover 
contributions from one or more of the preceding plans.
    If a particular plan in one Contracting State is of a type 
specified in paragraph 10 of the General Note with respect to 
paragraph 15 of Article XVIII, it will not be necessary for 
taxpayers to obtain a determination from the competent 
authority of the other Contracting State that the plan 
generally corresponds to a pension or retirement plan 
established in and recognized for tax purposes in that State. A 
taxpayer who believes a particular plan in one Contracting 
State that is not described in paragraph 10 of the General Note 
nevertheless satisfies the requirements of paragraph 15 may 
request a determination from the competent authority of the 
other Contracting State that the plan generally corresponds to 
a pension or retirement plan established in and recognized for 
tax purposes in that State. In the case of the United States, 
such a determination must be requested under Revenue Procedure 
2006-54, 2006-49 I.R.B. 655 (or any applicable analogous 
provision). In the case of Canada, the current version of 
Information Circular 71-17 provides guidance on obtaining 
assistance from the Canadian competent authority.

Source rule

    Paragraph 16 of Article XVIII provides that a distribution 
from a pension or retirement plan that is reasonably 
attributable to a contribution or benefit for which a benefit 
was allowed pursuant to paragraph 8, 10, or 13 of Article XVIII 
will be deemed to arise in the Contracting State in which the 
plan is established. This ensures that the Contracting State in 
which the plan is established will have the right to tax the 
gross amount of the distribution under subparagraph 2(a) of 
Article XVIII, even if a portion of the services to which the 
distribution relates were not performed in such Contracting 
State.

Partnerships

    Paragraph 17 of Article XVIII provides that paragraphs 8 
through 16 of Article XVIII apply, with such modifications as 
the circumstances require, as though the relationship between a 
partnership that carries on a business, and an individual who 
is a member of the partnership, were that of employer and 
employee. This rule is needed because paragraphs 8, 10, and 13, 
by their terms, apply only with respect to contributions made 
to, or benefits accrued under, qualifying retirement plans by 
or on behalf of individuals who perform services as an 
employee. Thus, benefits are not available with respect to 
retirement plans for self-employed individuals, who may be 
deemed under U.S. law to be employees for certain pension 
purposes. Paragraph 17 ensures that partners participating in a 
plan established by their partnership may be eligible for the 
benefits provided by paragraphs 8, 10, and 13.

Relationship to other Articles

    Paragraphs 8, 10, and 13 of Article XVIII are not subject 
to the saving clause of paragraph 2 of Article XXIX 
(Miscellaneous Rules) by reason of the exception in 
subparagraph 3(a) of Article XXIX.

                               ARTICLE 14

    Consistent with Articles 9 and 10 of the Protocol, Article 
14 of the Protocol amends Article XIX (Government Service) of 
the Convention by deleting the reference to ``Article XIV 
(Independent Personal Services)'' and replacing such reference 
with the reference to ``Article VII (Business Profits)'' and by 
reflecting the new name of Article XV (Income from Employment).

                               ARTICLE 15

    Article 15 of the Protocol replaces Article XX (Students) 
of the Convention. Article XX provides rules for host-country 
taxation of visiting students and business trainees. Persons 
who meet the tests of Article XX will be exempt from tax in the 
State that they are visiting with respect to designated classes 
of income. Several conditions must be satisfied in order for an 
individual to be entitled to the benefits of this Article.
    First, the visitor must have been, either at the time of 
his arrival in the host State or immediately before, a resident 
of the other Contracting State.
    Second, the purpose of the visit must be the full-time 
education or training of the visitor. Thus, if the visitor 
comes principally to work in the host State but also is a part-
time student, he would not be entitled to the benefits of this 
Article, even with respect to any payments he may receive from 
abroad for his maintenance or education, and regardless of 
whether or not he is in a degree program. Whether a student is 
to be considered full-time will be determined by the rules of 
the educational institution at which he is studying.
    The host State exemption in Article XX applies to payments 
received by the student or business trainee for the purpose of 
his maintenance, education or training that arise outside the 
host State. A payment will be considered to arise outside the 
host State if the payer is located outside the host State. 
Thus, if an employer from one of the Contracting States sends 
an employee to the other Contracting State for full-time 
training, the payments the trainee receives from abroad from 
his employer for his maintenance or training while he is 
present in the host State will be exempt from tax in the host 
State. Where appropriate, substance prevails over form in 
determining the identity of the payer. Thus, for example, 
payments made directly or indirectly by a U.S. person with whom 
the visitor is training, but which have been routed through a 
source outside the United States (e.g., a foreign subsidiary), 
are not treated as arising outside the United States for this 
purpose.
    In the case of an apprentice or business trainee, the 
benefits of Article XX will extend only for a period of one 
year from the time that the individual first arrives in the 
host country for the purpose of the individual's training. If, 
however, an apprentice or trainee remains in the host country 
for a second year, thus losing the benefits of the Arti-cle, he 
would not retroactively lose the benefits of the Article for 
the first year.

Relationship to other Articles

    The saving clause of paragraph 2 of Article XXIX 
(Miscellaneous Rules) does not apply to Article XX with respect 
to an individual who neither is a citizen of the host State nor 
has been admitted for permanent residence there. The saving 
clause, however, does apply with respect to citizens and 
permanent residents of the host State. Thus, a U.S. citizen who 
is a resident of Canada and who visits the United States as a 
full-time student at an accredited university will not be 
exempt from U.S. tax on remittances from abroad that otherwise 
constitute U.S. taxable income. However, an individual who is 
not a U.S. citizen, and who visits the United States as a 
student and remains long enough to become a resident under U.S. 
law, but does not become a permanent resident (i.e., does not 
acquire a green card), will be entitled to the full benefits of 
the Article.

                               ARTICLE 16

    Article 16 of the Protocol revises Article XXI (Exempt 
Organizations) of the existing Convention.

Paragraph 1

    Paragraph 1 amends Article XXI by renumbering paragraphs 4, 
5, and 6 as 5, 6, and 7, respectively.

Paragraph 2

    Paragraph 2 replaces paragraphs 1 through 3 of Article XXI 
with four new paragraphs. In general, the provisions of former 
paragraphs 1 through 3 have been retained.
    New paragraph 1 provides that a religious, scientific, 
literary, educational, or charitable organization resident in a 
Contracting State shall be exempt from tax on income arising in 
the other Contracting State but only to the extent that such 
income is exempt from taxation in the Contracting State in 
which the organization is resident.
    New paragraph 2 retains the provisions of former 
subparagraph 2(a), and provides that a trust, company, 
organization, or other arrangement that is resident in a 
Contracting State and operated exclusively to administer or 
provide pension, retirement or employee benefits or benefits 
for the self-employed under one or more funds or plans 
established to provide pension or retirement benefits or other 
employee benefits is exempt from taxation on dividend and 
interest income arising in the other Contracting State in a 
taxable year, if the income of such organization or other 
arrangement is generally exempt from taxation for that year in 
the Contracting State in which it is resident.
    New paragraph 3 replaces and expands the scope of former 
subparagraph 2(b) Former subparagraph 2(b) provided that, 
subject to the provisions of paragraph 3 (new paragraph 4), a 
trust, company, organization or other arrangement that was a 
resident of a Contracting State, generally exempt from income 
taxation in that State and operated exclusively to earn income 
for the benefit of one or more organizations described in 
subparagraph 2(a) (new paragraph 2) was exempt from taxation on 
dividend and interest income arising in the other Contracting 
State in a taxable year. The Internal Revenue Service concluded 
in private letter rulings (PLR 200111027 and PLR 200111037) 
that a pooled investment fund that included as investors one or 
more organizations described in paragraph 1 could not qualify 
for benefits under former subparagraph 2(b). New paragraph 3 
now allows organizations described in paragraph 1 to invest in 
pooled funds with trusts, companies, organizations, or other 
arrangements described in new paragraph 2.
    Former subparagraph 2(b) did not exempt income earned by a 
trust, company or other arrangement for the benefit of 
religious, scientific, literary, educational or charitable 
organizations exempt from tax under paragraph 1. Therefore, the 
Protocol expands the scope of paragraph 3 to include such 
income.
    As noted above with respect to Article X (Dividends), 
paragraph 3 of the General Note explains that distributions 
from Canadian income trusts and royalty trusts that are treated 
as dividends as a result of changes to Canada's law regarding 
taxation of income and royalty trusts shall be treated as 
dividends for the purposes of Article X. Accordingly, such 
distributions will also be entitled to the benefits of Article 
XXI.
    New paragraph 4 replaces paragraph 3 and provides that the 
exemptions provided by paragraphs 1, 2, 3 do not apply with 
respect to the income of a trust, company, organization or 
other arrangement from carrying on a trade or business or from 
a related person, other than a person referred to in paragraph 
1, 2 or 3. The term ``related person'' is not necessarily 
defined by paragraph 2 of Article IX (Related Person).

                               ARTICLE 17

    Article 17 of the Protocol amends Article XXII (Other 
Income) of the Convention by adding a new paragraph 4. Article 
XXII generally assigns taxing jurisdiction over income not 
dealt with in the other articles (Articles VI through XXI) of 
the Convention.
    New paragraph 4 provides a specific rule for residence 
State taxation of compensation derived in respect of a 
guarantee of indebtedness. New paragraph 4 provides that 
compensation derived by a resident of a Contracting State in 
respect of the provision of a guarantee of indebtedness shall 
be taxable only in that State, unless the compensation is 
business profits attributable to a permanent establishment 
situated in the other Contracting State, in which case the 
provisions of Article VII (Business Profits) shall apply. The 
clarification that Article VII shall apply when the 
compensation is considered business profits was included at the 
request of the United States. Compensation paid to a financial 
services entity to provide a guarantee in the ordinary course 
of its business of providing such guarantees to customers 
constitutes business profits dealt with under the provisions of 
Article VII. However, provision of guarantees with respect to 
debt of related parties is ordinarily not an independent 
economic undertaking that would generate business profits, and 
thus compensation in respect of such related-party guarantees 
is, in most cases, covered by Article XXII.

                               ARTICLE 18

    Article 18 of the Protocol amends paragraph 2 of Article 
XXIII (Capital) of the Convention by deleting language 
contained in that paragraph consistent with the changes made by 
Article 9 of the Protocol.

                               ARTICLE 19

    Article 19 of the Protocol deletes subparagraph 2(b) of 
Article XXIV (Elimination of Double Taxation) of the Convention 
and replaces it with a new subparagraph.
    New subparagraph 2(b) allows a Canadian company receiving a 
dividend from a U.S. resident company of which it owns at least 
10 percent of the voting stock, a credit against Canadian 
income tax of the appropriate amount of income tax paid or 
accrued to the United States by the dividend paying company 
with respect to the profits out of which the dividends are 
paid. The third Protocol to the Convention, signed March 17, 
1995, had amended subparagraph (b) to allow a Canadian company 
to deduct in computing its Canadian taxable income any dividend 
received by it out of the exempt surplus of a foreign affiliate 
which is a resident of the United States. This change is 
consistent with current Canadian tax treaty practice: it does 
not indicate any present intention to change Canada's ``exempt 
surplus'' rules, and those rules remain in effect.

                               ARTICLE 20

    Article 20 of the Protocol revises Article XXV (Non-
Discrimination) of the existing Convention to bring that 
Article into closer conformity to U.S. tax treaty policy.

Paragraphs 1 and 2

    Paragraph 1 replaces paragraph 1 of Article XXV of the 
existing Convention. New paragraph 1 provides that a national 
of one Contracting State may not be subject to taxation or 
connected requirements in the other Contracting State that are 
more burdensome than the taxes and connected requirements 
imposed upon a national of that other State in the same 
circumstances. The OECD Model would prohibit taxation that is 
``other than or more burdensome'' than that imposed on U.S. 
persons. Paragraph 1 omits the words ``other than or'' because 
the only relevant question under this provision should be 
whether the requirement imposed on a national of the other 
Contracting State is more burdensome. A requirement may be 
different from the requirements imposed on U.S. nationals 
without being more burdensome.
    The term ``national'' in relation to a Contracting State is 
defined in subparagraph 1(k) of Article III (General 
Definitions). The term includes both individuals and juridical 
persons. A national of a Contracting State is afforded 
protection under this paragraph even if the national is not a 
resident of either Contracting State. Thus, a U.S. citizen who 
is resident in a third country is entitled, under this 
paragraph, to the same treatment in Canada as a national of 
Canada in the same or similar circumstances (i.e., one who is 
resident in a third State).
    Whether or not the two persons are both taxable on 
worldwide income is a significant circumstance for this 
purpose. For this reason, paragraph 1 specifically refers to 
taxation or any requirement connected therewith, particularly 
with respect to taxation on worldwide income, as relevant 
circumstances. This language means that the United States is 
not obliged to apply the same taxing regime to a national of 
Canada who is not resident in the United States as it applies 
to a U.S. national who is not resident in the United States. 
U.S. citizens who are not resident in the United States but who 
are, nevertheless, subject to U.S. tax on their worldwide 
income are not in the same circumstances with respect to U.S. 
taxation as citizens of Canada who are not U.S. residents. 
Thus, for example, Article XXV would not entitle a national of 
Canada residing in a third country to taxation at graduated 
rates on U. S.-source dividends or other investment income that 
applies to a U.S. citizen residing in the same third country.
    Because of the increased coverage of paragraph 1 with 
respect to the treatment of nationals wherever they are 
resident, paragraph 2 of this Article no longer has 
application, and therefore has been omitted.

Paragraph 3

    Paragraph 3 makes changes to renumbered paragraph 3 of 
Article XXV in order to conform with Article 10 of the Protocol 
by deleting the reference to ``Article XV (Dependent Personal 
Services)'' and replacing it with a reference to ``Article XV 
(Income from Employment).''

                               ARTICLE 21

    Paragraph 1 of Article 21 of the Protocol replaces 
paragraph 6 of Article XXVI (Mutual Agreement Procedure) of the 
Convention with new paragraphs 6 and 7. New paragraphs 6 and 7 
provide a mandatory binding arbitration proceeding (Arbitration 
Proceeding). The Arbitration Note details additional rules and 
procedures that apply to a case considered under the 
arbitration provisions.
    New paragraph 6 provides that a case shall be resolved 
through arbitration when the competent authorities have 
endeavored but are unable through negotiation to reach a 
complete agreement regarding a case and the following three 
conditions are satisfied. First, tax returns have been filed 
with at least one of the Contracting States with respect to the 
taxable years at issue in the case. Second, the case (i) 
involves the application of one or more Articles that the 
competent authorities have agreed in an exchange of notes shall 
be the subject of arbitration and is not a case that the 
competent authorities agree before the date on which an 
Arbitration Proceeding would otherwise have begun, is not 
suitable for determination by arbitration; or (ii) is a case 
that the competent authorities agree is suitable for 
determination by arbitration. Third, all concerned persons and 
their authorized representatives agree, according to the 
provisions of subparagraph 7(d), not to disclose to any other 
person any information received during the course of the 
Arbitration Proceeding from either Contracting State or the 
arbitration board, other than the determination of the board 
(confidentiality agreement). The confidentiality agreement may 
also be executed by any concerned person that has the legal 
authority to bind any other concerned person on the matter. For 
example, a parent corporation with the legal authority to bind 
its subsidiary with respect to confidentiality may execute a 
comprehensive confidentiality agreement on its own behalf and 
that of its subsidiary.
    The United States and Canada have agreed in the Arbitration 
Note to submit cases regarding the application of one or more 
of the following Articles to mandatory binding arbitration 
under the provisions of paragraphs 6 and 7 of Article XXVI: IV 
(Residence), but only insofar as it relates to the residence of 
a natural person, V (Permanent Establishment), VII (Business 
Profits), IX (Related Persons), and XII (Royalties) (but only 
(i) insofar as Article XII might apply in transactions 
involving related persons to whom Article IX might apply, or 
(ii) to an allocation of amounts between royalties that are 
taxable under paragraph 2 thereof and royalties that are exempt 
under paragraph 3 thereof). The competent authorities may, 
however, agree, before the date on which an Arbitration 
Proceeding would otherwise have begun, that a particular case 
is not suitable for arbitration.
    New paragraph 7 provides six subparagraphs that detail the 
general rules and definitions to be used in applying the 
arbitration provisions.
    Subparagraph 7(a) provides that the term ``concerned 
person'' means the person that brought the case to competent 
authority for consideration under Article XXVI (Mutual 
Agreement Procedure) and includes all other persons, if any, 
whose tax liability to either Contracting State may be directly 
affected by a mutual agreement arising from that consideration. 
For example, a concerned person does not only include a U.S. 
corporation that brings a transfer pricing case with respect to 
a transaction entered into with its Canadian subsidiary for 
resolution to the U.S. competent authority, but also the 
Canadian subsidiary, which may have a correlative adjustment as 
a result of the resolution of the case.
    Subparagraph 7(c) provides that an Arbitration Proceeding 
begins on the later of two dates: two years from the 
``commencement date'' of the case (unless the competent 
authorities have previously agreed to a different date), or the 
earliest date upon which all concerned persons have entered 
into a confidentiality agreement and the agreements have been 
received by both competent authorities. The ``commencement 
date'' of the case is defined by subparagraph 7(b) as the 
earliest date the information necessary to undertake 
substantive consideration for a mutual agreement has been 
received by both competent authorities.
    Paragraph 16 of the Arbitration Note provides that each 
competent authority will confirm in writing to the other 
competent authority and to the concerned persons the date of 
its receipt of the information necessary to undertake 
substantive consideration for a mutual agreement. In the case 
of the United States, this information is (i) the information 
that must be submitted to the U.S. competent authority under 
Section 4.05 of Rev. Proc. 2006-54, 2006-49 I.R.B. 1035 (or any 
applicable successor publication), and (ii) for cases initially 
submitted as a request for an Advance Pricing Agreement, the 
information that must be submitted to the Internal Revenue 
Service under Rev. Proc. 2006-9, 2006-2 I.R.B. 278 (or any 
applicable successor publication). In the case of Canada, this 
information is the information required to be submitted to the 
Canadian competent authority under Information Circular 7 1-17 
(or any applicable successor publication). The information 
shall not be considered received until both competent 
authorities have received copies of all materials submitted to 
either Contracting State by the concerned person(s) in 
connection with the mutual agreement procedure. It is 
understood that confirmation of the ``information necessary to 
undertake substantive consideration for a mutual agreement'' is 
envisioned to ordinarily occur within 30 days after the 
necessary information is provided to the competent authority.
    The Arbitration Note also provides for several procedural 
rules once an Arbitration Proceeding under paragraph 6 of 
Article XXVI (''Proceeding'') has commenced, but the competent 
authorities may modify or supplement these rules as necessary. 
In addition, the arbitration board may adopt any procedures 
necessary for the conduct of its business, provided the 
procedures are not inconsistent with any provision of Article 
XXVI of the Convention.
    Paragraph 5 of the Arbitration Note provides that each 
Contracting State has 60 days from the date on which the 
Arbitration Proceeding begins to send a written communication 
to the other Contracting State appointing one member of the 
arbitration board. Within 60 days of the date the second of 
such communications is sent, these two board members will 
appoint a third member to serve as the chair of the board. It 
is agreed that this third member ordinarily should not be a 
citizen of either of the Contracting States.
    In the event that any members of the board are not 
appointed (including as a result of the failure of the two 
members appointed by the Contracting States to agree on a third 
member) by the requisite date, the remaining members are 
appointed by the highest ranking member of the Secretariat at 
the Centre for Tax Policy and Administration of the 
Organisation for Economic Co-operation and Development (OECD) 
who is not a citizen of either Contracting State, by written 
notice to both Contracting States within 60 days of the date of 
such failure.
    Paragraph 7 of the Arbitration Note establishes deadlines 
for submission of materials by the Contracting States to the 
arbitration board. Each competent authority has 60 days from 
the date of appointment of the chair to submit a Proposed 
Resolution describing the proposed disposition of the specific 
monetary amounts of income, expense or taxation at issue in the 
case, and a supporting Position Paper. Copies of each State's 
submissions are to be provided by the board to the other 
Contracting State on the date the later of the submissions is 
submitted to the board. Each of the Contracting States may 
submit a Reply Submission to the board within 120 days of the 
appointment of the chair to address points raised in the other 
State's Proposed Resolution or Position Paper. If one 
Contracting State fails to submit a Proposed Resolution within 
the requisite time, the Proposed Resolution of the other 
Contracting State is deemed to be the determination of the 
arbitration board. Additional information may be supplied to 
the arbitration board by a Contracting State only at the 
request of the arbitration board. The board will providecopies 
of any such requested information, along with the board's 
request, to the other Contracting State on the date the request 
is made or the response is received.
    All communication with the board is to be in writing 
between the chair of the board and the designated competent 
authorities with the exception of communication regarding 
logistical matters.
    In making its determination, the arbitration board will 
apply the following authorities as necessary: (i) the 
provisions of the Convention, (ii) any agreed commentaries or 
explanation of the Contracting States concerning the Convention 
as amended, (iii) the laws of the Contracting States to the 
extent they are not inconsistent with each other, and (iv) any 
OECD Commentary, Guidelines or Reports regarding relevant 
analogous portions of the OECD Model Tax Convention.
    The arbitration board must deliver a determination in 
writing to the Contracting States within six months of the 
appointment of the chair. The determination must be one of the 
two Proposed Resolutions submitted by the Contracting States. 
The determination shall provide a determination regarding only 
the amount of income, expense or tax reportable to the 
Contracting States. The determination has no precedential value 
and consequently the rationale behind a board's determination 
would not be beneficial and shall not be provided by the board.
    Paragraph 11 of the Arbitration Note provides that, unless 
any concerned person does not accept the decision of the 
arbitration board, the determination of the board constitutes a 
resolution by mutual agreement under Article XXVI and, 
consequently, is binding on both Contracting States. Each 
concerned person must, within 30 days of receiving the 
determination from the competent authority to which the case 
was first presented, advise that competent authority whether 
the person accepts the determination. The failure to advise the 
competent authority within the requisite time is considered a 
rejection of the determination. If a determination is rejected, 
the case cannot be the subject of a subsequent MAP procedure on 
the same issue(s) determined by the panel, including a 
subsequent Arbitration Proceeding. After the commencement of an 
Arbitration Proceeding but before a decision of the board has 
been accepted by all concerned persons, the competent 
authorities may reach a mutual agreement to resolve the case 
and terminate the Proceeding.
    For purposes of the Arbitration Proceeding, the members of 
the arbitration board and their staffs shall be considered 
``persons or authorities'' to whom information may be disclosed 
under Article XXVII (Exchange of Information). The Arbitration 
Note provides that all materials prepared in the course of, or 
relating to, the Arbitration Proceeding are considered 
information exchanged between the Contracting States. No 
information relating to the Arbitration Proceeding or the 
board's determination may be disclosed by members of the 
arbitration board or their staffs or by either competent 
authority, except as permitted by the Convention and the 
domestic laws of the Contracting States. Members of the 
arbitration board and their staffs must agree in statements 
sent to each of the Contracting States in confirmation of their 
appointment to the arbitration board to abide by and be subject 
to the confidentiality and nondisclosure provisions of Article 
XXVII of the Convention and the applicable domestic laws of the 
Contracting States, with the most restrictive of the provisions 
applying.
    The applicable domestic law of the Contracting States 
determines the treatment of any interest or penalties 
associated with a competent authority agreement achieved 
through arbitration.
    In general, fees and expenses are borne equally by the 
Contracting States, including the cost of translation services. 
However, meeting facilities, related resources, financial 
management, other logistical support, and general and 
administrative coordination of the Arbitration Proceeding will 
be provided, at its own cost, by the Contracting State that 
initiated the Mutual Agreement Procedure. The fees and expenses 
of members of the board will be set in accordance with the 
International Centre for Settlement of Investment Disputes 
(ICSID) Schedule of Fees for arbitrators (in effect on the date 
on which the arbitration board proceedings begin). All other 
costs are to be borne by the Contracting State that incurs 
them. Since arbitration of MAP cases is intended to assist 
taxpayers in resolving a governmental difference of opinion 
regarding the taxation of their income, and is merely an 
extension of the competent authority process, no fees will be 
chargeable to a taxpayer in connection with arbitration.

                               ARTICLE 22

    Article 22 of the Protocol amends Article XXVI A 
(Assistance in Collection) of the existing Convention. Article 
XXVI A sets forth provisions under which the United States and 
Canada have agreed to assist each other in the collection of 
taxes.

Paragraph 1

    Paragraph 1 replaces subparagraph 8(a) of Article XXVI A. 
In general, new subparagraph 8(a) provides the circumstances 
under which no assistance is to be given under the Article for 
a claim in respect of an individual taxpayer. New subparagraph 
8(a) contains language that is in substance the same as 
subparagraph 8(a) of Article XXVI A of the existing Convention. 
However, the revised subparagraph also provides that no 
assistance in collection is to be given for a revenue claim 
from a taxable period that ended before November 9, 1995 in 
respect of an individual taxpayer, if the taxpayer became a 
citizen of the requested State at any time before November 9, 
1995 and is such a citizen at the time the applicant State 
applies for collection of the claim.
    The additional language is intended to avoid the 
potentially discriminating application of former subparagraph 
8(a) as applied to persons who were not citizens of the 
requested State in the taxable period to which a particular 
collection request related, but who became citizens of the 
requested State at a time prior to the entry into force of 
Article XXVI A as set forth in the third protocol signed March 
17, 1995. New subparagraph 8(a) addresses this situation by 
treating the citizenship of a person in the requested State at 
anytime prior to November 9, 1995 as comparable to citizenship 
in the requested State during the period for which the claim 
for assistance relates if 1) the person is a citizen of the 
requested state at the time of the request for assistance in 
collection, and 2) the request relates to a taxable period 
ending prior to November 9, 1995. As is provided in 
subparagraph 3(g) of Article 27, this change will have effect 
for revenue claims finally determined after November 9, 1985, 
the effective date of the adoption of collection assistance in 
the third protocol signed March 17, 1995.

Paragraph 2

    Paragraph 2 replaces paragraph 9 of Article XXVI A of the 
Convention. Under paragraph 1 of Article XXVI A, each 
Contracting State generally agrees to lend assistance and 
support to the other in the collection of revenue claims. The 
term ``revenue claim'' is defined in paragraph 1 to include all 
taxes referred to in paragraph 9 of the Article, as well as 
interest, costs, additions to such taxes, and civil penalties. 
New paragraph 9 provides that, notwithstanding the provisions 
of Article II (Taxes Covered) of the Convention, Article XXVI A 
shall apply to all categories of taxes collected, and to 
contributions to social security and employment insurance 
premiums levied, by or on behalf of the Government of a 
Contracting State. Prior to the Protocol, paragraph 9 did not 
contain a specific reference to contributions to social 
security and employment insurance premiums. Although the prior 
language covered U.S. federal social security and unemployment 
taxes, the language did not cover Canada's social security 
(e.g., Canada Pension Plan) and employment insurance programs, 
contributions to which are not considered taxes under Canadian 
law and therefore would not otherwise have come within the 
scope of the paragraph.

                               ARTICLE 23

    Article 23 of the Protocol replaces Article XXVII (Exchange 
of Information) of the Convention.

Paragraph 1 of Article XXVI

    New paragraph 1 of Article XXVII is substantially the same 
as paragraph 1 of Article XXVII of the existing Convention. 
Paragraph 1 authorizes the competent authorities to exchange 
information as may be relevant for carrying out the provisions 
of the Convention or the domestic laws of Canada and the United 
States concerning taxes covered by the Convention, insofar as 
the taxation under those domestic laws is not contrary to the 
Convention. New paragraph 1 changes the phrase ``is relevant'' 
to ``may be relevant'' to clarify that the language 
incorporates the standard in Code section 7602 which authorizes 
the Internal Revenue Service to examine ``any books, papers, 
records, or other data which may be relevant or material.'' 
(Emphasis added.) In United States v. Arthur Young & Co., 465 
U.S. 805, 814 (1984), the Supreme Court stated that ``the 
language `may be' reflects Congress's express intention to 
allow the Internal Revenue Service to obtain `items of even 
potential relevance to an ongoing investigation, without 
reference to its admissibility.''' (Emphasis in original.) 
However, the language ``may be'' would not support a request in 
which a Contracting State simply asked for information 
regarding all bank accounts maintained by residents of that 
Contracting State in the other Contracting State, or even all 
accounts maintained by its residents with respect to a 
particular bank.
    The authority to exchange information granted by paragraph 
1 is not restricted by Article I (Personal Scope), and thus 
need not relate solely to persons otherwise covered by the 
Convention. Under paragraph 1, information may be exchanged for 
use in all phases of the taxation process including assessment, 
collection, enforcement or the determination of appeals. Thus, 
the competent authorities may request and provide information 
for cases under examination or criminal investigation, in 
collection, on appeals, or under prosecution.
    Any information received by a Contracting State pursuant to 
the Convention is to be treated as secret in the same manner as 
information obtained under the tax laws of that State. Such 
information shall be disclosed only to persons or authorities, 
including courts and administrative bodies, involved in the 
assessment or collection of, the administration and enforcement 
in respect of, or the determination of appeals in relation to, 
the taxes covered by the Convention and the information may be 
used by such persons only for such purposes. (In accordance 
with paragraph 4, for the purposes of this Article the 
Convention applies to a broader range of taxes than those 
covered specifically by Article II (Taxes Covered)). Although 
the information received by persons described in paragraph 1 is 
to be treated as secret, it may be disclosed by such persons in 
public court proceedings or in judicial decisions.
    Paragraph 1 also permits, however, a Contracting State to 
provide information received from the other Contracting State 
to its states, provinces, or local authorities, if it relates 
to a tax imposed by that state, province, or local authority 
that is substantially similar to a national-level tax covered 
under Article II (Taxes Covered). This provision does not 
authorize a Contracting State to request information on behalf 
of a state, province, or local authority. Paragraph 1 also 
authorizes the competent authorities to release information to 
any arbitration panel that may be established under the 
provisions of new paragraph 6 of Article XXVI (Mutual Agreement 
Procedure). Any information provided to a state, province, or 
local authority or to an arbitration panel is subject to the 
same use and disclosure provisions as is information received 
by the national Governments and used for their purposes.
    The provisions of paragraph 1 authorize the U.S. competent 
authority to continue to allow legislative bodies, such as the 
tax-writing committees of Congress and the Government 
Accountability Office to examine tax return information 
received from Canada when such bodies or offices are engaged in 
overseeing the administration of U.S. tax laws or a study of 
the administration of U.S. tax laws pursuant to a directive of 
Congress. However, the secrecy requirements of paragraph 1 must 
be met.
    It is contemplated that Article XXVII will be utilized by 
the competent authorities to exchange information upon request, 
routinely, and spontaneously.

Paragraph 2 of Article XXVI

    New paragraph 2 conforms with the corresponding U.S. and 
OECD Model provisions. The substance of the second sentence of 
former paragraph 2 is found in new paragraph 6 of the Article, 
discussed below.
    Paragraph 2 provides that if a Contracting State requests 
information in accordance with Article XXVII, the other 
Contracting State shall use its information gathering measures 
to obtain the requested information. The instruction to the 
requested State to ``use its information gathering measures'' 
to obtain the requested information communicates the same 
instruction to the requested State as the language of former 
paragraph 2 that stated that the requested State shall obtain 
the information ``in the same way as if its own taxation was 
involved.'' Paragraph 2 makes clear that the obligation to 
provide information is limited by the provisions of paragraph 
3, but that such limitations shall not be construed to permit a 
Contracting State to decline to obtain and supply information 
because it has no domestic tax interest in such information.
    In the absence of such a paragraph, some taxpayers have 
argued that subparagraph 3(a) prevents a Contracting State from 
requesting information from a bank or fiduciary that the 
Contracting State does not need for its own tax purposes. This 
paragraph clarifies that paragraph 3 does not impose such a 
restriction and that a Contracting State is not limited to 
providing only the information that it already has in its own 
files.

Paragraph 3 of Article XXVI

    New paragraph 3 is substantively the same as paragraph 3 of 
Article XXVII of the existing Convention. Paragraph 3 provides 
that the provisions of paragraphs 1 and 2 do not impose on 
Canada or the United States the obligation to carry out 
administrative measures at variance with the laws and 
administrative practice of either State; to supply information 
which is not obtainable under the laws or in the normal course 
of the administration of either State; or to supply information 
which would disclose any trade, business, industrial, 
commercial, or professional secret or trade process, or 
information the disclosure of which would be contrary to public 
policy.
    Thus, a requesting State may be denied information from the 
other State if the information would be obtained pursuant to 
procedures or measures that are broader than those available in 
the requesting State. However, the statute of limitations of 
the Contracting State making the request for information should 
govern a request for information. Thus, the Contracting State 
of which the request is made should attempt to obtain the 
information even if its own statute of limitations has passed. 
In many cases, relevant information will still exist in the 
business records of the taxpayer or a third party, even though 
it is no longer required to be kept for domestic tax purposes.
    While paragraph 3 states conditions under which a 
Contracting State is not obligated to comply with a request 
from the other Contracting State for information, the requested 
State is not precluded from providing such information, and 
may, at its discretion, do so subject to the limitations of its 
internal law.
    As discussed with respect to paragraph 2, in no case shall 
the limitations in paragraph 3 be construed to permit a 
Contracting State to decline to obtain information and supply 
information because it has no domestic tax interest in such 
information.

Paragraph 4 of Article XXVI

    The language of new paragraph 4 is substantially similar to 
former paragraph 4. New paragraph 4, however, consistent with 
new paragraph 1, discussed above, replaces the words ``is 
relevant'' with ``may be relevant'' in subparagraph 4(b).
    Paragraph 4 provides that, for the purposes of Article 
XXVII, the Convention applies to all taxes imposed by a 
Contracting State, and to other taxes to which any other 
provision of the Convention applies, but only to the extent 
that the information may be relevant for the purposes of the 
application of that provision.
    Article XXVII does not apply to taxes imposed by political 
subdivisions or local authorities of the Contracting States. 
Paragraph 4 is designed to ensure that information exchange 
will extend to taxes of every kind (including, for example, 
estate, gift, excise, and value added taxes) at the national 
level in the United States and Canada.

Paragraph 5 of Article XXVI

    New paragraph 5 conforms with the corresponding U.S. and 
OECD Model provisions. Paragraph 5 provides that a Contracting 
State may not decline to provide information because that 
information is held by a financial institution, nominee or 
person acting in an agency or fiduciary capacity. Thus, 
paragraph 5 would effectively prevent a Contracting State from 
relying on paragraph 3 to argue that its domestic bank secrecy 
laws (or similar legislation relating to disclosure of 
financial information by financial institutions or 
intermediaries) override its obligation to provide information 
under paragraph 1. This paragraph also requires the disclosure 
of information regarding the beneficial owner of an interest in 
a person.

Paragraph 6 of Article XXVI

    The substance of new paragraph 6 is similar to the second 
sentence of paragraph 2 of Article XXVII of the existing 
Convention. New paragraph 6 adopts the language of paragraph 6 
of Article 26 (Exchange of Information and Administrative 
Assistance) of the U.S. Model. New paragraph 6 provides that 
the requesting State may specify the form in which information 
is to be provided (e.g., depositions of witnesses and 
authenticated copies of original documents). The intention is 
to ensure that the information may be introduced as evidence in 
the judicial proceedings of the requesting State.
    The requested State should, if possible, provide the 
information in the form requested to the same extent that it 
can obtain information in that form under its own laws and 
administrative practices with respect to its own taxes.

Paragraph 7 of Article XXVI

    New paragraph 7 is consistent with paragraph 8 of Article 
26 (Exchange of Information and Administrative Assistance) of 
the U.S. Model. Paragraph 7 provides that the requested State 
shall allow representatives of the requesting State to enter 
the requested State to interview individuals and examine books 
and records with the consent of the persons subject to 
examination. Paragraph 7 was intended to reinforce that the 
administrations can conduct consensual tax examinations abroad, 
and was not intended to limit travel or supersede any 
arrangements or procedures the competent authorities may have 
previously had in place regarding travel for tax administration 
purposes.

Paragraph 13 of General Note

    As is explained in paragraph 13 of the General Note, the 
United States and Canada understand and agree that the 
standards and practices described in Article XXVII of the 
Convention are to be in no respect less effective than those 
described in the Model Agreement on Exchange of Information on 
Tax Matters developed by the OECD Global Forum Working Group on 
Effective Exchange of Information.

                               ARTICLE 24

Article 24 amends Article XXIX (Miscellaneous Rules) of the Convention. 
        Paragraph 1

    Paragraph 1 replaces paragraph 2 of Article XXIX of the 
existing Convention. New paragraph 2 is divided into two 
subparagraphs. In general, subparagraph 2(a) provides a 
``saving clause'' pursuant to which the United States and 
Canada may each tax its residents, as determined under Article 
IV (Residence), and the United States may tax its citizens and 
companies, including those electing to be treated as domestic 
corporations (e.g. under Code section 1504(d)), as if there 
were no convention between the United States and Canada with 
respect to taxes on income and capital. Subparagraph 2(a) 
contains language that generally corresponds to former 
paragraph 2, but omits certain language pertaining to former 
citizens, which are addressed in new subparagraph 2(b).
    New subparagraph 2(b) generally corresponds to the 
provisions of former paragraph 2 addressing former citizens of 
the United States. However, new subparagraph 2(b) also includes 
a reference to former long-term residents of the United States. 
This addition, as well as other changes in subparagraph 2(b), 
brings the Convention in conformity with the U.S. taxation of 
former citizens and long-term residents under Code section 877.
    Similar to subparagraph 2(a), new subparagraph 2(b) 
operates as a ``saving clause'' and provides that 
notwithstanding the other provisions of the Convention, a 
former citizen or former long-term resident of the United 
States, may, for a period of ten years following the loss of 
such status, be taxed in accordance with the laws of the United 
States with respect to income from sources within the United 
States (including income deemed under the domestic law of the 
United States to arise from such sources).
    Paragraphs 11 and 12 of the General Note provide 
definitions based on Code section 877 that are relevant to the 
application of paragraph 2 of Article XXIX. Paragraph 11 of the 
General Note provides that the term ``long-term resident'' 
means any individual who is a lawful permanent resident of the 
United States in eight or more taxable years during the 
preceding 15 taxable years. In determining whether the eight-
year threshold is met, one does not count any year in which the 
individual is treated as a resident of Canada under this 
Convention (or as a resident of any country other than the 
United States under the provisions of any other U.S. tax 
treaty), and the individual does not waive the benefits of such 
treaty applicable to residents of the other country. This 
understanding is consistent with how this provision is 
generally interpreted in U.S. tax treaties.
    Paragraph 12 of the General Note provides that the phrase 
``income deemed under the domestic law of the United States to 
arise from such sources'' as used in new subparagraph 2(b) 
includes gains from the sale or exchange of stock of a U.S. 
company or debt obligations of a U.S. person, the United 
States, a State, or a political subdivision thereof, or the 
District of Columbia, gains from property (other than stock or 
debt obligations) located in the United States, and, in certain 
cases, income or gain derived from the sale of stock of a non-
U.S. company or a disposition of property contributed to such 
non-U.S. company where such company would be a controlled 
foreign corporation with respect to the individual if such 
person had continued to be a U.S. person. In addition, an 
individual who exchanges property that gives rise or would give 
rise to U.S.-source income for property that gives rise to 
foreign-source income will be treated as if he had sold the 
property that would give rise to U.S.-source income for its 
fair market value, and any consequent gain shall be deemed to 
be income from sources within the United States.

Paragraph 2

    Paragraph 2 replaces subparagraph 3(a) of Article XXIX of 
the existing Convention. Paragraph 3 provides that, 
notwithstanding paragraph 2 of Article XXIX, the United States 
and Canada must respect specified provisions of the Convention 
in regard to certain persons, including residents and citizens. 
Therefore, subparagraph 3(a) lists certain paragraphs and 
Articles of the Convention that represent exceptions to the 
``saving clause'' in all situations. New subparagraph 3(a) is 
substantially similar to former subparagraph 3(a), but now 
contains a reference to paragraphs 8, 10, and 13 of Article 
XVIII (Pensions and Annuities) to reflect the changes made to 
that article in paragraph 3 of Article 13 of the Protocol.

                               ARTICLE 25

    Article 25 of the Protocol replaces Article XXIX A 
(Limitation on Benefits) of the existing Convention, which was 
added to the Convention by the Protocol done on March 17, 1995. 
Article XXIX A addresses the problem of ``treaty shopping'' by 
residents of third States by requiring, in most cases, that the 
person seeking benefits not only be a U.S. resident or Canadian 
resident but also satisfy other tests. For example, a resident 
of a third State might establish an entity resident in Canada 
for the purpose of deriving income from the United States and 
claiming U.S. treaty benefits with respect to that income. 
Article XXIX A limits the benefits granted by the United States 
or Canada under the Convention to those persons whose residence 
in the other Contracting State is not considered to have been 
motivated by the existence of the Convention. As replaced by 
the Protocol, new Article XXIX A is reciprocal, and many of the 
changes to the former paragraphs of Article XXIX A are made to 
effectuate this reciprocal application.
    Absent Article XXIX A, an entity resident in one of the 
Contracting States would be entitled to benefits under the 
Convention, unless it were denied such benefits as a result of 
limitations under domestic law (e.g., business purpose, 
substance-over-form, step transaction, or conduit principles or 
other anti-avoidance rules) applicable to a particular 
transaction or arrangement. As noted below in the explanation 
of paragraph 7, general anti-abuse provisions of this sort 
apply in conjunction with the Convention in both the United 
States and Canada. In the case of the United States, such anti-
abuse provisions complement the explicit anti-treaty-shopping 
rules of Article XXIX A. While the anti-treaty-shopping rules 
determine whether a person has a sufficient nexus to Canada to 
be entitled to benefits under the Convention, the anti-abuse 
provisions under U.S. domestic law determine whether a 
particular transaction should be recast in accordance with the 
substance of the transaction.

Paragraph 1 of Article XXIX A

    New paragraph 1 of Article XXIX A provides that, for the 
purposes of the application of the Convention, a ``qualifying 
person'' shall be entitled to all of the benefits of the 
Convention and, except as provided in paragraphs 3, 4, and 6, a 
person that is not a qualifying person shall not be entitled to 
any benefits of the Convention.

Paragraph 2 of Article XXIX A

    New paragraph 2 lists a number of characteristics any one 
of which will make a United States or Canadian resident a 
qualifying person. The ``look-through'' principles introduced 
by the Protocol (e.g. paragraph 6 of Article IV (Residence)) 
are to be applied in conjunction with Article XXIX A. 
Accordingly, the provisions of Article IV shall determine the 
person who derives an item of income, and the objective tests 
of Article XXIX A shall be applied to that person to determine 
whether benefits shall be granted. The rules are essentially 
mechanical tests and are discussed below.

Individuals and governmental entities

    Under new paragraph 2, the first two categories of 
qualifying persons are (1) natural persons resident in the 
United States or Canada (as listed in subparagraph 2(a)), and 
(2) the Contracting States, political subdivisions or local 
authorities thereof, and any agency or instrumentality of such 
Government, political subdivision or local authority (as listed 
in subparagraph 2(b)). Persons falling into these two 
categories are unlikely to be used, as the beneficial owner of 
income, to derive benefits under the Convention on behalf of a 
third-country person. If such a person receives income as a 
nominee on behalf of a third-country resident, benefits will be 
denied with respect to those items of income under the articles 
of the Convention that would otherwise grant the benefit, 
because of the requirements in those articles that the 
beneficial owner of the income be a resident of a Contracting 
State.

Publicly traded entities

    Under new subparagraph 2(c), a company or trust resident in 
a Contracting State is a qualifying person if the company's 
principal class of shares, and any disproportionate class of 
shares, or the trust's units, or disproportionate interest in a 
trust, are primarily and regularly traded on one or more 
recognized stock exchanges. The term ``recognized stock 
exchange'' is defined in subparagraph 5(f) of the Article to 
mean, in the United States, the NASDAQ System and any stock 
exchange registered as a national securities exchange with the 
Securities and Exchange Commission, and, in Canada, any 
Canadian stock exchanges that are ``prescribed stock 
exchanges'' or ``designated stock exchanges'' under the Income 
Tax Act. These are, at the time of signature of the Protocol, 
the Montreal Stock Exchange, the Toronto Stock Exchange, and 
Tiers 1 and 2 of the TSX Venture Exchange. Additional exchanges 
may be added to the list of recognized exchanges by exchange of 
notes between the Contracting States or by agreement between 
the competent authorities.
    If a company has only one class of shares, it is only 
necessary to consider whether the shares of that class meet the 
relevant trading requirements. If the company has more than one 
class of shares, it is necessary as an initial matter to 
determine which class or classes constitute the ``principal 
class of shares.'' The term ``principal class of shares'' is 
defined in subparagraph 5(e) of the Article to mean the 
ordinary or common shares of the company representing the 
majority of the aggregate voting power and value of the 
company. If the company does not have a class of ordinary or 
common shares representing the majority of the aggregate voting 
power and value of the company, then the ``principal class of 
shares'' is that class or any combination of classes of shares 
that represents, in the aggregate, a majority of the voting 
power and value of the company. Although in a particular case 
involving a company with several classes of shares it is 
conceivable that more than one group of classes could be 
identified that account for more than 50% of the voting power 
and value of the shares of the company, it is only necessary 
for one such group to satisfy the requirements of this 
subparagraph in order for the company to be entitled to 
benefits. Benefits would not be denied to the company even if a 
second, non-qualifying, group of shares with more than half of 
the company's voting power and value could be identified.
    A company whose principal class of shares is regularly 
traded on a recognized stock exchange will nevertheless not 
qualify for benefits under subparagraph 2(c) if it has a 
disproportionate class of shares that is not regularly traded 
on a recognized stock exchange. The term ``disproportionate 
class of shares'' is defined in subparagraph 5(b) of the 
Article. A company has a disproportionate class of shares if it 
has outstanding a class of shares which is subject to terms or 
other arrangements that entitle the holder to a larger portion 
of the company's income, profit, or gain in the other 
Contracting State than that to which the holder would be 
entitled in the absence of such terms or arrangements. Thus, 
for example, a company has a disproportionate class of shares 
if it has outstanding a class of ``tracking stock'' that pays 
dividends based upon a formula that approximates the company's 
return on its assets employed in the United States. Similar 
principles apply to determine whether or not there are 
disproportionate interests in a trust.

    The following example illustrates the application of 
subparagraph 5(b).

    Example. OCo is a corporation resident in Canada. OCo has 
two classes of shares: Common and Preferred. The Common shares 
are listed and regularly traded on a designated stock exchange 
in Canada. The Preferred shares have no voting rights and are 
entitled to receive dividends equal in amount to interest 
payments that OCo receives from unrelated borrowers in the 
United States. The Preferred shares are owned entirely by a 
single investor that is a resident of a country with which the 
United States does not have a tax treaty. The Common shares 
account for more than 50 percent of the value of OCo and for 
100 percent of the voting power. Because the owner of the 
Preferred shares is entitled to receive payments corresponding 
to the U.S.-source interest income earned by OCo, the Preferred 
shares are a disproportionate class of shares. Because the 
Preferred shares are not primarily and regularly traded on a 
recognized stock exchange, OCo will not qualify for benefits 
under subparagraph 2(c).
    The term ``regularly traded'' is not defined in the 
Convention. In accordance with paragraph 2 of Article III 
(General Definitions) and paragraph 1 of the General Note, this 
term will be defined by reference to the domestic tax laws of 
the State from which benefits of the Convention are sought, 
generally the source State. In the case of the United States, 
this term is understood to have the meaning it has under Treas. 
Reg. section 1.884-5(d)(4)(i)(B), relating to the branch tax 
provisions of the Code, as may be amended from time to time. 
Under these regulations, a class of shares is considered to be 
``regularly traded'' if two requirements are met: trades in the 
class of shares are made in more than de minimis quantities on 
at least 60 days during the taxable year, and the aggregate 
number of shares in the class traded during the year is at 
least 10 percent of the average number of shares outstanding 
during the year. Sections 1. 884-5(d)(4)(i)(A), (ii) and (iii) 
will not be taken into account for purposes of defining the 
term ``regularly traded'' under the Convention.
    The regularly-traded requirement can be met by trading on 
one or more recognized stock exchanges. Therefore, trading may 
be aggregated for purposes of this requirement. Thus, a U.S. 
company could satisfy the regularly traded requirement through 
trading, in whole or in part, on a recognized stock exchange 
located in Canada. Authorized but unissued shares are not 
considered for purposes of this test.
    The term ``primarily traded'' is not defined in the 
Convention. In accordance with paragraph 2 of Article III 
(General Definitions) and paragraph 1 of the General Note, this 
term will have the meaning it has under the laws of the State 
concerning the taxes to which the Convention applies, generally 
the source State. In the case of the United States, this term 
is understood to have the meaning it has under Treas. Reg. 
section 1.884-5(d)(3), as may be amended from time to time, 
relating to the branch tax provisions of the Code. Accordingly, 
stock of a corporation is ``primarily traded'' if the number of 
shares in the company's principal class of shares that are 
traded during the taxable year on all recognized stock 
exchanges exceeds the number of shares in the company's 
principal class of shares that are traded during that year on 
all other established securities markets.
    Subject to the adoption by Canada of other definitions, the 
U.S. interpretation of ``regularly traded'' and ``primarily 
traded'' will be considered to apply, with such modifications 
as circumstances require, under the Convention for purposes of 
Canadian taxation.

Subsidiaries of publicly traded entities

    Certain companies owned by publicly traded corporations 
also may be qualifying persons. Under subparagraph 2(d), a 
company resident in the United States or Canada will be a 
qualifying person, even if not publicly traded, if more than 50 
percent of the vote and value of its shares, and more than 50 
percent of the vote and value of each disproportionate class of 
shares, is owned (directly or indirectly) by five or fewer 
persons that are qualifying persons under subparagraph 2(c). In 
addition, each company in the chain of ownership must be a 
qualifying person. Thus, for example, a company that is a 
resident of Canada, all the shares of which are owned by 
another company that is a resident of Canada, would qualify for 
benefits of the Convention if the principal class of shares 
(and any disproportionate classes of shares) of the parent 
company are regularly and primarily traded on a recognized 
stock exchange. However, such a subsidiary would not qualify 
for benefits under subparagraph 2(d) if the publicly traded 
parent company were a resident of a third state, for example, 
and not a resident of the United States or Canada. Furthermore, 
if a parent company qualifying for benefits under subparagraph 
2(c) indirectly owned the bottom-tier company through a chain 
of subsidiaries, each subsidiary in the chain, as an 
intermediate owner, must be a qualifying person in order for 
the bottom-tier subsidiary to meet the test in subparagraph 
2(d).
    Subparagraph 2(d) provides that a subsidiary can take into 
account ownership by as many as five companies, each of which 
qualifies for benefits under subparagraph 2(c) to determine if 
the subsidiary qualifies for benefits under subparagraph 2(d). 
For example, a Canadian company that is not publicly traded but 
that is owned, one-third each, by three companies, two of which 
are Canadian resident corporations whose principal classes of 
shares are primarily and regularly traded on a recognized stock 
exchange, will qualify under subparagraph 2(d).
    By applying the principles introduced by the Protocol (e.g. 
paragraph 6 of Article IV) in the context of this rule, one 
``looks through'' entities in the chain of ownership that are 
viewed as fiscally transparent under the domestic laws of the 
State of residence (other than entities that are resident in 
the State of source).
    The 50-percent test under subparagraph 2(d) applies only to 
shares other than ``debt substitute shares.'' The term ``debt 
substitute shares'' is defined in subparagraph 5(a) to mean 
shares defined in paragraph (e) of the definition in the 
Canadian Income Tax Act of ``term preferred shares'' (see 
subsection 248(1) of the Income Tax Act), which relates to 
certain shares received in debt-restructuring arrangements 
undertaken by reason of financial difficulty or insolvency. 
Subparagraph 5(a) also provides that the competent authorities 
may agree to treat other types of shares as debt substitute 
shares.

Ownership/base erosion test

    Subparagraph 2(e) provides a two-part test under which 
certain other entities may be qualifying persons, based on 
ownership and lack of ``base erosion.'' A company resident in 
the United States or Canada will satisfy the first of these 
tests if 50 percent or more of the vote and value of its shares 
and 50 percent or more of the vote and value of each 
disproportionate class of shares, in both cases not including 
debt substitute shares, is not owned, directly or indirectly, 
by persons other than qualifying persons. Similarly, a trust 
resident in the United States or Canada will satisfy this first 
test if 50 percent or more of its beneficial interests, and 50 
percent or more of each disproportionate interest, is not 
owned, directly or indirectly, by persons other than qualifying 
persons. The wording of these tests is intended to make clear 
that, for example, if a Canadian company is more than 50 
percent owned, either directly or indirectly (including 
cumulative indirect ownership through a chain of entities), by 
a U.S. resident corporation that is, itself, wholly owned by a 
third-country resident other than a qualifying person, the 
Canadian company would not pass the ownership test. This is 
because more than 50 percent of its shares is owned indirectly 
by a person (the third-country resident) that is not a 
qualifying person.
    It is understood by the Contracting States that in 
determining whether a company satisfies the ownership test 
described in subparagraph 2(e)(i), a company, 50 percent of 
more of the aggregate vote and value of the shares of which and 
50 percent or more of the vote and value of each 
disproportionate class of shares (in neither case including 
debt substitute shares) of which is owned, directly or 
indirectly, by a company described in subparagraph 2(c) will 
satisfy the ownership test of subparagraph 2(e)(i). In such 
case, no further analysis of the ownership of the company 
described in subparagraph 2(c) is required. Similarly, in 
determining whether a trust satisfies the ownership test 
described in subparagraph 2(e)(ii), a trust, 50 percent or more 
of the beneficial interest in which and 50 percent or more of 
each disproportionate interest in which, is owned, directly or 
indirectly, by a trust described in subparagraph (2)(c) will 
satisfy the ownership test of subparagraph (2)(e)(ii), and no 
further analysis of the ownership of the trust described in 
subparagraph 2(c) is required.
    The second test of subparagraph 2(e) is the so-called 
``base erosion'' test. A company or trust that passes the 
ownership test must also pass this test to be a qualifying 
person under this subparagraph. This test requires that the 
amount of expenses that are paid or payable by the entity in 
question, directly or indirectly, to persons that are not 
qualifying persons, and that are deductible from gross income 
(with both deductibility and gross income as determined under 
the tax laws of the State of residence of the company or 
trust), be less than 50 percent of the gross income of the 
company or trust. This test is applied for the fiscal period 
immediately preceding the period for which the qualifying 
person test is being applied. If it is the first fiscal period 
of the person, the test is applied for the current period.
    The ownership/base erosion test recognizes that the 
benefits of the Convention can be enjoyed indirectly not only 
by equity holders of an entity, but also by that entity's 
obligees, such as lenders, licensors, service providers, 
insurers and reinsurers, and others. For example, a third-
country resident could license technology to a Canadian-owned 
Canadian corporation to be sub-licensed to a U.S. resident. The 
U.S.-source royalty income of the Canadian corporation would be 
exempt from U.S. withholding tax under Article XII (Royalties) 
of the Convention. While the Canadian corporation would be 
subject to Canadian corporation income tax, its taxable income 
could be reduced to near zero as a result of the deductible 
royalties paid to the third-country resident. If, under a 
convention between Canada and the third country, those 
royalties were either exempt from Canadian tax or subject to 
tax at a low rate, the U.S. treaty benefit with respect to the 
U.S.-source royalty income would have flowed to the third-
country resident at little or no tax cost, with no reciprocal 
benefit to the United States from the third country. The 
ownership/base erosion test therefore requires both that 
qualifying persons substantially own the entity and that the 
entity's tax base is not substantially eroded by payments 
(directly or indirectly) to nonqualifying persons.
    For purposes of this subparagraph 2(e) and other provisions 
of this Article, the term ``shares'' includes, in the case of a 
mutual insurance company, any certificate or contract entitling 
the holder to voting power in the corporation. This is 
consistent with the interpretation of similar limitation on 
benefits provisions in other U.S. treaties. In Canada, the 
principles that are reflected in subsection 256(8.1) of the 
Income Tax Act will be applied, in effect treating memberships, 
policies or other interests in a corporation incorporated 
without share capital as representing an appropriate number of 
shares.
    The look-through principles introduced by the Protocol 
(e.g. new paragraph 6 of Article IV) are to be taken into 
account when applying the ownership and base erosion provisions 
of Article XXIX A. Therefore, one ``looks through'' an entity 
that is viewed as fiscally transparent under the domestic laws 
of the residence State (other than entities that are resident 
in the source State) when applying the ownership/base erosion 
test. Assume, for example, that USCo, a company incorporated in 
the United States, wishes to obtain treaty benefits by virtue 
of the ownership and base erosion rule. USCo is owned by USLLC, 
an entity that is treated as fiscally transparent in the United 
States. USLLC in turn is wholly owned in equal shares by 10 
individuals who are residents of the United States. Because the 
United States views USLLC as fiscally transparent, the 10 U.S. 
individuals shall be regarded as the owners of USCo for 
purposes of the ownership test. Accordingly, USCo would satisfy 
the ownership requirement of the ownership/base erosion test. 
However, if USLLC were instead owned in equal shares by four 
U.S. individuals and six individuals who are not residents of 
either the United States or Canada, USCo would not satisfy the 
ownership requirement. Similarly, for purposes of the base 
erosion test, deductible payments made to USLLC will be treated 
as made to USLLC's owners.

Other qualifying persons

    Under new subparagraph 2(f), an estate resident in the 
United States or Canada is a qualifying person entitled to the 
benefits of the Convention.
    New subparagraphs 2(g) and 2(h) specify the circumstances 
under which certain types of not-for-profit organizations will 
be qualifying persons. Subparagraph 2(g) provides that a not-
for-profit organization that is resident in the United States 
or Canada is a qualifying person, and thus entitled to 
benefits, if more than half of the beneficiaries, members, or 
participants in the organization are qualifying persons. The 
term ``not-for-profit organization'' of a Contracting State is 
defined in subparagraph 5(d) of the Article to mean an entity 
created or established in that State that is generally exempt 
from income taxation in that State by reason of its not-for-
profit status. The term includes charities, private 
foundations, trade unions, trade associations, and similar 
organizations.
    New subparagraph 2(h) specifies that certain trusts, 
companies, organizations, or other arrangements described in 
paragraph 2 of Article XXI (Exempt Organizations) are 
qualifying persons. To be a qualifying person, the trust, 
company, organization or other arrangement must be established 
for the purpose of providing pension, retirement, or employee 
benefits primarily to individuals who are (or were, within any 
of the five preceding years) qualifying persons. A trust, 
company, organization, or other arrangement will be considered 
to be established for the purpose of providing benefits 
primarily to such persons if more than 50 percent of its 
beneficiaries, members, or participants are such persons. Thus, 
for example, a Canadian Registered Retirement Savings Plan 
(''RRSP'') of a former resident of Canada who is working 
temporarily outside of Canada would continue to be a qualifying 
person during the period of the individual's absence from 
Canada or for five years, whichever is shorter. A Canadian 
pension fund established to provide benefits to persons 
employed by a company would be a qualifying person only if most 
of the beneficiaries of the fund are (or were within the five 
preceding years) individual residents of Canada or residents or 
citizens of the United States.
    New subparagraph 2(i) specifies that certain trusts, 
companies, organizations, or other arrangements described in 
paragraph 3 of Article XXI (Exempt Organizations) are 
qualifying persons. To be a qualifying person, the 
beneficiaries of a trust, company, organization or other 
arrangement must be described in subparagraph 2(g) or 2(h).
    The provisions of paragraph 2 are self-executing, unlike 
the provisions of paragraph 6, discussed below. The tax 
authorities may, of course, on review, determine that the 
taxpayer has improperly interpreted the paragraph and is not 
entitled to the benefits claimed.

Paragraph 3 of Article XXIX A

    Paragraph 3 provides an alternative rule, under which a 
United States or Canadian resident that is not a qualifying 
person under paragraph 2 may claim benefits with respect to 
those items of income that are connected with the active 
conduct of a trade or business in its State of residence.
    This is the so-called ``active trade or business'' test. 
Unlike the tests of paragraph 2, the active trade or business 
test looks not solely at the characteristics of the person 
deriving the income, but also at the nature of the person's 
activity and the connection between the income and that 
activity. Under the active trade or business test, a resident 
of a Contracting State deriving an item of income from the 
other Contracting State is entitled to benefits with respect to 
that income if that person (or a person related to that person 
under the principles of Code section 482, or in the case of 
Canada, section 251 of the Income Tax Act) is engaged in an 
active trade or business in the State where it is resident, the 
income in question is derived in connection with, or is 
incidental to, that trade or business, and the size of the 
active trade or business in the residence State is substantial 
relative to the activity in the other State that gives rise to 
the income for which benefits are sought. Further details on 
the application of the substantiality requirement are provided 
below.
    Income that is derived in connection with, or is incidental 
to, the business of making or managing investments will not 
qualify for benefits under this provision, unless those 
investment activities are carried on with customers in the 
ordinary course of the business of a bank, insurance company, 
registered securities dealer, or deposit-taking financial 
institution.
    Income is considered derived ``in connection'' with an 
active trade or business if, for example, the income-generating 
activity in the State is ``upstream,'' ``downstream,'' or 
parallel to that conducted in the other Contracting State. 
Thus, for example, if the U.S. activity of a Canadian resident 
company consisted of selling the output of a Canadian 
manufacturer or providing inputs to the manufacturing process, 
or of manufacturing or selling in the United States the same 
sorts of products that were being sold by the Canadian trade or 
business in Canada, the income generated by that activity would 
be treated as earned in connection with the Canadian trade or 
business. Income is considered ``incidental'' to a trade or 
business if, for example, it arises from the short-term 
investment of working capital of the resident in securities 
issued by persons in the State of source.
    An item of income may be considered to be earned in 
connection with or to be incidental to an active trade or 
business in the United States or Canada even though the 
resident claiming the benefits derives the income directly or 
indirectly through one or more other persons that are residents 
of the other Contracting State. Thus, for example, a Canadian 
resident could claim benefits with respect to an item of income 
earned by a U.S. operating subsidiary but derived by the 
Canadian resident indirectly through a wholly-owned U.S. 
holding company interposed between it and the operating 
subsidiary. This language would also permit a resident to 
derive income from the other Contracting State through one or 
more residents of that other State that it does not wholly own. 
For example, a Canadian partnership in which three unrelated 
Canadian companies each hold a one-third interest could form a 
wholly-owned U.S. holding company with a U.S. operating 
subsidiary. The ``directly or indirectly'' language would allow 
otherwise unavailable treaty benefits to be claimed with 
respect to income derived by the three Canadian partners 
through the U.S. holding company, even if the partners were not 
considered to be related to the U.S. holding company under the 
principles of Code section 482.
    As described above, income that is derived in connection 
with, or is incidental to, an active trade or business in a 
Contracting State, must pass the substantiality requirement to 
qualify for benefits under the Convention. The trade or 
business must be substantial in relation to the activity in the 
other Contracting State that gave rise to the income in respect 
of which benefits under the Convention are being claimed. To be 
considered substantial, it is not necessary that the trade or 
business be as large as the income-generating activity. The 
trade or business cannot, however, in terms of income, assets, 
or other similar measures, represent only a very small 
percentage of the size of the activity in the other State.
    The substantiality requirement is intended to prevent 
treaty shopping. For example, a third-country resident may want 
to acquire a U.S. company that manufactures television sets for 
worldwide markets; however, since its country of residence has 
no tax treaty with the United States, any dividends generated 
by the investment would be subject to a U.S. withholding tax of 
30 percent. Absent a substantiality test, the investor could 
establish a Canadian corporation that would operate a small 
outlet in Canada to sell a few of the television sets 
manufactured by the U.S. company and earn a very small amount 
of income. That Canadian corporation could then acquire the 
U.S. manufacturer with capital provided by the third-country 
resident and produce a very large number of sets for sale in 
several countries, generating a much larger amount of income. 
It might attempt to argue that the U.S.-source income is 
generated from business activities in the United States related 
to the television sales activity of the Canadian parent and 
that the dividend income should be subject to U.S. tax at the 5 
percent rate provided by Article X (Dividends) of the 
Convention. However, the substantiality test would not be met 
in this example, so the dividends would remain subject to 
withholding in the United States at a rate of 30 percent.
    It is expected that if a person qualifies for benefits 
under one of the tests of paragraph 2, no inquiry will be made 
into qualification for benefits under paragraph 3. Upon 
satisfaction of any of the tests of paragraph 2, any income 
derived by the beneficial owner from the other Contracting 
State is entitled to treaty benefits. Under paragraph 3, 
however, the test is applied separately to each item of income.

Paragraph 4 of Article XXIX A

    Paragraph 4 provides a limited ``derivative benefits'' test 
that entitles a company that is a resident of the United States 
or Canada to the benefits of Articles X (Dividends), XI 
(Interest), and XII (Royalties), even if the company is not a 
qualifying person and does not satisfy the active trade or 
business test of paragraph 3. In general, a derivative benefits 
test entitles the resident of a Contracting State to treaty 
benefits if the owner of the resident would have been entitled 
to the same benefit had the income in question been earned 
directly by that owner. To qualify under this paragraph, the 
company must satisfy both the ownership test in subparagraph 
4(a) and the base erosion test of subparagraph 4(b).
    Under subparagraph 4(a), the derivative benefits ownership 
test requires that the company's shares representing more than 
90 percent of the aggregate vote and value of all of the shares 
of the company, and at least 50 percent of the vote and value 
of any disproportionate class of shares, in neither case 
including debt substitute shares, be owned directly or 
indirectly by persons each of whom is either (i) a qualifying 
person or (ii) another person that satisfies each of three 
tests. The three tests of subparagraph 4(a) that must be 
satisfied by these other persons are as follows:


          First, the other person must be a resident of a third 
        State with which the Contracting State that is granting 
        benefits has a comprehensive income tax convention. The 
        other person must be entitled to all of the benefits 
        under that convention. Thus, if the person fails to 
        satisfy the limitation on benefits tests, if any, of 
        that convention, no benefits would be granted under 
        this paragraph. Qualification for benefits under an 
        active trade or business test does not suffice for 
        these purposes, because that test grants benefits only 
        for certain items of income, not for all purposes of 
        the convention.

          Second, the other person must be a person that would 
        qualify for benefits with respect to the item of income 
        for which benefits are sought under one or more of the 
        tests of paragraph 2 or 3 of Article XXIX A, if the 
        person were a resident of the Contracting State that is 
        not providing benefits for the item of income and, for 
        purposes of paragraph 3, the business were carried on 
        in that State. For example, a person resident in a 
        third country would be deemed to be a person that would 
        qualify under the publicly-traded test of paragraph 2 
        of Article XXIX A if the principal class of its shares 
        were primarily and regularly traded on a stock exchange 
        recognized either under the Convention between the 
        United States and Canada or under the treaty between 
        the Contracting State granting benefits and the third 
        country. Similarly, a company resident in a third 
        country would be deemed to satisfy the ownership/base 
        erosion test of paragraph 2 under this hypothetical 
        analysis if, for example, it were wholly owned by an 
        individual resident in that third country and the 
        company's tax base were not substantially eroded by 
        payments (directly or indirectly) to nonqualifying 
        persons.

          The third requirement is that the rate of tax on the 
        item of income in respect of which benefits are sought 
        must be at least as low under the convention between 
        the person's country of residence and the Contracting 
        State granting benefits as it is under the Convention.


    Subparagraph 4(b) sets forth the base erosion test. This 
test requires that the amount of expenses that are paid or 
payable by the company in question, directly or indirectly, to 
persons that are not qualifying persons under the Convention, 
and that are deductible from gross income (with both 
deductibility and gross income as determined under the tax laws 
of the State of residence of the company), be less than 50 
percent of the gross income of the company. This test is 
applied for the fiscal period immediately preceding the period 
for which the test is being applied. If it is the first fiscal 
period of the person, the test is applied for the current 
period. This test is qualitatively the same as the base erosion 
test of subparagraph 2(e).
    Paragraph 5 of Article XXIX AParagraph 5 defines certain 
terms used in the Article. These terms were identified and 
discussed in connection with new paragraph 2, above.

Paragraph 6 of Article XXIX A

    Paragraph 6 provides that when a resident of a Contracting 
State derives income from the other Contracting State and is 
not entitled to the benefits of the Convention under other 
provisions of the Article, benefits may, nevertheless be 
granted at the discretion of the competent authority of the 
other Contracting State. This determination can be made with 
respect to all benefits under the Convention or on an item by 
item basis. In making a determination under this paragraph, the 
competent authority will take into account all relevant facts 
and circumstances relating to the person requesting the 
benefits. In particular, the competent authority will consider 
the history, structure, ownership (including ultimate 
beneficial ownership), and operations of the person. In 
addition, the competent authority is to consider (1) whether 
the creation and existence of the person did not have as a 
principal purpose obtaining treaty benefits that would not 
otherwise be available to the person, and (2) whether it would 
not be appropriate, in view of the purpose of the Article, to 
deny benefits. If the competent authority of the other 
Contracting State determines that either of these two standards 
is satisfied, benefits shall be granted.
    For purposes of implementing new paragraph 6, a taxpayer 
will be permitted to present his case to the competent 
authority for an advance determination based on a full 
disclosure of all pertinent information. The taxpayer will not 
be required to wait until it has been determined that benefits 
are denied under one of the other provisions of the Article. It 
also is expected that, if and when the competent authority 
determines that benefits are to be allowed, they will be 
allowed retroactively to the time of entry into force of the 
relevant provision of the Convention or the establishment of 
the structure in question, whichever is later (assuming that 
the taxpayer also qualifies under the relevant facts for the 
earlier period).

Paragraph 7 of Article XXIX A

    New paragraph 7 is in substance similar to paragraph 7 of 
Article XXIX A of the existing Convention and clarifies the 
application of general anti-abuse provisions. New paragraph 7 
provides that paragraphs 1 through 6 of Article XXIX A shall 
not be construed as limiting in any manner the right of a 
Contracting State to deny benefits under the Convention where 
it can reasonably be concluded that to do otherwise would 
result in an abuse of the provisions of the Convention. This 
provision permits a Contracting State to rely on general anti-
avoidance rules to counter arrangements involving treaty 
shopping through the other Contracting State.
    Thus, Canada may apply its domestic law rules to counter 
abusive arrangements involving ``treaty shopping'' through the 
United States, and the United States may apply its substance-
over-form and anti-conduit rules, for example, in relation to 
Canadian residents. This principle is recognized by the OECD in 
the Commentaries to its Model Tax Convention on Income and on 
Capital, and the United States and Canada agree that it is 
inherent in the Convention. The statement of this principle 
explicitly in the Protocol is not intended to suggest that the 
principle is not also inherent in other tax conventions 
concluded by the United States or Canada.

                               ARTICLE 26

    Article 26 of the Protocol replaces paragraphs 1 and 5 of 
Article XXIX B (Taxes Imposed by Reason of Death) of the 
Convention. In addition, paragraph 7 of the General Note 
provides certain clarifications for purposes of paragraphs 6 
and 7 of Article XXIX B.

Paragraph 1

    Paragraph 1 of Article XXIX B of the existing Convention 
generally addresses the situation where a resident of a 
Contracting State passes property by reason of the individual's 
death to an organization referred to in paragraph 1 of Article 
XXI (Exempt Organizations) of the Convention. The paragraph 
provided that the tax consequences in a Contracting State 
arising out of the passing of the property shall apply as if 
the organization were a resident of that State.
    The Protocol replaces paragraph 1, and the changes set 
forth in new paragraph 1 are intended to specifically address 
questions that have arisen about the application of former 
paragraph 1 where property of an individual who is a resident 
of Canada passes by reason of the individual's death to a 
charitable organization in the United States that is not a 
``registered charity'' under Canadian law. Under one view, 
paragraph 1 of Article XXIX B requires Canada to treat the 
passing of the property as a contribution to a ``registered 
charity'' and thus to allow all of the same deductions for 
Canadian tax purposes as if the U.S. charity had been a 
``registered charity'' under Canadian law. Under another view, 
paragraph 6 of Article XXI (Exempt Organizations) of the 
Convention continues to limit the amount of the income tax 
charitable deduction in Canada to the individual's income 
arising in the United States. The changes set forth in new 
paragraph 1 are intended to provide relief from the Canadian 
tax on gain deemed recognized by reason of death that would 
otherwise give rise to Canadian tax when the individual passes 
the property to a charitable organization in the United States, 
but, for purposes of the separate Canadian income tax, do not 
eliminate the limitation under paragraph 6 of Article XXI on 
the amount of the deduction in Canada for the charitable 
donation to the individual's income arising in the United 
States.
    As revised, paragraph 1 is divided into two subparagraphs. 
New subparagraph 1(a) applies where property of an individual 
who is a resident of the United States passes by reason of the 
individual's death to a qualifying exempt organization that is 
a resident of Canada. In such case, the tax consequences in the 
United States arising from the passing of such property apply 
as if the organization were a resident of the United States. A 
bequest by a U.S. citizen or U.S. resident (as defined for 
estate tax purposes under the Code) to an exempt organization 
generally is deductible for U.S. federal estate tax purposes 
under Code section 2055, without regard to whether the 
organization is a U.S. corporation. Thus, generally, the 
individual's estate will be entitled to a charitable deduction 
for Federal estate tax purposes equal to the value of the 
property transferred to the organization. Generally, the effect 
is that no Federal estate tax will be imposed on the value of 
the property.
    New subparagraph 1(b) applies where property of an 
individual who is a resident of Canada passes by reason of the 
individual's death to a qualifying exempt organization that is 
a resident of the United States. In such case, for purposes of 
the Canadian capital gains tax imposed at death, the tax 
consequences arising out of the passing of the property shall 
apply as if the individual disposed of the property for 
proceeds equal to an amount elected on behalf of the 
individual. For this purpose, the amount elected shall be no 
less than the individual's cost of the property as determined 
for purposes of Canadian tax, and no greater than the fair 
market value of the property. The manner in which the 
individual's representative shall make this election shall be 
specified by the competent authority of Canada. Generally, in 
the event of a full exercise of the election under new 
subparagraph 1(b), no capital gains tax will be imposed in 
Canada by reason of the death with regard to that property.
    New paragraph 1 does not address the situation in which a 
resident of one Contracting State bequeaths property with a 
situs in the other Contracting State to a qualifying exempt 
organization in the Contracting State of the decedent's 
residence. In such a situation, the other Contracting State may 
impose tax by reason of death, for example, if the property is 
real property situated in that State.

Paragraph 2

    Paragraph 2 of Article 26 of the Protocol replaces 
paragraph 5 of Article XXIX B of the existing Convention. The 
provisions of new paragraph 5 relate to the operation of 
Canadian law. Because Canadian law requires both spouses to 
have been Canadian residents in order to be eligible for the 
rollover, these provisions are intended to provide deferral 
(''rollover'') of the Canadian tax at death for certain 
transfers to a surviving spouse and to permit the Canadian 
competent authority to allow such deferral for certain 
transfers to a trust. For example, they would enable the 
competent authority to treat a trust that is a qualified 
domestic trust for U.S. estate tax purposes as a Canadian 
spousal trust as well for purposes of certain provisions of 
Canadian tax law and of the Convention. These provisions do not 
affect U.S. domestic law regarding qualified domestic trusts. 
Nor do they affect the status of U.S. resident individuals for 
any other purpose.
    New paragraph 5 adds a reference to subsection 70(5.2) of 
the Canadian Income Tax Act. This change is needed because the 
rollover in respect of certain kinds of property is provided in 
that subsection. Further, new paragraph 5 adds a clause ``and 
with respect to such property'' near the end of the second 
sentence to make it clear that the trust is treated as a 
resident of Canada only with respect to its Canadian property.
    For example, assume that a U.S. decedent with a Canadian 
spouse sets up a qualified domestic trust holding U.S. and 
Canadian real property, and that the decedent's executor 
elects, for Federal estate tax purposes, to treat the entire 
trust as qualifying for the Federal estate tax marital 
deduction. Under Canadian law, because the decedent is not a 
Canadian resident, Canada would impose capital gains tax on the 
deemed disposition of the Canadian real property immediately 
before death. In order to defer the Canadian tax that might 
otherwise be imposed by reason of the decedent's death, under 
new paragraph 5 of Article XXIX B, the competent authority of 
Canada shall, at the request of the trustee, treat the trust as 
a Canadian spousal trust with respect to the Canadian real 
property. The effect of such treatment is to defer the tax on 
the deemed distribution of the Canadian real property until an 
appropriate triggering event such as the death of the surviving 
spouse.

Paragraph 7 of the General Note

    In addition to the foregoing, paragraph 7 of the General 
Note provides certain clarifications for purposes of paragraphs 
6 and 7 of Article XXIX B. These clarifications ensure that tax 
credits will be available in cases where there are 
inconsistencies in the way the two Contracting States view the 
income and the property.
    Subparagraph 7(a) of the General Note applies where an 
individual who immediately before death was a resident of 
Canada held at the time of death a share or option in respect 
of a share that constitutes property situated in the United 
States for the purposes of Article XXIX B and that Canada views 
as giving rise to employment income (for example, a share or 
option granted by an employer). The United States imposes 
estate tax on the share or option in respect of a share, while 
Canada imposes income tax on income from employment. 
Subparagraph 7(a) provides that for purposes of clause 6(a)(ii) 
of Article XXIX B, any employment income in respect of the 
share or option constitutes income from property situated in 
the United States. This provision ensures that the estate tax 
paid on the share or option in the United States will be 
allowable as a deduction from the Canadian income tax.
    Subparagraph 7(b) of the General Note applies where an 
individual who immediately before death was a resident of 
Canada held at the time of death a registered retirement 
savings plan (RRSP) or other entity that is a resident of 
Canada and that is described in subparagraph 1(b) of Article IV 
(Residence) and such RRSP or other entity held property 
situated in the United States for the purposes of Article XXIX 
B. The United States would impose estate tax on the value of 
the property held by the RRSP or other entity (to the extent 
such property is subject to Federal estate tax), while Canada 
would impose income tax on a deemed distribution of the 
property in the RRSP or other entity. Subparagraph 7(b) 
provides that any income out of or under the entity in respect 
of the property is, for the purpose of subparagraph 6(a)(ii) of 
Article XXIX B, income from property situated in the United 
States. This provision ensures that the estate tax paid on the 
underlying property in the United States (if any) will be 
allowable as a deduction from the Canadian income tax.
    Subparagraph 7(c) of the General Note applies where an 
individual who immediately before death was a resident or 
citizen of the United States held at the time of death an RRSP 
or other entity that is a resident of Canada and that is 
described in subparagraph 1(b) of Article IV (Residence). The 
United States would impose estate tax on the value of the 
property held by the RRSP or other entity, while Canada would 
impose income tax on a deemed distribution of the property in 
the RRSP or other entity. Subparagraph 7(c) provides that for 
the purpose of paragraph 7 of Article XXIX B, the tax imposed 
in Canada is imposed in respect of property situated in Canada. 
This provision ensures that the Canadian income tax will be 
allowable as a credit against the U.S. estate tax.

                               ARTICLE 27

    Article 27 of the Protocol provides the entry into force 
and effective date of the provisions of the Protocol.

Paragraph 1

    Paragraph 1 provides generally that the Protocol is subject 
to ratification in accordance with the applicable procedures in 
the United States and Canada. Further, the Contracting States 
shall notify each other by written notification, through 
diplomatic channels, when their respective applicable 
procedures have been satisfied.

Paragraph 2

    The first sentence of paragraph 2 generally provides that 
the Protocol shall enter into force on the date of the later of 
the notifications referred to in paragraph 1, or January 1, 
2008, whichever is later. The relevant date is the date on the 
second of these notification documents, and not the date on 
which the second notification is provided to the other 
Contracting State. The January 1, 2008 date is intended to 
ensure that the provisions of the Protocol will generally not 
be effective before that date.
    Subparagraph 2(a) provides that the provisions of the 
Protocol shall have effect in respect of taxes withheld at 
source, for amounts paid or credited on or after the first day 
of the second month that begins after the date on which the 
Protocol enters into force. Further, subparagraph 2(b) provides 
that the Protocol shall have effect in respect of other taxes, 
for taxable years that begin after (or, if the later of the 
notifications referred to in paragraph 1 is dated in 2007, 
taxable years that begin in and after) the calendar year in 
which the Protocol enters into force. These provisions are 
generally consistent with the formulation in the U.S. Model 
treaty, with the exception that a parenthetical was added in 
subparagraph 2(b) to address the contingency that the written 
notifications provided pursuant to paragraph 1 may occur in the 
2007 calendar year. Further, subparagraph 3(d) of Article 27 of 
the Protocol contains special provisions with respect to the 
taxation of cross-border interest payments that have effect for 
the first two calendar years that end after the date the 
Protocol enters into force. Therefore, during this period, 
cross-border interest payments are not subject to the effective 
date provisions of subparagraph 2(a).

Paragraph 3

    Paragraph 3 sets forth exceptions to the general effective 
date rules set forth in paragraph 2 of Article 27 of the 
Protocol.

Dual corporate residence tie-breaker

    Subparagraph 3(a) of Article 27 of the Protocol provides 
that paragraph 1 of Article 2 of the Protocol relating to 
Article IV (Residence) shall have effect with respect to 
corporate continuations effected after September 17, 2000. This 
date corresponds to a press release issued on September 18, 
2000 in which the United States and Canada identified certain 
issues with respect to these transactions and stated their 
intention to negotiate a protocol that, if approved, would 
address the issues effective as of the date of the press 
release.

Certain payments through fiscally transparent entities

    Subparagraph 3(b) of Article 27 of the Protocol provides 
that new paragraph 7 of Article IV (Residence) set forth in 
paragraph 2 of Article 2 of the Protocol shall have effect as 
of the first day of the third calendar year that ends after the 
Protocol enters into force.

Permanent establishment from the provision of services

    Subparagraph 3(c) of Article 27 of the Protocol sets forth 
the effective date for the provisions of Article 3 of the 
Protocol, pertaining to Article V (Permanent Establishment) of 
the Convention. The provisions pertaining to Article V shall 
have effect as of the third taxable year that ends after the 
Protocol enters into force, but in no event shall it apply to 
include, in the determination of whether an enterprise is 
deemed to provide services through a permanent establishment 
under paragraph 9 of Article V of the Convention, any days of 
presence, services rendered, or gross active business revenues 
that occur or arise prior to January 1, 2010. Therefore, the 
provision will apply beginning no earlier than January 1, 2010 
and shall not apply with regard to any presence, services or 
related revenues that occur or arise prior to that date.

Withholding rates on cross-border interest payments

    Subparagraph 3(d) of Article 27 of the Protocol sets forth 
special effective date rules pertaining to Article 6 of the 
Protocol relating to Article XI (Interest) of the Convention. 
Article 6 of the Protocol sets forth a new Article XI of the 
Convention that provides for exclusive residence State taxation 
regardless of the relationship between the payer and the 
beneficial owner of the interest. Subparagraph 3(d), however, 
phases in the application of paragraph 1 of Article XI during 
the first two calendar years that end after the date the 
Protocol enters into force. During that period, paragraph 1 of 
Article XI of the Convention permits source State taxation of 
interest if the payer and the beneficial owner are related or 
deemed to be related by reason of paragraph 2 of Article IX 
(Related Persons) of the Convention (''related party 
interest''), and the interest would not otherwise be exempt 
under the provisions of paragraph 3 of Article XI as it read 
prior to the Protocol. However, subparagraph 3(d) also provides 
that the source State taxation on such related party interest 
is limited to 7 percent in the first calendar year that ends 
after entry into force of the Protocol and 4 percent in the 
second calendar year that ends after entry into force of the 
Protocol.
    Subparagraph 3(d) makes clear that the provisions of the 
Protocol with respect to exclusive residence based taxation of 
interest when the payer and the beneficial owner are not 
related or deemed related (''unrelated party interest'') 
applies for interest paid or credited during the first two 
calendar years that end after entry into force of the Protocol.
    The withholding rate reductions for related party interest 
and exemptions for unrelated party interest will likely apply 
retroactively. For example, if the Protocol enters into force 
on June 30, 2008, paragraph 1 of Article XI, as it reads under 
subparagraph 3(d) of Article 27, will have the following effect 
during the first two calendar years. First, unrelated party 
interest that is paid or credited on or after January 1, 2008 
will be exempt from taxation in the source State. Second, 
related party interest paid or credited on or after January 1, 
2008 and before January 1, 2009, will be subject to source 
State taxation but at a rate not to exceed 7 percent of the 
gross amount of the interest. Third, related party interest 
paid or credited on or after January 1, 2009 and before January 
1, 2010, will be subject to source State taxation but at a rate 
not to exceed 4 percent of the gross amount of the interest. 
Finally, all interest paid or credited after January 1, 2010, 
will be subject to the regular rules of Article XI without 
regard to subparagraph 3(d) of Article 27.
    Further, the provisions of subparagraph 3(d) ensure that 
even with respect to circumstances where the payer and the 
beneficial owner are related or deemed related under the 
provisions of paragraph 2 of Article IX, the source State 
taxation of such cross-border interest shall be no greater than 
the taxation of such interest prior to the Protocol.

Gains

    Subparagraph 3(e) of Article 27 of the Protocol provides 
the effective date for paragraphs 2 and 3 of Article 8 of this 
Protocol, which relate to the changes made to paragraphs 5 and 
7 of Article XIII (Gains) of the Convention. The changes set 
forth in those paragraphs shall have effect with respect to 
alienations of property that occur (including, for greater 
certainty, those that are deemed under the law of a Contracting 
State to occur) after September 17, 2000. This date corresponds 
to the press release issued on September 18, 2000 which 
announced the intention of the United States and Canada to 
negotiate a protocol that, if approved, would incorporate the 
changes set forth in these paragraphs to coordinate the tax 
treatment of an emigrant's gains in the United States and 
Canada.

Arbitration

    Subparagraph 3(f) of Article 27 of the Protocol pertains to 
Article 21 of the Protocol which implements the new arbitration 
provisions. An arbitration proceeding will generally begin two 
years after the date on which the competent authorities of the 
Contracting States began consideration of a case. Subparagraph 
3(f), however, makes clear that the arbitration provisions 
shall apply to cases that are already under consideration by 
the competent authorities when the Protocol enters into force, 
and in such cases, for purposes of applying the arbitration 
provisions, the commencement date shall be the date the 
Protocol enters into force. Further, the provisions of Article 
21 of the Protocol shall be effective for cases that come into 
consideration by the competent authorities after the date that 
the Protocol enters into force. In order to avoid the potential 
for a large number of MAP cases becoming subject to arbitration 
immediately upon the expiration of two years from entry into 
force, the competent authorities are encouraged to develop and 
implement procedures for arbitration by January 1, 2009, and 
begin scheduling arbitration of otherwise unresolvable MAP 
cases in inventory (and meeting the agreed criteria) prior to 
two years from entry into force.

Assistance in collection

    Subparagraph 3(g) of Article 27 of the Protocol pertains to 
the date when the changes set forth in Article 22 of the 
Protocol, relating to assistance in collection of taxes, shall 
have effect. Consistent with the third protocol that entered 
into force on November 9, 1995, and which had effect for 
requests for assistance on claims finally determined after 
November 9, 1985, the provisions of Article 22 of the Protocol 
shall have effect for revenue claims finally determined by an 
applicant State after November 9, 1985.
             X. Annex II.--Treaty Hearing of July 10, 2008




                                TREATIES

                              ----------                              


                        Thursday, July 10, 2008

                                        U.S. Senate
                             Committee on Foreign Relations
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 2:45 p.m., in 
Room SD-419, Dirksen Senate Office Building, Hon. Robert 
Menendez, presiding.
    Present: Senators Menendez [presiding] and Lugar.

 OPENING STATEMENT OF HON. ROBERT MENENDEZ, U.S. SENATOR FROM 
                           NEW JERSEY

    Senator Menendez.  This hearing of the Committee on Foreign 
Relations will now come to order.
    Today, the committee meets to consider 12 treaties, many of 
which represent years of work that have culminated in the 
international frameworks we will discuss today. The topics vary 
widely--tax, the environment, telecommunications--and all are 
important issues for which international coordination is 
crucial. We have an ambitious agenda today, so I will keep my 
statement brief.
    Two of the environmental treaties that we are considering 
today build on existing treaties to which the United States is 
already a party and has benefited from over the years. The 
London dumping protocol represents the culmination of a 
thorough and intensive effort to update and improve the 1972 
London Convention. The land-based sources protocol builds on 
the 1983 Convention for the Protection and Development of the 
Marine Environment of the Wider Caribbean Region, also known as 
the Cartagena Convention.
    The third treaty, the anti-fouling convention, stands on 
its own, but it was negotiated at and relies on the 
International Maritime Organization, to which the United States 
is an active member.
    The next set of treaties are tax treaties. A basic 
objective of our bilateral income tax treaties, as their full 
title implies, is to prevent double taxation of income. In many 
cases, both the country where a company is headquartered and 
the company (sic) where a company earns its income tax a 
company's earnings with the result that the same dollars are 
taxed twice.
    Tax treaties tend to allocate the right to certain income 
to the residence country rather than the source country or at 
least to limit source country taxation with the ultimate goal 
of minimizing the tax burden for the taxpayer. But in many 
ways, this is just the tip of the iceberg in terms of what tax 
treaties help the United States to accomplish.
    Tax treaties can, one, reduce tax barriers to cross-border 
trade and investment; two, provide, if well drafted, clarity 
and greater certainty to taxpayers who are attempting to assess 
their potential liability to tax in foreign jurisdictions in 
which they are doing business or working; and, three, ensure 
that U.S. taxpayers are not being subject to discriminatory 
taxes in foreign jurisdictions.
    And last, but not least, tax treaties facilitate U.S. 
Government efforts to prevent tax evasion through important, 
but often overlooked provisions that provide for the exchange 
of information between tax authorities.
    The United States is a party to 58 income tax treaties 
covering 66 countries. If we ratify the treaty with Bulgaria, 
along with the 2008 protocol, we will be adding yet another 
country to that impressive record. Today, we are considering 
four tax treaties with three different countries--Canada, 
Iceland, and Bulgaria. All are important instruments.
    It is worth noting that the Canadian protocol we consider 
today has been in negotiations for over a decade. We do a 
tremendous amount of cross-border trade with Canada, and Canada 
is our leading merchandise export destination. It is easy to 
understand why this protocol is of such importance.
    Perhaps the most important aspect of the Canada protocol is 
the binding arbitration mechanism that Treasury has negotiated. 
The first U.S. tax agreement to include a binding arbitration 
provision was the U.S.-Germany income tax treaty, which the 
committee considered and voted to approve last year.
    Many U.S. entities have been caught up in unresolved 
disputes between the tax authorities of both countries when 
interpreting and applying the convention. This arbitration 
mechanism will afford those entities some relief through final 
decisions made by an arbitration board.
    Now, I and other members have raised questions about this 
mechanism regarding how it might be improved. But I recognize 
this is a valuable addition to the U.S.-Canada tax treaty.
    The new treaty with Iceland would replace an older treaty 
from 1975. The most important aspect of this treaty is the 
addition of a strong limitation on benefits provision, which 
will, if ratified, limit abuse of our treaty with Iceland by 
nonresidents.
    The other two treaties are with Hungary and Poland. 
Consequently, these three countries present an attractive 
opportunity for treaty shopping, and it is certainly good to 
see that Treasury has worked to close this loophole. And I hope 
to see new treaties with Hungary and Poland that also include 
strong limitation on benefit provisions.
    The new treaty with Bulgaria, along with the 2008 protocol, 
would be the first income tax treaty between the United States 
and Bulgaria. The treaty is designed to reduce tax barriers to 
cross-border investment, provide for better exchange of tax 
information, and facilitate cross-border tax administration 
more generally.
    Finally, the last set of treaties are the ITU treaties, 
which was founded in 1865, barely 10 years after the first 
public message over a telegraph was sent between Washington and 
Baltimore. Back then, the organization was called the 
International Telegraph Union. Today, some 140 years later, the 
fundamental objectives of the organization remain basically 
unchanged. It is the leading international organization in the 
world for information and communication technologies, based in 
Geneva, and its membership includes 191 countries.
    Three of these treaties under consideration today amend the 
constituent documents that define the ITU and its day-to-day 
functioning, its constitution, and its convention. These 
amendments have three main objectives--to facilitate private 
sector involvement in the organization, to improve the ITU's 
working methods and flexibility as an organization in order to 
respond to rapidly changing technology and membership needs, 
and, three, to promote greater fiscal stability and 
transparency.
    The remaining two ITU treaties under consideration are 
revisions to the radio regulations, which are instruments 
negotiated under the auspices of the ITU. These treaties are 
technical instruments that address international spectrum 
allocations and radio regulations in many different services, 
including broadcasting, satellite sound broadcasting, mobile 
satellite services, and space services.
    We are pleased to have a distinguished panel of witnesses, 
who will help us understand the treaties before us. Let me, on 
behalf of the committee, welcome Ambassador Balton from the 
Department of State, the Deputy Assistant Secretary for Oceans 
and Fisheries who will be testifying on the environmental 
treaties.
    For the tax treaties, we have two witnesses. Let me welcome 
Mr. Michael Mundaca from the Department of Treasury, the Deputy 
Assistant Secretary in the Office of Tax Policy. And Ms. Emily 
McMahon, who is the Deputy Chief of Staff for the Joint 
Committee on Taxation.
    And finally, let me welcome Mr. Richard Beaird, the Senior 
Deputy U.S. Coordinator for International Communications and 
Information Policy at the Department of State, who will testify 
on the ITU treaties.
    With that, let me recognize the distinguished Ranking 
Member of the committee, Senator Lugar, for his opening 
statement.

 STATEMENT OF HON. RICHARD G. LUGAR, U.S. SENATOR FROM INDIANA

    Senator Lugar.  Well, thank you very much, Mr. Chairman, 
and I join you in welcoming our distinguished witnesses, who 
will help us examine the diverse group of treaties you have 
described.
    The Senate has an important role under the Constitution in 
the treaty-making process. And this committee's work is central 
to the exercise of that role.
    The treaties before the committee today address several 
issues in which cooperation between the United States and other 
governments can advance the interests of all parties. In the 
economic realm, the tax treaties with Bulgaria, Canada, and 
Iceland will bolster our economic relationships with countries 
that are already close trade and investment partners.
    As the United States considers how to create jobs and 
maintain economic growth, it is important that we try to 
eliminate impediments that prevent our companies from fully 
accessing international markets. We should work to ensure that 
the companies pay their fair share of taxes while not being 
unfairly taxed twice on the same revenue.
    Tax treaties are intended to prevent double taxation so 
that companies are not inhibited from doing business overseas. 
Now they also strengthen the United States Government's ability 
to enforce existing laws by enhancing our efforts to gather and 
compare information in cooperation with foreign governments. As 
the United States moves to keep the economy growing and to 
increase the United States employment, international tax 
policies that promote foreign direct investment in the United 
States are critically important.
    The three environmental treaties before us provide 
frameworks for cooperation to address a variety of threats to 
the health of our oceans. These agreements seek to combat 
pollution of the oceans from multiple sources, including the 
dumping of waste into ocean waters, the leaching of protective 
coatings applied to the hulls of ships, and the runoff of 
wastewater and agricultural pollutants. Such pollution harms 
our ability to make productive use of ocean resources and 
threatens public health.
    With respect to telecommunications, the agreements before 
us are part of the ongoing efforts of the United States to 
advance cooperation in the management and use of the radio 
spectrum under the auspices of the International 
Telecommunications Union. Reliable telecommunications 
capabilities play a critical role in economic activity and 
growth, and we have an interest in facilitating productive 
cooperation in this area.
    Today's group of treaties places a number of important 
issues on the committee's plate. Several of these agreements 
are quite detailed and will require the committee's careful 
study and analysis. I appreciate the opportunity to discuss 
these treaties and look forward to the testimony of our 
witnesses today.
    And I thank you, Mr. Chairman, for conducting the hearing.
    Senator Menendez.  Thank you. Thank you, Senator Lugar.
    With that, we will start the testimony of the witnesses. We 
ask that you keep your statements to about 5 minutes. Your 
entire statement will be included in the record, and this will 
give us some time for some questions and answers.
    And if you would start, Ambassador Balton, in the order 
that I introduced you and move down the line? Thank you.

 STATEMENT OF HON. DAVID A. BALTON, DEPUTY ASSISTANT SECRETARY 
FOR OCEANS AND FISHERIES, BUREAU OF OCEANS, ENVIRONMENTAL, AND 
   SCIENTIFIC AFFAIRS, DEPARTMENT OF STATE, WASHINGTON, D.C.

    Ambassador Balton.  Thank you very much, Mr. Chairman, 
members of the committee.
    I am pleased to testify in support of the three treaties 
designed to protect the oceans. The three treaties address 
different aspects of marine pollution. We commend the committee 
for taking advantage of this opportunity to consider them 
together. Ratification of these treaties will allow the United 
States to reinforce its leadership role on oceans at the 
international level.
    Two of these treaties require implementing legislation. The 
administration has, in both cases, forwarded to Congress draft 
legislation for this purpose. We believe that Senate advice and 
consent to these treaties would spur both houses to enact such 
legislation.
    Please allow me to highlight a few key elements of each 
treaty. First, the convention on anti-fouling systems. This 
treaty prohibits the use and application of certain paint-like 
coatings on a ship's hull. Some of these coatings, while 
effective in preventing the attachment of barnacles and similar 
creatures, have significant adverse environmental side effects.
    In particular, those coatings that contain organotin 
biocides can harm oysters and other valuable marine resources 
when those biocides leach into the water. U.S. law already 
prohibits use of such anti-foulants on most vessels in the 
United States. The United States canceled the last registration 
of organotin paint in 19--I am sorry--in 2005.
    To implement the convention fully, the administration has 
proposed new legislation that would, among other things, 
broaden existing requirements to cover all U.S. ships as well 
as foreign ships entering U.S. ports and certain other waters. 
The anti-fouling coatings industry in the United States 
supports the standards in the convention and the proposed 
implementing legislation.
    This treaty will enter into force this September. Thirty 
states representing more than 49 percent of the world's 
shipping tonnage have already adhered to it. As a party, the 
United States could participate fully in the international 
implementation of the convention, especially in the review and 
adoption of possible proposals to control other anti-fouling 
systems.
    The second treaty is a protocol to the Cartagena 
Convention, which concerns environmental protection and 
sustainable development in the Caribbean region. The United 
States ratified the convention in 1984. The protocol before the 
Senate today is actually the third protocol to this convention. 
The United States is already a party to the other two, which 
deal with oil spills and specially protected areas and 
wildlife.
    This third protocol addresses pollution of the marine 
environment from land-based sources and activities. Improving 
control over these sources of pollution, which account for an 
estimated 70 to 90 percent of all marine pollution, will help 
protect coral reefs and other sensitive coastal habitats, 
recreation, tourism, and public health.
    Among other things, the protocol sets forth specific 
effluent limitations for domestic wastewater. The United States 
already meets or exceeds these standards in all respects.
    The United States signed the protocol in 1999. Four states 
have ratified it so far. We believe U.S. ratification would 
spur others to follow suit. The protocol will enter into force 
when nine nations have adhered to it. Although the protocol 
applies only to the wider Caribbean region, it is the first 
regional agreement to establish effluent standards of this kind 
and may well serve as a model for other regions.
    The third treaty is the 1996 London protocol, which 
regulates dumping of harmful wastes and other matter into the 
sea. The protocol updates the original London convention to 
which the United States has been a party since 1975. Although 
the convention and the protocol share many features, the 
protocol will protect the marine environment more effectively.
    Where the convention generally prohibits the dumping of 
specifically listed substances, the protocol generally 
prohibits the dumping of all substances except those that are 
specifically listed. The list of substances that may be 
permitted for dumping can be amended in light of new 
information and technologies. Indeed, the list was already 
amended once to facilitate certain initiatives to sequester 
carbon dioxide below the sea floor.
    The United States would join the treaty as amended. And as 
a party, the United States would best be able to influence 
possible further changes to this list as well as fully 
participate in all issues arising under the protocol.
    The United States signed this protocol in 1998. It entered 
into force in 2006. Currently, it has 35 parties. U.S. 
ratification would not require significant changes for the 
United States. However, the administration has submitted 
proposed implementing legislation in the form of several 
amendments to the Ocean Dumping Act to bring U.S. law fully 
into conformity with the requirements of the protocol.
    Thank you very much for this opportunity to convey the 
support of the administration for these vital treaties. I would 
be happy to answer any questions.
    [The prepared statement of Ambassador Balton follows:]


            Prepared Statement of Ambassador David A. Balton

    Mr. Chairman and members of the committee: I am pleased to testify 
today in support of the Senate's provision of advice and consent to 
three treaties designed to protect the oceans. The three treaties 
address different aspects of marine pollution in distinct and vital 
ways. One controls toxic side effects of certain substances used on 
hulls to prevent attachment of barnacles and other unwanted organisms. 
Another reduces land-based sources of marine pollution in the Wider 
Caribbean Region. The third updates and improves an existing treaty on 
ocean dumping.
    As you know, the administration supported Senate action on each of 
these treaties in its February 2007 letter to Chairman Biden setting 
out its treaty priorities for the 110th Congress. Although the treaties 
are not legally or institutionally connected, we commend the committee 
for taking advantage of this opportunity to consider them together in 
an effort to send a strong message about the urgent need to protect the 
world's oceans.
    The three treaties before you are: the International Convention on 
the Control of Harmful Anti-Fouling Systems on Ships, or the ``AFS 
Convention,'' transmitted to the Senate on January 22, 2008; the 
Protocol Concerning Pollution from Land-Based Sources and Activities, 
or the ``LBS Protocol'' to the Convention for the Protection and 
Development of the Marine Environment of the Wider Caribbean Region, or 
the ``Cartagena Convention,'' transmitted to the Senate on February 16, 
2007; and the 1996 Protocol to the Convention on the Prevention of 
Marine Pollution by Dumping of Wastes and Other Matter, or the ``London 
Protocol,'' transmitted to the Senate on September 4, 2007.
    Prompt action to facilitate ratification of these treaties will 
allow the United States to reinforce and maintain its leadership role 
on oceans issues at the international and regional levels. Ratification 
would enhance our ability to work with other States to promote 
effective implementation of these treaties. As a Party to these 
treaties, the United States would be able to participate fully in 
meetings of States Parties aimed at implementation of these treaties 
and, thereby, more directly affect the implementation and 
interpretation of these treaties. Further, after the United States 
ratifies a treaty, other nations are more likely to ratify as well, 
resulting in greater overall protection of the oceans from marine 
pollution.
    The United States participated actively in the negotiation of each 
of these treaties. Our technical expertise and drafting skills 
significantly influenced the final language of each instrument. 
Throughout these processes, affected U.S. stakeholders provided 
meaningful input. We believe that ratification of all three treaties 
enjoys widespread support among these stakeholders and should not be 
contentious.
    Two of the three treaties--the London Protocol and the AFS 
Convention--require implementing legislation prior to ratification. As 
discussed in more detail below, the administration has in both cases 
developed and forwarded to Congress draft legislation for this purpose. 
We believe that early action by the Senate to provide advice and 
consent would spur both Houses to enact such legislation.
    The transmittal packages for these treaties detail the provisions 
under each regime. I would, however, like to highlight a few key 
elements in this testimony.
                    anti-fouling systems convention
    I would like to first address the AFS Convention, which was adopted 
at the International Maritime Organization (IMO) in London and aims to 
protect the marine environment and human health from the negative 
effects of certain anti-fouling systems.
    Anti-fouling systems are mainly paint-like coatings used on a 
ship's hull to prevent attachment of barnacles and other unwanted 
organisms that slow down ships. Some anti-fouling systems may adversely 
affect the marine environment through leaching of biocides into the 
water. In particular, anti-fouling systems containing organotin 
biocides can cause adverse reproductive effects and shell deformities 
in marine animals, including economically important species of oysters.
    A Party to the AFS Convention must prohibit use and application of 
organotin-based anti-fouling systems on ships flying its flag or 
operating under its authority, as well as ships entering its ports, 
shipyards, or offshore terminals. A survey and certification system, 
which the Coast Guard would implement domestically for the United 
States, serves to verify that a ship is in compliance. Domestic law 
would govern violations of the certificate system and resulting 
sanctions. The Convention contains standard language on the treatment 
of vessels entitled to sovereign immunity.
    While the treaty is currently limited to prohibitions on organotin-
based systems, Annex 1 sets forth procedures for evaluating proposals 
to add controls on other harmful anti-fouling systems, after the IMO's 
Marine Environment Protection Committee has completed a comprehensive 
risk and benefits analysis. As described in the proposed declaration 
for Article 16 in the administration's transmittal package, a Party may 
choose to require its express consent prior to being bound by any 
amendment to Annex 1. The administration recommends that the United 
States exercise this option.
    The Organotin Anti-Fouling Paint Control Act of 1988 (OAPCA), 33 
U.S.C.A. Sec. Sec. 2401-2410, restricts the release rate of organotin 
from anti-fouling systems and prohibits use of such systems on most 
vessels in the United States under 25 meters in length. The last 
organotin anti-fouling paint registration was cancelled in December 
2005. The proposed implementing legislation forwarded to Congress would 
prohibit the use of organotin anti-fouling systems on U.S. ships and 
foreign ships entering U.S. ports and certain other waters. This 
prohibition would result in greater protection of the marine 
environment in near-coastal waters of the United States, and apply the 
same standards for anti-fouling systems on U.S. vessels and foreign 
vessels entering U.S. ports. The anti-fouling coatings industry has 
consistently supported the standards in the AFS Convention and the 
proposed implementing legislation. Most international shipping 
interests have already switched to alternative anti-fouling systems 
that do not contain organotin.
    The AFS Convention will enter into force on September 17, 2008. 
Thirty States have ratified or otherwise accepted the Convention, 
including Panama, Japan, Mexico and Spain, representing more than 49% 
of the world's shipping tonnage. It would be highly desirable for the 
United States to be a Party to the Convention when it enters into 
force, or soon thereafter, so that we can participate fully in the 
international implementation of the Convention, especially the review 
of proposals to control other anti-fouling systems. Ratification of the 
treaty by the United States would more generally demonstrate our 
continued environmental leadership in this area and our support for 
more environmentally friendly anti-fouling technologies.
                      land-based sources protocol
    The second treaty I would like to address is a Protocol to the 
Cartagena Convention, a regional seas agreement negotiated under the 
auspices of the United Nations Environment Program. The Cartagena 
Convention, which the United States ratified in 1984, is a framework 
agreement that sets out general obligations to protect the marine 
environment of the Wider Caribbean Region, an area encompassing the 
Gulf of Mexico, Straits of Florida, Caribbean Sea, and the immediately 
adjacent areas of the Atlantic Ocean within 200-nautical miles of 
shore. This region is of particular importance to the United States, as 
waste from other nations combined with the circulation patterns in this 
area could result in increased pollution in U.S. waters.
    The LBS Protocol is in fact one of three subsidiary agreements to 
the Cartagena Convention. The United States is already a Party to the 
other two agreements: the Protocol Concerning Co-operation in Combating 
Oil Spills in the Wider Caribbean Region, and the Protocol Concerning 
Specially Protected Areas and Wildlife. Together, these agreements 
offer significant protection to marine and coastal resources in this 
crucial region.
    In negotiating the LBS Protocol, the United States sought to create 
requirements for other nations bordering this region that would, in 
effect, bring them up to U.S. standards with respect to controlling 
land-based sources of marine pollution. As a result of the success of 
this strategy, U.S. ratification of this instrument would not require 
new implementing legislation.
    It is estimated that 70 to 90 percent of pollution entering the 
marine environment worldwide emanates from land-based sources and 
activities. Land-based sources of pollution endanger public health, 
degrade coral reefs and other sensitive coastal habitats, undermine 
fisheries resources, and negatively affect regional economies, 
recreation, and tourism.
    The LBS Protocol elaborates on the obligation set forth in Article 
7 of the Cartagena Convention to ``take all appropriate measures to 
prevent, reduce and control pollution of the Convention area caused by 
coastal disposal or by discharges emanating from rivers, estuaries, 
coastal establishments, outfall structures, or any other sources on 
their territories.''
    Among the principal land-based sources of marine pollution in the 
Wider Caribbean Region are domestic wastewater and agricultural non-
point source runoff. Specific effluent limitations for domestic 
wastewater and a requirement to develop plans for the prevention, 
reduction and control of agricultural non-point sources of pollution 
are contained in the legally binding annexes III and IV. Annex I sets 
forth a list of additional pollutants for Parties to take into account. 
The Protocol envisions that additional annexes will be developed to 
address these pollutants, and Annex II sets out factors to be 
considered by the Parties in developing such annexes. While these 
original four annexes apply to all Protocol Parties, a Party to the 
Protocol may choose to require its express consent prior to being bound 
by any additional annexes that may be adopted in the future. As 
described in the proposed declaration under Article XVII of the 
transmittal package, the administration recommends that the United 
States exercise this option.
    While having significant beneficial impacts in a region of specific 
interest to the United States, the Protocol is also expected to have an 
impact even beyond the Wider Caribbean Region, as it is the first 
regional agreement to establish effluent standards to protect the 
marine environment. It therefore serves as a model for other regions 
that are also seeking to address this urgent problem.
    The United States signed the LBS Protocol in October 1999. It is 
not yet in force, as only four of the nine necessary ratifications for 
entry into force have been received--from France, Panama, Saint Lucia, 
and Trinidad and Tobago.
    However, given the strong leadership role played by the United 
States in the negotiation of the Protocol, U.S. ratification would 
provide strong encouragement to other States to become contracting 
parties. Indeed, several States in the region have indicated that they 
would be more likely to join following U.S. ratification.
                            london protocol
    The third treaty before you is the 1996 London Protocol, a treaty 
designed to protect the world's oceans from the dumping of harmful 
wastes and other matter. The Protocol regulates deliberate disposal at 
sea of wastes or other matter from vessels, aircraft, platforms, or 
man-made structures at sea. The Protocol also bans incineration at sea 
of all wastes or other matter. It represents the culmination of a 
thorough and intensive effort to update the 1972 London Convention, to 
which the United States has been a Party since 1975. The Protocol is a 
free-standing treaty that is intended eventually to replace the London 
Convention.
    Although the Protocol and the London Convention share many 
features, the Protocol will protect the marine environment more 
effectively. The Protocol moves from a structure of listing substances 
that may not be dumped to a ``reverse list'' approach, which generally 
prohibits ocean dumping of all wastes or other matter, except for a few 
specified wastes in Annex 1. When considering whether to allow the 
dumping of a waste or other matter listed in Annex 1, a Party must 
follow detailed environmental assessment criteria found in Annex 2, 
which provide a complete waste management strategy, including 
consideration of alternatives to ocean disposal.
    A few types of activities are not considered dumping under the 
Protocol. These include placement of matter, such as research devices 
or artificial reefs, for a purpose other than mere disposal, provided 
that such placement is not contrary to the aims of the Protocol. 
Activities related to oil and gas exploration are excluded from the 
definition of dumping. Further, there are exceptions for ``force 
majeure'' and emergency situations. The Protocol contains standard 
language on the sovereign immunity of ships.
    The Protocol, like the Convention, requires a Party to use a permit 
process to regulate dumping activities within areas subject to national 
jurisdiction, on vessels loaded in its territory and on vessels flying 
its flag. Permits are issued and violations are addressed domestically.
    The list of substances on Annex 1 that currently may be considered 
for dumping is meant to be a dynamic list that can be amended when 
necessary as new information and technologies develop. For example, an 
amendment, which the U.S. supported, was adopted in November 2006 to 
add carbon dioxide streams from carbon dioxide capture processes for 
sequestration, to allow for the possibility of sequestration in sub-
seabed geological formations. The United States would join the treaty 
as amended. As a party, of course, the United States would be able to 
have a say in the addition of other substances to this list, thereby 
protecting its interests in determining how and when the ocean may be 
used for dumping.
    The administration's transmittal package proposes one declaration 
and one understanding to be deposited along with the instrument of 
ratification. The declaration in Article 3 stems from a suggestion of 
the United States during the negotiations that at the time of 
ratification, a State may declare that its consent is required before 
it may be subject to binding arbitration about the interpretation or 
application of the general principles in Article 3.1 or 3.2 on 
precaution and polluter pays. The administration proposes making such a 
declaration for the United States.
    With respect to Article 10, the administration proposes an 
understanding making clear that disputes regarding the interpretation 
or application of the Protocol with respect to sovereign immune vessels 
are not subject to Article 16 dispute settlement procedures.
    The United States signed the Protocol on March 31, 1998. It entered 
into force on March 24, 2006, having met the 26-State requirement. It 
currently has 35 Parties. The IMO serves as the Secretariat for both 
the Convention and the Protocol.
    Now that the London Protocol has entered into force, it is highly 
desirable for the United States to join. The United States supported 
the updating and improvements of the Convention that the Protocol 
reflects. Further, it is important for the United States to maintain 
its current leadership role in this area and to ensure our 
participation in the development of policies and procedures under the 
Protocol.
    The administration has transmitted to Congress a legislative 
proposal to implement the London Protocol in the form of amendments to 
the Ocean Dumping Act. While ratification of the Protocol would not 
require significant changes to the U.S. ocean dumping program as it 
currently operates, some changes to the Ocean Dumping Act would be 
needed. For example, it has long been U.S. practice not to authorize 
incineration at sea or dumping of low-level radioactive wastes. The 
proposed amendments to the Ocean Dumping Act would explicitly reflect 
those prohibitions.
                               conclusion
    United States' ratification of the treaties before you today would 
advance our national interest and would promote our leadership on the 
prevention of marine pollution. These treaties are widely supported and 
not contentious in our view.
    Thank you, Mr. Chairman and members of the committee for this 
opportunity to convey the support of the administration for this 
effort. I urge that the committee give prompt and favorable 
consideration to these treaties. I would be happy to answer any 
questions.


    Senator Menendez.  Thank you.
    Mr. Mundaca?

   STATEMENT OF MICHAEL MUNDACA, DEPUTY ASSISTANT SECRETARY 
   (INTERNATIONAL), OFFICE OF TAX POLICY, DEPARTMENT OF THE 
                   TREASURY, WASHINGTON, D.C.

    Mr. Mundaca.  Mr. Chairman, ranking member Lugar, I 
appreciate the opportunity to appear today to recommend on 
behalf of the administration favorable action on three tax 
treaties. We appreciate the committee's interest in these 
treaties and in the tax treaty network generally.
    One of the primary functions of tax treaties is to provide 
certainty to taxpayers regarding whether their cross-border 
activities will subject them to tax in another country. Another 
primary function is to relieve double taxation, including 
through the reduction of withholding tax rates.
    Tax treaties also provide a mechanism for dealing with tax 
treaty disputes, most often regarding double taxation. To 
resolve disputes, designated officials of the two governments, 
known as the competent authorities, consult and endeavor to 
reach agreement.
    In addition, tax treaties include provisions related to tax 
administration, including information exchange, which is a 
priority for the United States. In fact, the inclusion of 
appropriate information exchange provisions is one of the few 
tax treaty matters we regard as non-negotiable.
    The treaties before the committee today with Canada, 
Iceland, and Bulgaria would further the goals of our tax treaty 
program, and we urge the committee and the Senate to take 
prompt and favorable action on these agreements, which I will 
now describe very briefly.
    The proposed protocol with Canada is the fifth protocol to 
the current convention. The most significant provisions in this 
protocol relate to the taxation of cross-border interest, the 
treatment of income derived from fiscally transparent entities, 
the taxation of services, and mandatory binding arbitration.
    More specifically, the proposed protocol eliminates 
withholding taxes on cross-border interest, which has been a 
priority for the U.S. business community and the U.S. Treasury 
Department for a number of years, and represents a substantial 
improvement over the current convention, which generally 
provides for a 10 percent withholding tax rate.
    In addition, the proposed protocol provides for mandatory 
binding arbitration of certain cases not able to be resolved by 
the competent authorities. The U.S. competent authority has a 
good track record in resolving disputes. Even in the most 
cooperative bilateral relationships, however, there will be 
instances in which the competent authorities will not be able 
to reach a timely and satisfactory result.
    The mandatory binding arbitration provision included in the 
protocol with Canada was negotiated contemporaneously with and 
is very similar to a provision in our tax treaties with Germany 
and Belgium, which this committee and the Senate considered 
last year. We look forward to continuing to work with this 
committee to make arbitration an effective tool in promoting 
fair and expeditious resolution of tax treaty disputes.
    The committee's comments made with respect to the German 
and Belgian arbitration provisions have been very helpful and 
will inform future negotiations of arbitration provisions.
    Finally, the proposed protocol with Canada would allow 
taxation of income from certain provisions of services not 
subject to source country tax under the current convention. 
This rule is broader than the rule in the U.S. model treaty but 
was key to achieving an overall agreement that we believe is in 
the best interests of the U.S. taxpayers and the United States.
    The proposed convention with Iceland would replace the 
current convention concluded in 1975. The most important change 
from the current convention is the addition of a limitation on 
benefits provision. The current convention does not contain 
anti-treaty shopping provisions and, as a result, has been 
abused by third country investors.
    The proposed convention generally provides for withholding 
tax rates on investment income that are the same as or lower 
than those in the current convention. However, while the 
current convention eliminates withholding tax on cross-border 
payments of royalties, the proposed convention would allow 
withholding tax of 5 percent on certain trademark royalty 
payments. Inclusion of this provision was key to achieving an 
overall agreement.
    The proposed convention with Bulgaria will be the first tax 
treaty between our two countries. Under the proposed 
convention, withholding taxes on dividend payments can be 
imposed at a maximum rate of 10 percent, lowered to 5 percent 
in the case of a dividend paid to a company that directly holds 
at least 10 percent of the company paying the dividend.
    The proposed convention generally limits withholding taxes 
on cross-border interest and cross-border royalty payments to 5 
percent. And the proposed convention includes a rule, similar 
to the rule in the proposed protocol with Canada, allowing 
source country taxation of income from services in certain 
cases.
    Mr. Chairman and ranking member Lugar, let me conclude by 
thanking you for the opportunity to appear before the committee 
to discuss these three tax agreements. We thank the committee 
members and staff for devoting the time and attention to the 
review of these new agreements, and we are grateful for the 
assistance and cooperation of the staff on the Joint Committee 
on Taxation.
    On behalf of the administration, we urge the committee and 
the Senate to take prompt and favorable action on the 
agreements before you, and I would be happy to answer any 
questions you might have.
    [The prepared statement of Mr. Mundaca follows:]


                 Prepared Statement of Michael Mandaca

    Mr. Chairman, ranking member Lugar, and distinguished members of 
the committee, I appreciate the opportunity to appear today to 
recommend, on behalf of the administration, favorable action on three 
tax treaties pending before this committee. We appreciate the 
committee's interest in these treaties and in the U.S. tax treaty 
network overall.
    This administration is committed to eliminating barriers to cross-
border trade and investment, and tax treaties are the primary means for 
eliminating tax barriers to such trade and investment. Tax treaties 
provide greater certainty to taxpayers regarding their potential 
liability to tax in foreign jurisdictions; they allocate taxing rights 
between the two jurisdictions and include other provisions that reduce 
the risk of double taxation, including provisions that reduce gross-
basis withholding taxes; and they ensure that taxpayers are not subject 
to discriminatory taxation in the foreign jurisdiction.
    This administration is also committed to preventing tax evasion, 
and our tax treaties play an important role in this area as well. A key 
element of U.S. tax treaties is exchange of information between tax 
authorities. Under tax treaties, one country may request from the other 
such information as may be relevant for the proper administration of 
the first country's tax laws. Because access to information from other 
countries is critically important to the full and fair enforcement of 
U.S. tax laws, information exchange is a top priority for the United 
States in its tax treaty program.
    A tax treaty reflects a balance of benefits that is agreed to when 
the treaty is negotiated. In some cases, changes in law or policy in 
one or both of the treaty partners make the partners more willing to 
increase the benefits beyond those provided by the treaty; in these 
cases, negotiation of a revised treaty may be very beneficial. In other 
cases, developments in one or both countries, or international 
developments more generally, may make is desirable to revisit a treaty 
to prevent exploitation of treaty provisions and eliminate unintended 
and inappropriate consequences in the application of the treaty; in 
these cases, it may be expedient to modify the agreement. Both in 
setting our overall negotiation priorities and in negotiating 
individual treaties, our focus is on ensuring that our tax treaty 
network fulfills its goals of facilitating cross border trade and 
investment and preventing fiscal evasion.
    The treaties before the committee today with Canada, Iceland, and 
Bulgaria serve to further the goals of our tax treaty network. The 
treaties with Canada and Iceland would modify existing tax treaty 
relationships. The tax treaty with Bulgaria would be the first between 
our two countries. We urge the committee and the Senate to take prompt 
and favorable action on all of these agreements.
    Before discussing the pending treaties in more detail, I would like 
to address some more general tax treaty matters, to provide background 
for the committee's and the Senate's consideration of the pending tax 
treaties.
                 purposes and benefits of tax treaties
    Tax treaties set out clear ground rules that govern tax matters 
relating to trade and investment between the two countries.
    One of the primary functions of tax treaties is to provide 
certainty to taxpayers regarding the threshold question with respect to 
international taxation: whether a taxpayer's cross-border activities 
will subject it to taxation by two or more countries. Tax treaties 
answer this question by establishing the minimum level of economic 
activity that must be engaged in within a country by a resident of the 
other before the first country may tax any resulting business profits. 
In general terms, tax treaties provide that if branch operations in a 
foreign country have sufficient substance and continuity, the country 
where those activities occur will have primary (but not exclusive) 
jurisdiction to tax. In other cases, where the operations in the 
foreign country are relatively minor, the home country retains the sole 
jurisdiction to tax.
    Another primary function is relief of double taxation. Tax treaties 
protect taxpayers from potential double taxation primarily through the 
allocation of taxing rights between the two countries. This allocation 
takes several forms. First, the treaty has a mechanism for resolving 
the issue of residence in the case of a taxpayer that otherwise would 
be considered to be a resident of both countries. Second, with respect 
to each category of income, the treaty assigns the primary right to tax 
to one country, usually (but not always) the country in which the 
income arises (the ``source'' country), and the residual right to tax 
to the other country, usually (but not always) the country of residence 
of the taxpayer (the ``residence'' country). Third, the treaty provides 
rules for determining which country will be treated as the source 
country for each category of income. Finally, the treaty establishes 
the obligation of the residence country to eliminate double taxation 
that otherwise would arise from the exercise of concurrent taxing 
jurisdiction by the two countries.
    In addition to reducing potential double taxation, tax treaties 
also reduce potential ``excessive'' taxation by reducing withholding 
taxes that are imposed at source. Under U.S. law, payments to non-U.S. 
persons of dividends and royalties as well as certain payments of 
interest are subject to withholding tax equal to 30 percent of the 
gross amount paid. Most of our trading partners impose similar levels 
of withholding tax on these types of income. This tax is imposed on a 
gross, rather than net, amount. Because the withholding tax does not 
take into account expenses incurred in generating the income, the 
taxpayer that bears the burden of withholding tax frequently will be 
subject to an effective rate of tax that is significantly higher than 
the tax rate that would be applicable to net income in either the 
source or residence country. The taxpayer may be viewed, therefore, as 
suffering excessive taxation. Tax treaties alleviate this burden by 
setting maximum levels for the withholding tax that the treaty partners 
may impose on these types of income or by providing for exclusive 
residence-country taxation of such income through the elimination of 
source-country withholding tax. Because of the excessive taxation that 
withholding taxes can represent, the United States seeks to include in 
tax treaties provisions that substantially reduce or eliminate source-
country withholding taxes.
    As a complement to these substantive rules regarding allocation of 
taxing rights, tax treaties provide a mechanism for dealing with 
disputes between the countries regarding the treaties, including 
questions regarding the proper application of the treaties that arise 
after the treaty enters into force. To resolve disputes, designated tax 
authorities of the two governments--known as the ``competent 
authorities'' in tax treaty parlance--are to consult and to endeavor to 
reach agreement. Under many such agreements, the competent authorities 
agree to allocate a taxpayer's income between the two taxing 
jurisdictions on a consistent basis, thereby preventing the double 
taxation that might otherwise result. The U.S. competent authority 
under our tax treaties is the Secretary of the Treasury. That function 
has been delegated to the Deputy Commissioner (International) of the 
Large and Mid-Size Business Division of the Internal Revenue Service.
    Tax treaties also include provisions intended to ensure that cross-
border investors do not suffer discrimination in the application of the 
tax laws of the other country. This is similar to a basic investor 
protection provided in other types of agreements, but the non-
discrimination provisions of tax treaties are specifically tailored to 
tax matters and, therefore, are the most effective means of addressing 
potential discrimination in the tax context. The relevant tax treaty 
provisions explicitly prohibit types of discriminatory measures that 
once were common in some tax systems. At the same time, tax treaties 
clarify the manner in which possible discrimination is to be tested in 
the tax context.
    In addition to these core provisions, tax treaties include 
provisions dealing with more specialized situations, such as rules 
coordinating the pension rules of the tax systems of the two countries 
or addressing the treatment of Social Security benefits and alimony and 
child-support payments in the cross-border context. These provisions 
are becoming increasingly important as more individuals move between 
countries or otherwise are engaged in cross-border activities. While 
these matters may not involve substantial tax revenue from the 
perspective of the two governments, rules providing clear and 
appropriate treatment are very important to the affected taxpayers.
    Tax treaties also include provisions related to tax administration. 
A key element of U.S. tax treaties is the provision addressing the 
exchange of information between the tax authorities. Under tax 
treaties, the competent authority of one country may request from the 
other competent authority such information as may be relevant for the 
proper administration of the first country's tax laws; the information 
provided pursuant to the request is subject to the strict 
confidentiality protections that apply to taxpayer information. Because 
access to information from other countries is critically important to 
the full and fair enforcement of the U.S. tax laws, information 
exchange is a priority for the United States in its tax treaty program. 
If a country has bank-secrecy rules that would operate to prevent or 
seriously inhibit the appropriate exchange of information under a tax 
treaty, we will not enter into a new tax treaty relationship with that 
country. Indeed, the need for appropriate information exchange 
provisions is one of the treaty matters that we consider non-
negotiable.
             tax treaty negotiating priorities and process
    The United States has a network of 58 income tax treaties covering 
66 countries. This network covers the vast majority of foreign trade 
and investment of U.S. businesses and investors. In establishing our 
negotiating priorities, our primary objective is the conclusion of tax 
treaties that will provide the greatest benefit to the United States 
and to U.S. taxpayers. We communicate regularly with the U.S. business 
community and the Internal Revenue Service, seeking input regarding the 
areas in which treaty network expansion and improvement efforts should 
be focused and seeking information regarding practical problems 
encountered under particular treaties and particular tax regimes.
    The primary constraint on the size of our tax treaty network may be 
the complexity of the negotiations themselves. Ensuring that the 
various functions to be performed by tax treaties are all properly 
taken into account makes the negotiation process exacting and time 
consuming.
    Numerous features of a country's particular tax legislation and its 
interaction with U.S. domestic tax rules must be considered in 
negotiating a treaty or protocol. Examples include whether the country 
eliminates double taxation through an exemption system or a credit 
system, the country's treatment of partnerships and other transparent 
entities, and how the country taxes contributions to pension funds, 
earnings of the funds, and distributions from the funds.
    Moreover, a country's fundamental tax policy choices are reflected 
not only in its tax legislation but also in its tax treaty positions. 
These choices differ significantly from country to country, with 
substantial variation even across countries that seem to have quite 
similar economic profiles. A treaty negotiation must take into account 
all of these aspects of the particular treaty partner's tax system and 
treaty policies to arrive at an agreement that accomplishes the United 
States' tax treaty objectives.
    Obtaining the agreement of our treaty partners on provisions of 
importance to the United States sometimes requires concessions on our 
part. Similarly, the other country sometimes must make concessions to 
obtain our agreement on matters that are critical to it. Each treaty 
that we present to the Senate represents not only the best deal that we 
believe can be achieved with the particular country, but also 
constitutes an agreement that we believe is in the best interests of 
the United States.
    In some situations, the right result may be no tax treaty at all. 
Prospective treaty partners must evidence a clear understanding of what 
their obligations would be under the treaty, especially those with 
respect to information exchange, and must demonstrate that they would 
be able to fulfill those obligations. Sometimes a tax treaty may not be 
appropriate because a potential treaty partner is unable to do so.
    In other cases, a tax treaty may be inappropriate because the 
potential treaty partner is not willing to agree to particular treaty 
provisions that are needed to address real tax problems that have been 
identified by U.S. businesses operating there or because the potential 
treaty partner insists on provisions the United States will not agree 
to, such as providing a U.S. tax credit for investment in the foreign 
country (so-called ``tax sparing''). With other countries there simply 
may not be the type of cross-border tax issues that are best resolved 
by treaty. For example, if a country does not impose significant income 
taxes, there is little possibility of double taxation of cross-border 
income, and an agreement that is focused on the exchange of tax 
information (``tax information exchange agreements'' or TIEAs) may be 
the most appropriate agreement.
    A high priority for improving our overall treaty network is 
continued focus on prevention of ``treaty shopping.'' The U.S. 
commitment to including comprehensive limitation on benefits provisions 
is one of the keys to improving our overall treaty network. Our tax 
treaties are intended to provide benefits to residents of the United 
States and residents of the particular treaty partner on a reciprocal 
basis. The reductions in source-country taxes agreed to in a particular 
treaty mean that U.S. persons pay less tax to that country on income 
from their investments there and residents of that country pay less 
U.S. tax on income from their investments in the United States. Those 
reductions and benefits are not intended to flow to residents of a 
third country. If third-country residents are able to exploit one of 
our tax treaties to secure reductions in U.S. tax, such as through the 
use of an entity resident in a treaty country that merely holds passive 
U.S. assets, the benefits would flow only in one direction as third-
country residents would enjoy U.S. tax reductions for their U.S. 
investments, but U.S. residents would not enjoy reciprocal tax 
reductions for their investments in that third country. Moreover, such 
third-country residents may be securing benefits that are not 
appropriate in the context of the interaction between their home 
country's tax systems and policies and those of the United States. This 
use of tax treaties is not consistent with the balance of the deal 
negotiated in the underlying tax treaty. Preventing this exploitation 
of our tax treaties is critical to ensuring that the third country will 
sit down at the table with us to negotiate on a reciprocal basis, so we 
can secure for U.S. persons the benefits of reductions in source-
country tax on their investments in that country.
                      consideration of arbitration
    Tax treaties cannot facilitate cross-border investment and provide 
a more stable investment environment unless the treaty is effectively 
implemented by the tax administrations of the two countries. Under our 
tax treaties, when a U.S. taxpayer becomes concerned about 
implementation of the treaty, the taxpayer can bring the matter to the 
U.S. competent authority who will seek to resolve the matter with the 
competent authority of the treaty partner. The competent authorities 
will work cooperatively to resolve genuine disputes as to the 
appropriate application of the treaty.
    The U.S. competent authority has a good track record in resolving 
disputes. Even in the most cooperative bilateral relationships, 
however, there will be instances in which the competent authorities 
will not be able to reach a timely and satisfactory resolution. 
Moreover, as the number and complexity of cross-border transactions 
increases, so does the number and complexity of cross-border tax 
disputes. Accordingly, we have considered ways to equip the U.S. 
competent authority with additional tools to resolve disputes promptly, 
including the possible use of arbitration in the competent authority 
mutual agreement process.
    The first U.S. tax agreement that contemplated arbitration was the 
U.S.-Germany income tax treaty signed in 1989. Tax treaties with 
several other countries, including Canada, Mexico, and the Netherlands, 
incorporate authority for establishing voluntary binding arbitration 
procedures based on the provision in the prior U.S.-Germany treaty. 
Although we believe that the presence of these voluntary arbitration 
provisions may have provided some limited assistance in reaching mutual 
agreements, it has become clear that the ability to enter into 
voluntary arbitration does not provide sufficient incentive to resolve 
problem cases in a timely fashion.
    Over the past few years, we have carefully considered and studied 
various types of mandatory arbitration procedures that could be used as 
part of the competent authority mutual agreement process. In 
particular, we examined the experience of countries that adopted 
mandatory binding arbitration provisions with respect to tax matters. 
Many of them report that the prospect of impending mandatory 
arbitration creates a significant incentive to compromise before 
commencement of the process. Based on our review of the U.S. experience 
with arbitration in other areas of the law, the success of other 
countries with arbitration in the tax area, and the overwhelming 
support of the business community, we concluded that mandatory binding 
arbitration as the final step in the competent authority process can be 
an effective and appropriate tool to facilitate mutual agreement under 
U.S. tax treaties.
    One of the treaties before the committee, the Protocol with Canada, 
includes a type of mandatory arbitration provision negotiated 
contemporaneously with, and very similar to, a provision in our 
current, recently ratified treaties with Germany and Belgium, which 
this committee and the Senate considered last year.
    In the typical competent authority mutual agreement process, a U.S. 
taxpayer presents its problem to the U.S. competent authority and 
participates in formulating the position the U.S. competent authority 
will take in discussions with the treaty partner. Under the arbitration 
provision proposed in the Canadian protocol, as in the similar 
provisions that are now part of our treaties with Germany and Belgium, 
if the competent authorities cannot resolve the issue within two years, 
the competent authorities must present the issue to an arbitration 
board for resolution, unless both competent authorities agree that the 
case is not suitable for arbitration. The arbitration board must 
resolve the issue by choosing the position of one of the competent 
authorities. That position is adopted as the agreement of the competent 
authorities and is treated like any other mutual agreement (i.e., one 
that has been negotiated by the competent authorities) under the 
treaty.
    Because the arbitration board can only choose between the positions 
of each competent authority, the expectation is that the differences 
between the positions of the competent authorities will tend to narrow 
as the case moves closer to arbitration. In fact, if the arbitration 
provision is successful, difficult issues will be resolved without 
resort to arbitration. Thus, it is our expectation that these 
arbitration provisions will be rarely utilized, but that their presence 
will encourage the competent authorities to take approaches to their 
negotiations that result in mutually agreed conclusions in the first 
instance.
    The arbitration process proposed in the agreement with Canada, 
consistent with the German and Belgian provisions, is mandatory and 
binding with respect to the competent authorities. However, consistent 
with the negotiation process under the mutual agreement procedure, the 
taxpayer can terminate the arbitration at any time by withdrawing its 
request for competent authority assistance. Moreover, the taxpayer 
retains the right to litigate the matter (in the United States or the 
treaty partner) in lieu of accepting the result of the arbitration, 
just as it would be entitled to litigate in lieu of accepting the 
result of a negotiation under the mutual agreement procedure.
    Arbitration is a growing and developing field, and there are many 
forms of arbitration from which to choose. We intend to continue to 
study other arbitration provisions and to monitor the performance of 
the provisions in the agreements with Belgium and Germany, as well as 
the performance of the provision in the agreement with Canada, if 
ratified. We look forward to continuing to work with the committee to 
make arbitration an effective tool in promoting the fair and 
expeditious resolution of treaty disputes. The committee's comments 
made with respect to the German and Belgian arbitration provisions have 
been very helpful and will inform future negotiations of arbitration 
provisions.
                    discussion of proposed treaties
    I now would like to discuss in more detail the three treaties that 
have been transmitted for the Senate's consideration. We have submitted 
a Technical Explanation of each treaty that contains detailed 
discussions of the provisions of each treaty. These Technical 
Explanations serve as an official guide to each treaty. The Technical 
Explanation to the Protocol with Canada was reviewed by Canada, and 
Canada subscribes to its contents, as will be confirmed by a press 
release from the Canadian Ministry of Finance.
Canada
    The proposed Protocol with Canada was signed in Chelsea on 
September 21, 2007, and is the fifth protocol of amendment to the 
current Convention negotiated in 1980 and amended by prior protocols in 
1983, 1984, 1995, and 1997. The most significant provisions in this 
treaty relate to the taxation of cross-border interest, the treatment 
of income derived through fiscally transparent entities, the taxation 
of certain provisions of services, and the adoption of mandatory 
arbitration to facilitate the resolution of disputes between the U.S. 
and Canadian revenue authorities. The proposed Protocol also makes a 
number of changes to reflect changes in U.S. and Canadian law, and to 
bring the current Convention into closer conformity with current U.S. 
tax treaty policy.
    The proposed Protocol eliminates withholding taxes on cross-border 
interest payments. The elimination of withholding taxes on all cross-
border interest payments between the United States and Canada has been 
a top tax treaty priority for both the business community and the 
Treasury Department for many years. The proposed Protocol represents a 
substantial improvement over the current Convention, which generally 
provides for a source-country withholding tax rate of 10 percent. This 
provision would be effective for interest paid to unrelated parties on 
the first day of January of the year in which the proposed Protocol 
enters into force, and it would be phased in for interest paid to 
related persons over a three-year period. Consistent with U.S. tax 
treaty policy, the proposed Protocol also provides exceptions to the 
elimination of source-country taxation with respect to contingent 
interest and payments from a U.S. real estate mortgage investment 
conduit.
    The proposed Protocol also would provide that a U.S. person is 
generally eligible to claim the benefits of the treaty when such person 
derives income through an entity that is considered by the United 
States to be fiscally transparent (e.g., a partnership) unless the 
entity is a Canadian entity and is not treated by Canada as fiscally 
transparent. The proposed Protocol in addition contains anti-abuse 
provisions intended to address certain situations involving the use of 
these entities to obtain treaty benefits inappropriately.
    The current Convention generally limits the taxation by one country 
of the business profits of a resident of the other country. The source 
country's right to tax such profits is generally limited to cases in 
which the profits are attributable to a permanent establishment located 
in that country. The proposed Protocol would add provisions related to 
the taxation of permanent establishments. Most importantly, the 
proposed Protocol includes a special rule allowing source-country 
taxation of income from certain provisions of services not otherwise 
considered to be provided through a permanent establishment. This rule 
is broader than the permanent establishment rule in the U.S. Model tax 
treaty but was key to achieving an overall agreement that we believe is 
in the best interests of the United States and U.S. taxpayers.
    As previously noted, the proposed Protocol provides for mandatory 
arbitration of certain cases that have not been resolved by the 
competent authority within a specified period, generally two years from 
the commencement of the case. Under the proposed Protocol, the 
arbitration process may be used to reach an agreement with respect to 
certain issues relating to residence, permanent establishment, business 
profits, related persons, and royalties. The arbitration board must 
deliver a determination within six months of the appointment of the 
chair of the arbitration board, and the determination must either be 
the proposed resolution submitted by the United States or the proposed 
resolution submitted by Canada. The board's determination has no 
precedential value and the board shall not provide a rationale for its 
determination.
    The proposed Protocol also makes a number of other modifications to 
the current Convention to reflect changes to U.S. law and current U.S. 
tax treaty policy. For example, the proposed Protocol updates the 
current Convention's treatment of pensions for cross-border workers to 
remove barriers to the flow of personal services between the United 
States and Canada that could otherwise result from discontinuities in 
the laws of the two countries regarding the tax treatment of pensions. 
In addition, the proposed Protocol updates the current Convention's 
limitation on benefits provisions so that they apply on a reciprocal 
basis. The proposed Protocol also addresses the treatment of companies 
that engages in corporate ``continuance'' transactions and revises the 
current Convention's rules regarding the residence of so-called dual 
resident companies.
    The proposed Protocol provides that the United States and Canada 
shall notify each other in writing, through diplomatic channels, when 
their respective applicable procedures for ratification have been 
satisfied. The proposed Protocol will enter into force upon the date of 
the later of the required notifications. For taxes withheld at source, 
it will generally have effect for amounts paid or credited on or after 
the first day of the second month that begins after the date the 
proposed Protocol enters into force, although certain provisions with 
respect to interest may have earlier effect. With respect to other 
taxes, the proposed Protocol will generally have effect for taxable 
years that begin after the calendar year in which the proposed Protocol 
enters into force. Certain provisions will be phased in or have a 
delayed effective date. Provisions regarding corporate continuance 
transactions will apply retroactively, consistent with prior Treasury 
Department public statements.
Iceland
    The proposed Convention and accompanying Protocol with Iceland was 
signed in Washington, D.C., on October 23, 2007. It would replace the 
current Convention, concluded in 1975. The most important change from 
the current Convention is the addition of a limitation on benefits 
provision. The proposed Convention also makes changes to some of the 
withholding tax rates provided in the current Convention. In addition, 
the proposed Convention makes a number of changes to reflect changes in 
U.S. and Icelandic law, and to conform to current U.S. tax treaty 
policy.
    As just noted, the proposed Convention contains a comprehensive 
limitation on benefits provision, generally following the current U.S. 
Model income tax treaty. The current Convention does not contain treaty 
shopping protections and, as a result, has been abused by third-country 
investors in recent years. For this reason, revising the current 
Convention has been a top tax treaty priority.
    The proposed Convention generally provides for withholding rates on 
investment income that are the same as or lower than those in the 
current Convention. Like the current Convention, the proposed 
Convention provides for reduced source-country taxation of cross-border 
dividends. In addition, the proposed Convention would eliminate source-
country withholding tax on cross-border dividend payments to pension 
funds. As with the current Convention, the proposed Convention 
generally would eliminate source-country withholding tax on cross-
border interest payments. However, while the current Convention 
eliminates source-country withholding taxes on all cross-border 
payments of royalties, the proposed Convention would allow the country 
in which certain cross-border trademark royalties arise to impose a 
withholding tax of up to 5 percent. Inclusion of this provision was key 
to achieving an overall agreement that we believe is in the best 
interests of the United States and U.S. taxpayers.
    In addition, the proposed Convention provides for the exchange 
between the tax authorities of each country of information relevant to 
carrying out the provisions of the agreement or the domestic tax laws 
of either country.
    The proposed Convention provides that the United States and Iceland 
shall notify each other in writing, through diplomatic channels, when 
their respective applicable procedures for ratification have been 
satisfied. The proposed Convention will enter into force on the date of 
the later of the required notifications. It will have effect, with 
respect to taxes withheld at source, for amounts paid or credited on or 
after the first day of January of the calendar year following entry 
into force, and with respect to other taxes, for taxable years 
beginning on or after the first day of January following the date upon 
which the proposed Convention enters into force. The current Convention 
will, with respect to any tax, cease to have effect as of the date on 
which this proposed Convention has effect with respect to such tax. 
However, where any person would be entitled to greater benefits under 
the current Convention, at the election of the person, the current 
Convention shall continue to have effect in its entirety with respect 
to such person for a period of 12 months from the date the provisions 
of the proposed Convention are effective.
Bulgaria
    The proposed income tax Convention and accompanying Protocol with 
Bulgaria signed in Washington, D.C., on February 23, 2007, and the 
subsequent Protocol with Bulgaria signed in Sofia, on February 26, 
2008, together would represent the first income tax treaty between the 
United States and Bulgaria. The proposed Convention is generally 
consistent with the current U.S. Model income tax treaty and with 
treaties that the United States has with other countries.
    Under the proposed Convention, withholding taxes on cross-border 
portfolio dividend payments may be imposed by the source state at a 
maximum rate of 10 percent. When the beneficial owner of a cross-border 
dividend is a company that directly owns at least 10 percent of the 
stock of the company paying the dividend, withholding tax may be 
imposed at a maximum rate of 5 percent. The proposed Convention also 
provides for a withholding rate of zero on cross-border dividend 
payments to pension funds.
    The proposed Convention generally limits withholding taxes on 
cross-border interest payments to a maximum rate of 5 percent. No 
withholding tax on a cross-border interest payment is generally 
permitted, however, when the interest is beneficially owned by, or 
guaranteed by, the government or the central bank of the other country 
(or any institution owned by that country), a pension fund resident in 
the other country, or a financial institution (including a bank or an 
insurance company) resident in the other country.The proposed 
Convention provides that withholding taxes on cross-border royalty 
payments are limited to a maximum rate of 5 percent.
    The proposed Convention also incorporates rules provided in the 
U.S. Model tax treaty for certain classes of investment income. For 
example, dividends paid by entities such as U.S. regulated investment 
companies and real estate investment trusts, are subject to special 
rules to prevent the use of these entities to transform what is 
otherwise higher-taxed income into lower-taxed income.
    The proposed Convention limits the taxation by one country of the 
business profits of a resident of the other country. The source 
country's right to tax such profits is generally limited to cases in 
which the profits are attributable to a permanent establishment located 
in that country. The proposed Convention includes a rule, similar to a 
rule in the proposed Protocol with Canada, allowing source-country 
taxation of income from certain provisions of services. The proposed 
Convention also provides that certain employees or agents that maintain 
a stock of goods from which the agent regularly fills orders on behalf 
of the principal, and conduct additional activities contributing to the 
conclusion of sales, may result in a permanent establishment.
    Consistent with current U.S. tax treaty policy, the proposed 
Convention includes a comprehensive limitation on benefits article, 
which is designed to deny treaty shoppers the benefits of the 
Convention. The proposed Convention provides for non-discriminatory 
treatment by one country to residents and nationals of the other 
country. In addition, the proposed Convention provides for the exchange 
between the tax authorities of each country of information relevant to 
carrying out the provisions of the agreement or the domestic tax laws 
of either country. This will facilitate the enforcement of U.S. 
domestic tax rules.
    The proposed Convention provides that the United States and 
Bulgaria shall notify each other, through diplomatic channels, when 
their respective applicable procedures for ratification have been 
satisfied.
    The proposed Convention will enter into force upon the date of 
receipt of the later of the required notifications. It will have 
effect, with respect to taxes withheld at source, for amounts paid or 
credited on or after the first day of January in the year following the 
date upon which the proposed Convention enters into force and, with 
respect to other taxes, for taxable years beginning on or after the 
first day of January in the year following the date upon which the 
proposed Convention enters into force.
                       treaty program priorities
    A key continuing priority for the Treasury Department is updating 
the few remaining U.S. tax treaties that provide for low withholding 
tax rates but do not include the limitation on benefits provisions 
needed to protect against the possibility of treaty shopping. 
Accordingly, we currently are in ongoing discussions with both Poland 
and Hungary regarding the inclusion of anti-treaty shopping provisions.
    In addition, we continue to maintain a very active calendar of tax 
treaty negotiations. We recently initialed a new tax treaty with Malta. 
We also are currently negotiating with France and New Zealand, and 
expect to announce soon the opening of other negotiations.
    We also have undertaken exploratory discussions with several 
countries in Asia and South America that we hope will lead to 
productive negotiations later in 2008 or in 2009.
                               conclusion
    Mr. Chairman and ranking member Lugar, let me conclude by thanking 
you for the opportunity to appear before the committee to discuss the 
administration's efforts with respect to the three agreements under 
consideration. We appreciate the committee's continuing interest in the 
tax treaty program, and we thank the members and staff for devoting 
time and attention to the review of these new agreements. We are also 
grateful for the assistance and cooperation of the staff of the Joint 
Committee on Taxation.
    On behalf of the administration, we urge the committee to take 
prompt and favorable action on the agreements before you today. I would 
be happy to respond to any question you may have.


    Senator Menendez.  Thank you.
    Ms. McMahon?

  STATEMENT OF EMILY S. MCMAHON, DEPUTY CHIEF OF STAFF, JOINT 
COMMITTEE ON TAXATION, UNITED STATES CONGRESS, WASHINGTON, D.C.

    Ms. McMahon.  Thank you, Mr. Chairman.
    I appreciate the opportunity to present the testimony of 
the staff of the Joint Committee on Taxation concerning the 
proposed protocol with Canada and the proposed treaties with 
Iceland and Bulgaria.
    As we have in the past, the Joint Committee staff has 
prepared pamphlets concerning the proposed protocol and the 
treaties. These provide detailed descriptions of their 
provisions and comparisons with the U.S. model treaty and with 
other recent U.S. income tax treaties. Therefore, in my time 
today, I am going to focus just on a few of the more 
significant features of the proposed agreements.
    First, with respect to Canada, as has been mentioned, the 
proposed protocol would modify an existing treaty with Canada 
that was signed in 1980. Most of the provisions are intended to 
bring the treaty more in line with other recent U.S. treaties, 
but there are at least four provisions that merit particular 
attention.
    The first is that the proposed protocol would reduce the 
rate of withholding tax on interest payments from 10 percent 
under the existing treaty to zero in most cases. The existing 
treaty with Canada is only--is one of only a handful of U.S. 
treaties that currently permit withholding on interest 
payments. So the proposed protocol would bring the Canadian 
treaty in line with most other U.S. treaties and with the 
model.
    The protocol does not, however, provide for a zero rate of 
withholding on dividends paid by a subsidiary to a corporate 
parent, and that is a distinction from several of the more 
recent--a number of the more recent treaties with major trading 
partners.
    Second, the proposed protocol, as has been mentioned, would 
replace the voluntary arbitration procedures of the present 
treaty with a mandatory binding arbitration procedure for 
resolving disputes between the competent authorities. The U.S. 
model also does not include a mandatory arbitration procedure, 
but a similar provision does appear in the recent treaties with 
Belgium and Germany.
    We understand that there are a significant number of 
competent authority cases now pending between the United States 
and Canada and that, historically, a substantial number of 
these cases simply have not been resolved. The mandatory 
arbitration procedure is intended to ensure that tax disputes 
between the two countries are resolved effectively and within a 
limited time period. In fact, the mere existence of the 
procedure is expected to encourage the competent authorities to 
settle cases promptly in order to avoid arbitration.
    However, it will take time to determine whether the 
procedure is effective or whether there may be unexpected 
problems. At this point, it is still too early to assess the 
effect of the mandatory arbitration provisions in the treaties 
with Germany and Belgium, and therefore, the committee may wish 
to understand how the Treasury Department intends to monitor 
the effectiveness of the arbitration procedures in all three of 
these treaties and the extent to which future treaties are 
expected to include similar procedures.
    Third, the proposed protocol would add some new rules 
regarding the circumstances in which income earned through or 
paid by fiscally transparent entities will be entitled to 
treaty benefits. In many respects, those rules are consistent 
with existing U.S. internal tax rules. However, they also 
include some more restrictive rules that are designed to 
address so-called double-dip financing structures under which 
U.S. and Canadian taxpayers have used fiscally transparent 
hybrid entities to produce income that effectively escapes tax 
in both countries.
    And finally, the proposed protocol adds a special rule 
under which income from services performed by an enterprise of 
one country in the other country can be taxed in the recipient 
country even if the service provider does not otherwise have a 
permanent establishment in that country. A similar provision 
appears in several existing U.S. treaties with developing 
countries and in the proposed treaty with Bulgaria, but this is 
the first time that such a provision has been proposed with a 
developed country.
    There are a number of unresolved questions regarding the 
administration of this provision, and the committee may wish to 
understand whether discussion is going on between the U.S. and 
Canada to resolve these questions, especially in light of the 
substantial flow of cross-border services between the two 
countries.
    With respect to Iceland, the proposed treaty would replace 
an existing treaty signed in 1975. And in most respects, the 
proposed new treaty is consistent with the U.S. model and other 
recent U.S. treaties. But as indicated earlier, its most 
significant feature is the inclusion of a comprehensive modern 
limitation on benefits provision that will prevent the 
inappropriate use of the treaty by third country residents, a 
practice known as treaty shopping.
    The present treaty with Iceland is one of three treaties, 
the others being Hungary and Poland, that are especially--
present especially attractive opportunities for treaty 
shopping. And the fact that the new treaty with Iceland 
includes a comprehensive limitation on benefits provision will 
eliminate one of those major opportunities.
    And finally, with respect to Bulgaria, the proposed treaty 
would be the first treaty with that country, the first income 
tax treaty with that country. It is generally consistent with 
the provisions of the U.S. model and with other recent treaties 
with developing countries.
    A somewhat unusual feature is that it does permit a 5 
percent withholding rate on interest and dividends, but that is 
consistent with an EU directive that Bulgaria is eligible for 
for a transitional period in respect to payments to other EU 
countries, and Bulgaria has agreed to reconsider that rate in 
2014 in connection with the expiration of that transitional 
period.
    And finally, as mentioned earlier, the Bulgaria treaty does 
have the same services provision that appears in the Canadian 
treaty. But that is not so unusual in this case, given that 
this is a treaty with a developing country.
    As I mentioned earlier, all of these provisions and issues 
are discussed in more detail in the Joint Committee pamphlets, 
and I would be happy to answer any questions that the committee 
may have either now or in the future.
    Thank you.
    [The prepared statement of Ms. McMahon follows:]


                 Prepared Statement of Emily S. McMahon

    My name is Emily S. McMahon. I am Deputy Chief of Staff of the 
Joint Committee on Taxation. It is my pleasure to present today the 
testimony of the staff of the Joint Committee on Taxation concerning 
the proposed protocol to the income tax treaty with Canada and the 
proposed income tax treaties with Iceland and Bulgaria.\1\
---------------------------------------------------------------------------
    \1\This document may be cited as follows: Joint Committee on 
Taxation, Testimony of the Staff of the Joint Committee on Taxation 
Before the Senate Committee on Foreign Relations Hearing on the 
Proposed Protocol to the Income Tax Treaty with Canada and the Proposed 
Tax Treaties with Iceland and Bulgaria (JCX-60-08), July 10, 2008. This 
publication can also be found at www.jct.gov.
---------------------------------------------------------------------------
                                overview
    As in the past, the Joint Committee staff has prepared pamphlets 
covering the proposed protocol and treaties. The pamphlets provide 
detailed descriptions of the proposed protocol and treaties, including 
comparisons with the United States Model Income Tax Convention of 
November 15, 2006 (the ``U.S. Model treaty''), prepared by the Treasury 
Department, and with other recent U.S. income tax treaties.\2\ The 
pamphlets also provide detailed discussions of certain issues raised by 
the proposed protocol and treaties. We consulted with the Treasury 
Department and with the staff of your committee in analyzing the 
proposed protocol and treaties and in preparing the pamphlets.
---------------------------------------------------------------------------
    \2\Joint Committee on Taxation, Explanation of Proposed Protocol to 
the Income Tax Treaty Between the United States and Canada (JCX-57-08), 
July 8, 2008; Joint Committee on Taxation, Explanation of Proposed 
Income Tax Treaty Between the United States and Iceland (JCX-58-08), 
July 8, 2008; Joint Committee on Taxation, Explanation of Proposed 
Income Tax Treaty Between the United States and Bulgaria (JCX-59-08), 
July 8, 2008.
---------------------------------------------------------------------------
    The principal purposes of the protocol and each treaty are to 
reduce or eliminate double taxation of income earned by residents of 
either the United States or the treaty country from sources within the 
other country and to prevent avoidance or evasion of the taxes of the 
two countries. The proposed protocol and each treaty also are intended 
to promote close economic cooperation between the United States and the 
respective treaty country and to eliminate possible barriers to trade 
and investment caused by the overlapping taxing jurisdictions of the 
United States and the treaty country. As in other U.S. income tax 
treaties, these objectives principally are achieved through each 
country's agreement to limit, in certain specified situations, its 
right to tax income derived from its territory by residents of the 
other country.
    The proposed protocol with Canada would make several modifications 
to an existing income tax treaty that was signed in 1980. The U.S.-
Canada income tax treaty has been modified by four previous protocols, 
in 1983, 1984, 1995, and 1997. The proposed income tax treaty with 
Iceland, together with a contemporaneously signed protocol, would 
replace an existing treaty signed in 1975. The proposed income tax 
treaty with Bulgaria, together with the proposed 2007 and 2008 
protocols, would be the first income tax treaty between the United 
States and Bulgaria.
    My testimony today will highlight some of the significant features 
of the proposed protocol and treaties and certain issues that they 
raise.
U.S. Model treaty
    In November 2006, the Treasury Department released the present U.S. 
Model treaty.\3\ As a general matter, the U.S. model tax treaties are 
intended to provide a framework for U.S. tax treaty policy and a 
starting point for negotiations with our treaty partners. These models 
provide helpful information to taxpayers, the Congress, and foreign 
governments as to U.S. policies on tax treaty matters. Periodical 
updates to reflect new developments and congressional views with regard 
to particular issues of U.S. tax treaty policy ensure that the model 
treaties remain meaningful and relevant.
---------------------------------------------------------------------------
    \3\For a comparison of the 2006 U.S. model income tax treaty with 
its 1996 predecessor, see Joint Committee on Taxation, Comparison of 
the United States Model Income Tax Convention of September 15, 1996 
with the United States Model Income Tax Convention of November 15, 2006 
(JCX-27-07), May 8, 2007.
---------------------------------------------------------------------------
    The present U.S. Model treaty incorporates the key developments in 
U.S. income tax treaty policy that are reflected in recent U.S. income 
tax treaties. The proposed protocol and treaties that are the subject 
of this hearing are generally consistent with the provisions found in 
the U.S. Model treaty. However, there are some significant differences 
from the U.S. Model treaty that I will discuss.
Limitation-on-benefits provisions
    One important area in which the proposed protocol and treaties are 
generally consistent with the U.S. Model treaty is the inclusion in all 
three proposed instruments of a comprehensive limitation-on-benefits 
provision. These limitation-on-benefits provisions generally are 
intended to make it more difficult for residents of countries other 
than the United States and the treaty partner to benefit 
inappropriately from the treaty.
    When a resident of one country derives income from another country, 
the internal tax rules of the two countries may cause that income to be 
taxed in both countries. One purpose of a bilateral income tax treaty 
is to allocate taxing rights for cross-border income and thereby to 
prevent double taxation of residents of the treaty countries. Although 
a bilateral income tax treaty is intended to apply only to residents of 
the two treaty countries, residents of third countries may attempt to 
benefit from a treaty by engaging in a practice known as ``treaty 
shopping.'' Treaty shopping may involve directing an investment in one 
treaty country through an entity organized in the other treaty country 
or engaging in income-stripping transactions with a treaty-country 
resident. Limitation-on-benefits provisions are intended to deny treaty 
benefits in certain cases of treaty shopping.
    The proposed treaty with Iceland contains a detailed limitation-on-
benefits provision (Article 21) that reflects the anti-treaty-shopping 
provisions included in the U.S. Model treaty and more recent U.S. 
income tax treaties. In contrast, the present treaty between the United 
States and Iceland is one of only eight remaining U.S. income tax 
treaties that do not include any limitation-on-benefits rules. Three of 
those eight treaties, including the treaties with Iceland, Hungary, and 
Poland, provide for a complete exemption from withholding on interest 
payments from one treaty country to the other treaty country. 
Consequently, those three treaties present particularly attractive 
opportunities for treaty-shopping. In fact, a November 2007 report 
prepared by the Treasury Department at the request of the U.S. Congress 
suggests that the income tax treaties with Hungary and Iceland have 
increasingly been used for treaty-shopping purposes in recent years as 
the United States adopted modern limitation-on-benefits provisions in 
its other treaties.\4\ The proposed treaty with Iceland, including its 
modern limitation-on-benefits rules, would thus eliminate a significant 
treaty-shopping opportunity. Nevertheless, the Committee may wish to 
inquire of the Treasury Department regarding its plans to address the 
remaining U.S. income tax treaties that do not include limitation-on-
benefits provisions, and in particular the treaties with Hungary and 
Poland.
---------------------------------------------------------------------------
    \4\Department of the Treasury, Report to the Congress on Earnings 
Stripping, Transfer Pricing and U.S. Income Tax Treaties (Nov. 28, 
2007). The report states that, as of 2004, it does not appear that the 
U.S.-Poland income tax treaty has been extensively exploited by third-
country residents.
---------------------------------------------------------------------------
    The proposed protocol with Canada replaces Article XXIX A 
(Limitation on Benefits) of the present treaty with a new article that 
reflects the anti-treaty-shopping provisions included in the U.S. Model 
treaty and more recent U.S. income tax treaties. Unlike the rules in 
the present treaty (which may be applied only by the United States), 
the new rules are reciprocal and are intended to prevent the indirect 
use of the treaty by persons who are not entitled to its benefits by 
reason of residence in Canada or the United States.
    The proposed treaty with Bulgaria also contains a detailed 
limitation-on-benefits provision similar to that of the U.S. Model 
treaty to prevent the inappropriate use of the treaty by third-country 
residents (Article 21).
``Zero-rate'' dividend provisions
    Another significant similarity between the U.S. Model treaty and 
the proposed protocol and treaties is the lack of a ``zero-rate'' of 
withholding tax on certain intercompany dividends. Until 2003, no U.S. 
income tax treaty provided for a complete exemption from dividend 
withholding tax, and the U.S. Model treaty and the 2005 Model 
Convention on Income and Capital of the Organisation for Economic Co-
operation and Development (``OECD'') do not provide an exemption. By 
contrast, many bilateral income tax treaties of other countries 
eliminate withholding taxes on direct dividends between treaty 
countries, and the European Union (``EU'') Parent-Subsidiary Directive 
repeals withholding taxes on intra-EU direct dividends (determined by 
reference to a 15-percent ownership threshold in 2007).
    Moreover, the recent U.S. income tax treaties and protocols with 
Australia, Japan, Mexico, the Netherlands, Sweden, the United Kingdom, 
Germany, Belgium, Denmark, and Finland include zero-rate dividend 
provisions. Eligibility for this zero rate generally is contingent on 
meeting an 80-percent ownership threshold and certain additional 
requirements. The Senate ratified those treaties and protocols in 2003 
(Australia, Mexico, and the United Kingdom), 2004 (Japan and the 
Netherlands), 2006 (Sweden), and 2007 (Germany, Belgium, Denmark, and 
Finland). On the other hand, neither the recent protocol with France 
nor the recent treaties with Bangladesh and Sri Lanka include an 
exemption from dividend withholding.
    In general, the dividend articles of the proposed protocol and 
treaties provide a maximum source-country withholding tax rate of 15 
percent (10 percent under the proposed treaty with Bulgaria) and a 
reduced five-percent maximum rate for dividends received by a company 
owning at least 10 percent of the dividend-paying company. A zero rate 
of withholding is generally available under the proposed protocol and 
treaties for dividends received by a pension fund. The proposed 
protocol and treaties also include special rules for dividends received 
from U.S. regulated investment companies and real estate investment 
trusts. These special rules generally are similar to provisions 
included in other recent U.S. treaties and protocols.
    In previous testimony before the Committee, the Treasury Department 
has indicated that zero-rate dividend provisions should be allowed only 
under treaties that have restrictive limitation-on-benefits rules and 
that provide comprehensive information exchange. Even in those 
treaties, according to previous Treasury Department statements, 
dividend withholding tax should be eliminated only based on an 
evaluation of the overall balance of benefits under the treaty. The 
Committee may wish to consider what overall balance of considerations 
prompted the Treasury Department not to seek a zero-rate provision in 
the proposed protocol and treaties, all of which have comprehensive 
limitation-on-benefits and information-exchange provisions.
Mandatory and binding arbitration provision in proposed protocol with 
        Canada
    One important feature of the proposed protocol with Canada is the 
replacement of the voluntary arbitration procedure of Article XXVI 
(Mutual Agreement Procedure) of the present treaty with a mandatory 
arbitration procedure that is sometimes referred to as ``last best 
offer'' arbitration. Under this procedure, each of the competent 
authorities proposes one and only one figure for settlement of a 
dispute, and the arbitrator must select one of those figures as the 
award. The last best offer approach is intended to induce the competent 
authorities to moderate their positions, including before arbitration 
proceedings would commence, and thus to increase the possibility of a 
negotiated settlement. Under the proposed protocol, unless a taxpayer 
or other ``concerned person'' (in general, a person whose tax liability 
is affected by the arbitration determination) does not accept the 
arbitration determination, it is binding on the treaty countries with 
respect to the case.
    The U.S. Model treaty does not include a mandatory arbitration 
procedure. However, the use of mandatory and binding arbitration in tax 
disputes between countries is not a novel concept. A provision similar 
to the provision in the proposed protocol with Canada does appear in 
the protocol with Germany and the treaty with Belgium, both ratified by 
the Senate in 2007. Also in 2007, the OECD Committee on Fiscal Affairs 
adopted proposed changes to its model treaty and commentary that 
incorporate a mandatory and binding arbitration procedure, some 
elements of which are generally similar to those of the proposed 
protocol. The OECD has announced that it will be adopting those changes 
in final form shortly. In addition, the EU has adopted certain 
mandatory and binding arbitration procedures that are applicable to 
transfer pricing disputes between members of the EU.
    Judging from the actions taken by the OECD and the EU, unresolved 
competent authority proceedings appear to be a multinational 
occurrence. As a general matter, it is beneficial to resolve tax 
disputes effectively and efficiently. The new arbitration procedures 
included in the proposed protocol are intended to ensure that the 
mutual agreement procedures occur pursuant to a schedule and that all 
cases are resolved within a limited time period.
    We understand that there are a significant number of competent 
authority cases pending between the United States and Canada, and that, 
historically, a substantial number of double taxation cases have not 
been satisfactorily resolved by the U.S. and Canadian competent 
authorities. The Treasury Department does not release statistics that 
reflect competent authority activities by individual treaty partners. 
While many expect that the proposed mandatory and binding arbitration 
procedures will be successful in resolving recurring issues and will 
encourage the competent authorities to settle cases without resort to 
arbitration, it will take time to ascertain if these procedures are 
effective or if unexpected problems arise.
    Meanwhile, the Treasury Department or other trading partners may 
seek to negotiate treaty provisions with current or future treaty 
partners that are similar, in whole or in part, to the arbitration 
procedures of the proposed treaty and protocol. It is still too early 
to assess the effect of the addition of mandatory arbitration 
provisions to the Germany and Belgium treaties on the competent 
authority processes with respect to those countries. Therefore, the 
Committee may wish to better understand how the Treasury Department 
intends to monitor the competent authority function, as well as 
arbitration developments with respect to other countries, to determine 
the overall effects of the new arbitration procedures on the mutual 
agreement process. The Committee may wish to consider what information 
is needed to measure whether the proposed arbitration procedures result 
in more efficient case resolution, both before and during arbitration, 
and whether they enhance the quality of the outcome of the competent 
authority cases. In addition, the Committee may wish to inquire as to 
whether and under what circumstances the Treasury Department intends to 
pursue similar provisions in other treaties.
    The Committee may also wish to consider certain specific features 
of the arbitration procedures included in the proposed protocol. For 
example, the mandatory arbitration procedure is available under the 
proposed protocol only with respect to certain articles specified by 
the treaty partners in diplomatic notes accompanying the protocol.\5\ 
The Committee may wish to inquire about the basis for selection of 
those particular articles and the implications of excluding the others. 
Other points that the Committee may wish to clarify include the extent 
to which decisions of the arbitration board will be taken into account 
in subsequent competent authority cases involving the same taxpayer, 
the same issue and substantially similar facts, and the application of 
the mandatory arbitration procedures to competent authority cases 
already pending on the date on which the proposed protocol enters into 
force.
---------------------------------------------------------------------------
    \5\These articles are: Article IV (Residence), but only to the 
extent the case relates to the residence of natural persons; Article V 
(Permanent Establishment); Article VII (Business Profits); Article IX 
(Related Persons); and Article XII (Royalties), but only to the extent 
the case relates (1) to the application of Article XII to transactions 
involving related persons, or (2) to an allocation of amounts between 
taxable and non-taxable royalties.
---------------------------------------------------------------------------
Other provisions of the proposed protocol with Canada
    The proposed protocol modifies a number of the provisions in the 
existing treaty. The rules of the proposed protocol generally are 
similar to rules of recent U.S. income tax treaties, the U.S. Model 
treaty, and the 2005 Model Convention on Income and on Capital of the 
Organisation for Economic Cooperation and Development (the ``OECD Model 
treaty''). However, the existing treaty, as amended by the proposed 
protocol, contains certain substantive deviations from these treaties 
and models.
    The proposed protocol amends Article IV (Residence) of the existing 
treaty specifically to address companies that are residents of both 
treaty countries. The proposed protocol provides that if such a dual-
resident company is created under the laws in force in a treaty country 
but not under the laws in force in the other treaty country, the 
company is deemed to be a resident only of the first treaty country. If 
that rule does not apply (for example, because a company created in one 
country is continued in the other country in accordance with its 
corporate law), the competent authorities of the treaty countries must 
endeavor to settle the question of residency by mutual agreement and 
determine the mode of application of the treaty to the company. In the 
absence of such an agreement, the company is not considered to be a 
resident of either treaty country for purposes of claiming any benefits 
under the treaty.
    The proposed protocol also amends Article IV of the existing treaty 
to provide specific rules regarding the circumstances in which amounts 
of income, profit, or gain are deemed to be derived through or paid by 
fiscally transparent entities. In general, an amount of income, profit, 
or gain is considered to be derived by a resident of a treaty country 
if (1) that person is considered under the taxation law of that country 
to have derived the amount through an entity, other than an entity that 
is a resident of the other treaty country, and (2) by reason of that 
entity being treated as fiscally transparent under the laws of the 
first treaty country, the treatment of the amount under the taxation 
law of that country is the same as its treatment would be if that 
amount had been derived directly by that person. Notwithstanding the 
general rule, an amount of income, profit, or gain is considered not to 
be paid to or derived by a person who is a resident of a treaty country 
if (1) that person is considered under the taxation law of the other 
treaty country as deriving the amount through an entity that is not a 
resident of the first treaty country, but (2) by reason of the entity 
not being treated as fiscally transparent under the laws of that treaty 
country, the treatment of the amount under the taxation law of that 
country is not the same as its treatment would be if that amount had 
been derived directly by the person. These rules are consistent with 
present U.S. tax rules.
    The proposed protocol provides an additional rule applicable in the 
area of fiscally transparent entities that is new to the U.S. tax 
treaty network. Under this new rule, an amount of income, profit, or 
gain is not considered to be paid to or derived by a person who is a 
resident of a treaty country if (1) the person is considered under the 
tax law of the other treaty country to have received the amount from an 
entity resident in the other treaty country, but (2) by reason of the 
entity being treated as fiscally transparent under the laws of the 
first treaty country, the treatment of the amount received by that 
person under the tax law of that country is not the same as its 
treatment would be if the entity were treated as not fiscally 
transparent under the laws of that country. Thus, treaty benefits may 
not be claimed with respect to such payments. There is some uncertainty 
with regard to how this rule applies to deductible payments made by 
hybrid partnerships, and the Committee may wish to inquire about this 
point.
    The proposed protocol amends Article V of the existing treaty to 
add a special rule under which services performed by an enterprise of a 
treaty country in the other treaty country may give rise to a permanent 
establishment in the other country if the enterprise exceeds certain 
levels of presence in the other country and if certain other conditions 
are met. The special rule applies if the enterprise does not have a 
permanent establishment in the other country by virtue of any of the 
customary treaty standards. A similar provision appears in several 
existing U.S. tax treaties with developing countries (and in the 
proposed treaty with Bulgaria), but this is the first time such a 
provision has been proposed with a developed country. If certain 
additional conditions are met, the provision would subject individual 
employees to taxation as well. There are several unresolved questions 
regarding the administration of this provision. The Committee may wish 
to inquire whether active discussion is occurring between the United 
States and Canada on these matters, and whether these questions will be 
resolved before the protocol becomes effective.
    The proposed protocol applies the treaty partners' interpretation 
of the arm's-length standard in a manner consistent with the OECD 
Transfer Pricing Guidelines to the attribution of profits to a 
permanent establishment under Article VII, taking into account the 
different economic and legal circumstances of a single legal entity. 
Under the proposed protocol, the business profits to be attributed to a 
permanent establishment include only the profits derived from the 
assets used, risks assumed, and activities performed by the permanent 
establishment. The proposed protocol also amends Article VII of the 
existing treaty to clarify that income may be attributable to a 
permanent establishment that no longer exists in one of the treaty 
countries. In addition, the proposed protocol provides that income 
derived from independent personal services (i.e., income from the 
performance of professional services and of other activities of an 
independent character) is included within the meaning of the term 
``business profits.'' Accordingly, the treatment of such income is 
governed by Article VII rather than by present treaty Article XIV 
(Independent Personal Services), which the proposed protocol deletes. 
These new rules are similar to provisions included in other recent U.S. 
treaties and protocols, including the U.S Model treaty.
    The proposed protocol modifies Article X (Dividends) of the present 
treaty to reflect more closely the dividend provisions included in the 
U.S. Model treaty and recent U.S. income tax treaties. The 
modifications include a revised definition of the term ``dividends'' 
and an updated special rule that applies to dividends paid by U.S. 
REITs.
    The proposed protocol replaces Article XI (Interest) of the present 
treaty with a new article that generally provides for exclusive 
residence-country taxation of interest. Limited exceptions permit 
source-country taxation of interest if the beneficial owner of the 
interest carries on, or has carried on, business through a permanent 
establishment in the source country and the debt-claim in respect of 
which the interest is paid is effectively connected with that permanent 
establishment. Two anti-abuse provisions relating to contingent 
interest payments and residual interests in real estate mortgage 
investment conduits also permit source-country taxation of interest. 
Special rules apply to cases involving a non-arm's-length interest 
charge between a payer and a beneficial owner that have a special 
relationship.
    The proposed protocol conforms Article XII (Royalties) to the 
proposed elimination of Article XIV (Independent Personal Services) and 
clarifies the treatment of income attributable to a permanent 
establishment that has ceased to exist.
    The proposed protocol modifies Article XIII (Gains) of the present 
treaty in two principal respects. First, the proposed protocol narrows 
the emigration exception to the Article's rule providing for exclusive 
residence-country taxation of gains from the alienation of property in 
cases other than those specifically enumerated in Article XIII. The 
proposed protocol provides that this exception will not apply if the 
property was treated as alienated immediately before an individual's 
emigration. Second, the proposed protocol provides a revised election 
intended to coordinate U.S. and Canadian taxation of gains in the case 
of timing mismatches.
    The proposed protocol conforms Article XV (Dependent Personal 
Services) of the present treaty to the U.S. and OECD Model treaties, as 
well as to the proposed elimination of Article XIV (Independent 
Personal Services), and broadens the definition of ``remuneration. In 
addition, the proposed protocol changes the rules with respect to 
calculating the number of days an individual is present in the other 
treaty country for purposes of determining if a resident of one treaty 
country may be taxed by the other treaty country. The proposed protocol 
also contains provisions intended to eliminate potential abuses through 
the use of intermediary employers. The diplomatic notes exchanged in 
connection with the proposed protocol set forth new rules for 
allocating income from the exercise or disposal of an option between 
the two treaty countries.
    The proposed protocol modifies some of the existing treaty rules of 
Article XVIII of the present treaty (Pensions and Annuities), mostly to 
address Roth individual retirement accounts, and adds several new 
provisions that address cross-border pension contributions and benefits 
accruals. Many of the new rules are similar to those found in the U.S. 
Model treaty, but several reflect the uniquely large cross-border flow 
of personal services between Canada and the United States, including 
the large number of cross-border commuters. These rules are intended to 
remove barriers to the flow of personal services between the two 
countries that could otherwise result from discontinuities under the 
laws of each country regarding the deductibility of pension 
contributions and the taxation of a pension plan's earnings and 
accretions in value. In addition, the proposed protocol adds a new 
provision to address the source of certain annuity or life insurance 
payments made by branches of insurance companies.
    The proposed protocol replaces Article XX (Students) of the present 
treaty with a new article that generally corresponds to the treatment 
provided under the present treaty. The proposed protocol adds a one-
year limitation on the exemption from income tax in the host country in 
the case of apprentices and business trainees.
    The proposed protocol modifies Article XXI (Exempt Organizations). 
The new rules are intended to permit charitable-type organizations to 
invest indirectly and to pool their investments with pension-type 
organizations.
    The proposed protocol adds a new paragraph to Article XXII (Other 
Income) of the treaty for guarantee fees. The new paragraph provides 
that compensation derived by a resident of a contracting state in 
respect of a guarantee of indebtedness shall be taxable only in that 
state, unless the compensation is business profits attributable to a 
permanent establishment in the other contracting state, in which case 
Article VII (Business Profits) shall apply.
    The proposed protocol changes the obligations of Canada under 
Article XXIV (Elimination of Double Taxation) of the treaty with 
respect to dividends received by a Canadian company from a U.S. 
resident company. Under the proposed protocol, a Canadian company 
receiving a dividend from a U.S. resident company of which it owns at 
least 10 percent of the voting stock, is allowed a credit against 
Canadian income tax for the appropriate amount of income tax paid or 
accrued to the United States by the dividend paying company with 
respect to the profits out of which the dividends are paid.
    The proposed protocol revises the general rules of Article XXV 
(Non-Discrimination) of the present treaty to bring those rules into 
closer conformity with the U.S. Model treaty and recent U.S. income tax 
treaties. The proposed protocol generally prohibits a treaty country 
from discriminating against nationals of the other treaty country by 
imposing on those nationals more burdensome taxation than it imposes or 
may impose on its own nationals in the same circumstances.
    The proposed protocol modifies Article XXVI A (Assistance in 
Collection) of the present treaty to further limit, in a narrow class 
of cases, one treaty country's obligation to assist the other treaty 
country in collecting taxes. The modifications also explicitly provide 
that the assistance-in-collection provisions apply to contributions to 
social security and employment insurance premiums levied by or on 
behalf of the government of a treaty country.
    The proposed protocol replaces Article XXVII (Exchange of 
Information) of the present treaty with rules similar to those in the 
U.S. model treaty. The proposed rules generally provide that the two 
competent authorities will exchange such information as may be relevant 
in carrying out the provisions of the domestic laws of the United 
States and Canada concerning taxes to which the treaty applies to the 
extent the taxation under those laws is not contrary to the treaty.
    The proposed protocol amends the saving clause in Article XXIX 
(Miscellaneous Rules) to bring the treaty generally in conformity with 
the U.S. taxation of former citizens and former long-term residents 
under section 877 of the Code. The proposed protocol provides that 
notwithstanding the other provisions of the treaty, a former citizen or 
former long-term resident of the United States, may, for a period of 
ten years following the loss of such status, be taxed in accordance 
with the laws of the United States with respect to income from sources 
within the United States (including income deemed under the domestic 
law of the United States to arise from such sources). Section 877 is 
applicable to individuals who relinquish their U.S. citizenship or 
cease to be a lawful permanent resident prior to June 17, 2008.
    For any individual who relinquishes U.S. citizenship or ceases to 
be a lawful permanent resident of the United States on or after June 
17, 2008, a new set of rules applies. In general, to the extent those 
rules impose U.S. tax on an individual after the individual 
expatriates, they require or deem the individual to waive any rights to 
claim a reduction in U.S. tax under a U.S. tax treaty and any other 
rights under a U.S. tax treaty that would preclude the assessment or 
collection of tax imposed by the new rules.
    The proposed protocol replaces Article XXIX B (Taxes Imposed by 
Reason of Death) of the present treaty with a new article that 
generally addresses certain concerns regarding the application of 
Canadian tax rules and regarding the availability of tax credits or 
deductions when the United States and Canada impose tax on the same 
items of income or property.
    Article 27 of the proposed protocol provides for the entry into 
force of the proposed protocol. The provisions of the proposed protocol 
are generally effective on a prospective basis. However, the provisions 
with respect to dual-residence tie breakers (Article 2 of the proposed 
protocol) and an emigrant's gain (Article 8 of the proposed protocol) 
are effective retroactive to September 17, 2000. In certain situations, 
the reduction of interest withholding rates is also retroactive, with 
the initial phase-in rate applicable for the year in which the proposed 
protocol becomes effective. Also, the provisions for assistance in the 
collection of taxes are retroactively effective to revenue claims that 
have been definitively determined after November 9, 1985.
    With respect to certain payments through fiscally transparent 
entities and the new provisions regarding permanent establishments, the 
proposed protocol is effective as of the first day of the third year 
that ends after the proposed protocol enters into force. Special rules 
apply for determining when to start counting (1) days present, (2) 
services rendered, and (3) gross active business revenues for purposes 
of the permanent establishment provision. With respect to the 
arbitration provisions, the proposed protocol clarifies that a 
competent authority matter currently in progress will be deemed to have 
started on the date on which the proposed protocol enters into force.
Iceland
    The proposed treaty replaces the existing treaty that was signed in 
1975. The rules of the proposed treaty generally are similar to rules 
of recent U.S. income tax treaties, the U.S Model treaty, and the OECD 
Model treaty. However, the proposed treaty contains certain substantive 
deviations from these treaties and models.
    The proposed treaty contains provisions under which each country 
generally agrees not to tax business income derived from sources within 
that country by residents of the other country unless the business 
activities in the taxing country are substantial enough to constitute a 
permanent establishment (Article 7). Similarly, the proposed treaty 
contains certain exemptions under which residents of one country 
performing personal services in the other country will not be required 
to pay tax in the other country unless their contact with the other 
country exceeds specified minimums (Articles 7, 14, and 16). The 
proposed treaty also provides that pensions and other similar 
remuneration paid to a resident of one country may be taxed only by 
that country, and only at such time and to the extent that a pension 
distribution is made (Article 17).
    The proposed treaty provides that dividends and certain gains 
derived by a resident of either country from sources within the other 
country generally may be taxed by both countries (Articles 10 and 13); 
however, the rate of tax that the source country may impose on a 
resident of the other country on dividends may be limited by the 
proposed treaty. The proposed treaty provides that, subject to certain 
rules and exceptions, interest and most types of royalties derived by a 
resident of either country from sources within the other country may be 
taxed only by the residence country (Articles 11 and 12). 
Notwithstanding this general rule, the source country may impose tax on 
certain royalties in an amount not to exceed five percent of such 
royalties.
    In situations in which the country of source retains the right 
under the proposed treaty to tax income derived by residents of the 
other country, the proposed treaty generally provides for relief from 
the potential double taxation through the allowance by the country of 
residence of a tax credit for foreign taxes paid to the other country 
(Article 22).
    The proposed treaty contains the standard provision (the ``saving 
clause'') included in U.S. tax treaties pursuant to which each country 
retains the right to tax its residents and citizens as if the treaty 
had not come into effect (Article 1). In addition, the proposed treaty 
contains the standard provision that the treaty may not be applied to 
deny any taxpayer any benefits to which the taxpayer would be entitled 
under the domestic law of a country or under any other agreement 
between the two countries (Article 1).
    The proposed treaty (Article 19) generally provides that students, 
business trainees, and researchers visiting the other treaty country 
are exempt from host country taxation on certain types of payments 
received.
    The proposed treaty includes the standard provision (Article 20) 
that assigns taxing jurisdiction over income not addressed in the other 
articles of the proposed treaty. In general, such income is taxable 
solely by the residence country. The proposed treaty provides authority 
for the two countries to resolve disputes (Article 24) and exchange 
information (Article 25) in order to carry out the provisions of the 
proposed treaty.
    The provisions of the proposed treaty will have effect generally on 
or after the first day of January following the date that the proposed 
treaty enters into force. The proposed treaty allows taxpayers to 
temporarily continue to claim benefits under the present treaty for up 
to an additional year if they would have been entitled to greater 
benefits under the present treaty. In addition, a teacher entitled to 
benefits under the present treaty at the time the proposed treaty 
enters into force will continue to be entitled to the benefits 
available under the present treaty for as long as such individual would 
have been entitled to the previously existing benefits.
Bulgaria
    The United States and Bulgaria do not have an income tax treaty 
currently in force. The rules of the proposed treaty and protocols 
generally are similar to various rules of recent U.S. income tax 
treaties, the U.S. Model treaty, the OECD Model treaty, and the 1980 
United Nations Model Double Taxation Convention between Developed and 
Developing Countries, as amended January 11, 2001 (``the U.N. Model 
treaty''). However, the proposed treaty, as amended by the proposed 
2007 and 2008 protocols, also contains certain substantive deviations 
from these treaties and models.
    The proposed treaty contains provisions under which each country 
generally agrees not to tax business income derived from sources within 
that country by residents of the other country unless the business 
activities in the taxing country are substantial enough to constitute a 
permanent establishment (Article 5). The proposed treaty includes a 
special rule under which services performed by an enterprise of a 
treaty country in the other treaty country may give rise to a permanent 
establishment in the other country if the enterprise's activities in 
the other country occur for a certain number days and if certain other 
conditions are met. The special rule applies if the enterprise does not 
have a permanent establishment in the other country by virtue of any of 
the customary treaty standards.
    The proposed treaty provides that dividends, interest, royalties, 
and certain capital gains derived by a resident of either country from 
sources within the other country generally may be taxed by both 
countries (Articles 10, 11, 12, and 13); however, the rate of tax that 
the source country may impose on a resident of the other country on 
dividends, interest, and royalties may be limited by the proposed 
treaty (Articles 10, 11, and 12). Withholding tax on dividends is 
limited to 10 percent in most cases and is limited to five percent for 
dividends received by a company owning at least 10 percent of the 
dividend-paying company. A zero rate of withholding tax generally 
applies to dividends received by pension funds. In general, withholding 
tax on interest and royalties is limited to five percent under the 
proposed treaty. Under the proposed 2007 protocol, the treaty countries 
agree to reconsider source-country taxation of interest and royalties 
arising in Bulgaria and beneficially owned by a resident of the United 
States, at a time that is consistent with the December 31, 2014 
conclusion of the transition period under a European Union Council 
Directive applicable to interest and royalties deemed to arise in 
Bulgaria and beneficially owned by a resident of the European Union.
    In situations in which the country of source retains the right 
under the proposed treaty to tax income derived by residents of the 
other country, the proposed treaty generally provides for relief from 
the potential double taxation, in the case of residents of the United 
States, through the allowance of a credit for foreign taxes paid to 
Bulgaria, and, in the case of residents of Bulgaria, through a 
combination of credits and exemptions (Article 22).
    The proposed treaty contains the standard provision (the ``saving 
clause'') included in U.S. tax treaties pursuant to which each country 
retains the right to tax its residents and citizens as if the treaty 
had not come into effect (Article 1). In addition, the proposed treaty 
contains the standard provision providing that the treaty may not be 
applied to deny any taxpayer any benefits the taxpayer would be 
entitled under the domestic law of a country or under any other 
agreement between the two countries (Article 1).
    The proposed treaty includes the standard provision (Article 20) 
that assigns taxing jurisdiction over income not addressed in the other 
articles of the proposed treaty. In general, such income is taxable 
solely by the residence country. The proposed treaty provides authority 
for the two countries to exchange information (Article 25) in order to 
carry out the provisions of the proposed treaty. The proposed treaty 
also contains a detailed limitation-on-benefits provision to prevent 
the inappropriate use of the treaty by third-country residents (Article 
21).
ConclusionThese provisions and issues are all discussed in more detail 
        in the Joint Committee staff pamphlets on the proposed protocol 
        and treaties. I am happy to answer any questions that the 
        Committee may have at this time or in the future.


    Senator Menendez.  Thank you.
    Mr. Beaird?

STATEMENT OF RICHARD C. BEAIRD, SENIOR DEPUTY U.S. COORDINATOR 
FOR INTERNATIONAL COMMUNICATIONS AND INFORMATION POLICY, BUREAU 
   FOR ECONOMIC, ENERGY, AND BUSINESS AFFAIRS, DEPARTMENT OF 
                    STATE, WASHINGTON, D.C.

    Mr. Beaird.  Thank you, Mr. Chairman.
    Mr. Chairman, ranking member Lugar, I am pleased to be here 
to testify in support of the five telecommunications treaties 
before you this afternoon and to urge the Senate's advice and 
consent to ratification by the President.
    These treaties flow from the work of the International 
Telecommunications Union, the United Nations (U.N.) specialized 
agency for telecommunication matters. Ratification of these 
treaties will advance the interests of U.S. businesses, 
consumers, and the United States Government. These treaties 
have enabled U.S. businesses to secure valuable radio spectrum 
and allowed them to offer innovative products and services to 
U.S. and foreign markets.
    They have also protected U.S. Government spectrum interests 
and ensured that critical Government programs, ranging from the 
International Space Station to essential equipment for weather 
sensing and forecasting, can operate without interference. 
Furthermore, these treaties have ensured that first responders 
can more quickly and effectively coordinate their response to 
natural disasters and other emergencies.
    These treaties have also helped make the ITU a more 
transparent, nimble, and accountable international organization 
that better serves the interests of its member states. As a 
result of these treaties--as a result, these treaties are 
strongly supported by U.S. businesses and by the Government, 
subject to the declarations and reservations outlined in each 
of the treaty packages.
    In fact, a broad range of representatives from U.S. 
businesses and Government agencies were involved at every step 
in establishing and pursuing our negotiating objectives for 
these treaties. By becoming a party to these five ITU 
instruments, we will convey to the other members of the union 
our commitment to these important decisions and our continuing 
strong support for the mission of the ITU.
    Mr. Chairman, I would like to identify some of the 
highlights of the ITU treaties, which fall into two main 
categories corresponding to the world radiocommunication 
conferences and the plenipotentiary conferences. The first 
category involves amendments to the radio regulations, which 
are treaties governing the use of the radio frequency spectrum 
and the geostationary and non-geostationary satellite orbits.
    At the 1992 World Administrative Radio Conference, the 
United States was successful in obtaining additional spectrum 
for Voice of America, spectrum allocation for low-Earth orbit 
satellite systems, frequency allocation for digital audio radio 
service, and additional spectrum for NASA projects such as the 
lunar and Martian missions.
    At the 1995 World Radiocommunication Conference, the United 
States achieved new spectrum allocation for mobile satellite 
systems and a new allocation for non-geostationary fixed 
satellite services for broadband Internet.
    The second category of treaties are proposed amendments to 
the ITU constitution and convention, which are the result of 
ITU plenipotentiary conferences which are the principal 
administrative and policy conferences of the ITU.
    In 1998, the United States hosted the first plenipotentiary 
conference since it hosted the conference in 1947. The United 
States achieved several objectives at this conference including 
enhanced status of public and private companies participating 
in ITU activities, added provisions in the constitution to 
convene world radio conferences every 2 to 3 years to meet the 
challenges of a dynamic telecom environment, improved ITU's 
accountability through changes in the budget process.
    At the 2002 Plenipotentiary Conference in Marrakesh, 
Morocco, that conference adopted the following. The conference 
developed a financial plan to balance the ITU budget and reduce 
expenditures by 10 percent. The conference allowed private 
companies to become observers at ITU council meetings, and it 
changed the structure of the Radio Regulations Board to make it 
more effective.
    At the 2006 Plenipotentiary Conference held in Antalya, 
Turkey, the United States achieved the following results. The 
conference enhanced ITU budgetary process requiring ITU carry 
out annual review of income and expenditures. It lengthened the 
dates between ITU's established conferences so as to hold down 
costs. It enhanced member state oversight of ITU financial and 
administrative activities. It promoted budgetary transparency, 
and it preserved the private sector role within the ITU.
    Mr. Chairman, this completes my summary of the treaties. 
Telecommunications is growing at an incredible pace, and U.S. 
companies are introducing new services here and abroad on a 
steady basis. The United States Government stands ready to move 
forward as rapidly as possible to bring the benefits of 
international telecommunications to our citizens.
    It was my pleasure and honor to present this testimony. I 
recommend that the Senate act favorably on these treaties. This 
concludes my oral statement, and I have submitted a more 
comprehensive account in my written statement and ask that it 
be entered into the record.
    Mr. Chairman, I stand ready to answer any questions that 
the committee may have. Thank you.
    [The prepared statement of Mr. Beaird follows:]


                Prepared Statement of Richard C. Beaird

    Chairman Menendez, ranking member Hagel, members of the 
subcommittee, I am pleased to be here to testify in support of the five 
telecommunications treaties before you this morning, and to urge the 
Senate's advice and consent to ratification by the President. These 
treaties flow from the work of the International Telecommunication 
Union (ITU), the United Nations' (UN) specialized agency for 
telecommunication matters. They are contained in the Final Acts of:


    The ITU World Administrative Radio Conference--1992

    The ITU World Radiocommunication Conference--1995

    The ITU Plenipotentiary Conference--1998

    The ITU Plenipotentiary Conference--2002

    The ITU Plenipotentiary Conference--2006


    Ratification of these treaties will advance the interests of U.S. 
businesses, consumers and the U.S. Government. These treaties have 
enabled U.S. businesses to secure valuable radio spectrum and allowed 
them to offer innovative products and services to U.S. and foreign 
markets. They also have protected U.S. Government spectrum interests 
and ensured that critical government programs ranging from the 
International Space Station to essential equipment for weather sensing 
and forecasting can operate without interference. Furthermore, these 
treaties have ensured that first responders can more quickly and 
effectively coordinate their response to natural disasters and other 
emergencies. These treaties also have helped make the ITU a more 
transparent, nimble and accountable international organization that 
better serves the interests of its Member States.
    As a result, these treaties are strongly supported by U.S. 
businesses and by the U.S. Government, subject to the declarations and 
reservations outlined in each of the treaty packages. In fact, a very 
broad range of representatives from U.S. businesses, and government 
agencies were involved at every step in establishing and pursuing U.S. 
negotiating objectives for these treaties. By becoming a party to these 
five ITU instruments, we will convey to the other members of the Union 
our commitment to these important decisions and our continuing strong 
support for the mission of the ITU.
    Before I summarize what each of the treaties does, it might be 
helpful for me to quickly share with you some background about the ITU 
and how the United States organizes its participation in the 
negotiations that led to these treaties.
    The International Telecommunication Union was formed in 1865 when 
European countries saw the need to work together to facilitate 
telegraphic communications across their borders. Today, the ITU is 
involved in every phase of global telecommunications, working to 
maintain international cooperation among its 191 Member States for 
management of global spectrum use, and the adoption of international 
telecommunication standards, and to foster the expansion of 
telecommunication systems and services in developing countries. ITU's 
purposes and activities are governed by several international 
instruments, including the Constitution, the Convention, and the 
Administrative Regulations.
    The organization is unusual among UN agencies in that its 
membership also includes 715 Sector Members (86 of which are from the 
United States) and 164 Associates, representing companies and 
organizations with an interest in telecommunications. This feature is 
particularly vital to U.S. interests, in view of our reliance on the 
private sector for the provision of telecommunications networks and 
services on both the national and international levels, and in view of 
the dependence of many U.S. companies on effective communications to 
support their multinational operations.
    As a result of the 1992 Plenipotentiary Conference, the ITU was 
reorganized to give it greater flexibility to adapt to today's 
increasingly complex, interactive, and competitive environment. 
Consequently, the Union is organized into three Sectors, corresponding 
to its three main areas of activity: (1) Telecommunication 
Standardization (ITU-T); (2) Radiocommunication (ITU-R); and (3) 
Telecommunication Development (ITU-D). The reorganization also 
introduced a regular cycle of conferences to help the Union rapidly 
respond to new technological advances.
    The Union's three sectors represent an extremely diverse comm 
unity, ranging from regulators to users, manufacturers to service 
providers, as well as consumers. In one form or another, international 
telecommunications involve every government agency and touch most 
aspects of A merican business and the public in general. Hence, the 
work of the ITU is of great importance and interest to the United 
States.
    The Union convenes Plenipotentiary Conferences to set the Union's 
general policies, which often are reflected in amendments to the ITU 
Constitution and Convention, and World Radiocommunication Conferences 
(WRCs) to revise international Radio Regulations. Three of the treaties 
before the Committee are the result of the Union's top policy making 
body, the Plenipotentiary Conference, and the remaining two treaties 
are the result of WRCs.
    The Department of State's responsibility is to coordinate U.S. 
participation in the activities of the U nion. This includes the 
presentation of U.S. proposals to the ITU and its member countries, 
development of strategies and positions relating to conference issues, 
and assembly of well-qualified delegations from both the public and 
private sector to carry out the complex and often technical 
negotiations. For these five treaties which amend the ITU Constitution 
and Convention, and the Radio Regulations, the Department is assisted 
in the detailed preparations for the ITU conferences by the Federal 
Communications Commission (FCC) and the National Telecommunications and 
Information Administration (NTIA) in the Department of Commerce. The 
FCC regulates all non-Federal use of the radio spectrum and all 
interstate telecommunications as well as all international 
communications that originate or terminate in the United States. The 
NTIA manages Federal use of the radio spectrum and is the President's 
principal adviser on telecommunications and information policy issues, 
representing the Executive Branch in both domestic and international 
telecommunications and information policy activities.
    One important advantage of this extensive national effort is that 
it ensures the United States is well prepared to negotiate at the 
conferences. Moreover, private groups and individuals have the 
opportunity to express their views at each stage of the process, from 
initial conception of ideas to the eventual adoption of the national 
regulations.
    I will now give a summary of the treaties that fall into two main 
categories, corresponding to the W RCs and the Plenipotentiary 
Conferences.
    The first category involves amendments to the Radio Regulations 
which are treaties governing the use of the radio-frequency spectrum 
and the geostationary and non-geostationary satellite orbits. At the 
1992 World Administrative Radio Conference (WARC), the United States 
was successful in obtaining a considerable amount of additional 
spectrum to relieve frequency congestion in the existing broadcasting 
bands used by Voice of America. Allocation for Low Earth Orbit (LEO) 
satellite systems to enable voice-grade telephony and data was one of 
the most difficult and complex debates during WARC-92 and one of the 
highest U.S. priorities and achievements. The conference essentially 
adopted the U.S. allocation proposal. The United States also secured a 
Satellite Digital Audio Radio
    Service frequency allocation. In support of NASA's communication 
needs, the U nited States obtained additional spectrum for such 
programs as the International Space Station, lunar and Mars missions, 
and NASA's next-generation robotic deep space exploration programs.
    At the 1995 World Radiocommunication Conference (W RC), the United 
States achieved a new spectrum allocation that would permit global 
deployment of new satellite technologies, specifically, Mobile 
Satellite Systems. This allocation was critical to the future operation 
of LEO satellite systems, which are used for expanding communications 
and observation networks. WRC-95 also acted favorably on the U.S. 
spectrum proposal for non-geostationary fixed satellites. This new 
technology paved the way for U.S. industry to provide satellite based 
global broadband Internet to remote regions. All these achievements are 
reflected in the proposed amendments to the Radio Regulations for which 
we are seeking advice and consent.
    The second category of treaties are proposed amendments to the ITU 
Constitution and Convention which are the result of ITU Plenipotentiary 
Conferences, which are the principal administrative and policy 
conferences of the ITU. In 1998, the United States hosted its first 
Plenipotentiary Conference since 1947. The United States achieved 
several objectives at this Conference, including enhancing the status 
of public and private companies that participate in ITU activities, 
adding a provision in the Constitution to convene W RCs every two to 
three years to meet the challenges of a dynamic telecom environment, 
and improving the ITU's accountability through changes in the budget 
process. All of these changes improved the function of the ITU and 
strengthened the role of the private sector within the ITU.
    The 2002 Plenipotentiary Conference in Marrakesh, Morocco, adopted 
several amendments supported by the U nited States to improve 
management, functioning and finances of the ITU. Because of ITU's 
serious budget shortfalls, the United States led in the effort to 
develop a financial plan that balanced the ITU budget and reduced 10% 
of program expenditures. One of the U.S. proposed amendments allows 
private companies to be represented as observers at ITU Council 
meetings. A nother broadened the field of potential candidates to the 
ITU's Radio Regulation Board (RRB). These and other amendments approved 
by the 2002 Plenipotentiary Conference have made it easier for the ITU 
to respond to changes in the telecom munications environment.
    The 2006 Plenipotentiary Conference held in Antalya, Turkey, 
adopted new provisions to enhance the ITU budgetary process by 
requiring that the ITU Council carry out an annual review of income and 
expenditures and by advancing the deadline for budget contributions. 
The Conference also adopted another fiscally responsible measure by 
lengthening the dates between ITU's established Conferences and 
Assemblies so as to hold down costs. The United States achieved many of 
its objectives at this Conference, including enhancing Member State 
oversight of ITU financial and administrative activities, promoting 
budgetary transparency, and preserving the role of the private sector 
in the ITU.
    Mr. Chairman, this completes my summary of the treaties. 
Telecommunication is growing at an incredible pace and U.S. companies 
are introducing new services here and abroad on a steady basis. They 
are looking for a quick response from the U.S. Government as they 
conduct business in this fast-moving world. The United States 
understands that the ITU must encourage rapid progress in 
telecommunications; the ITU must be a partner in progress and a 
catalyst to technological innovation. The United States Government 
stands ready to move forward as rapidly as possible to bring the 
benefits of international telecommunications to our citizens.
    Mr. Chairman, it was my pleasure and honor to present this 
testimony, and to discuss the International Telecommunication Union. In 
conclusion, I recommend that the Senate act favorably on these 
treaties. I stand ready to answer any questions that the committee may 
have.


    Senator Menendez.  Thank you.
    All of your statements will be fully included in the 
record, and we will start with 10-minute rounds since I see 
there is massive interest here. I think you and I, Senator 
Lugar, might cover the waterfront.
    So let me start off. I have questions for all of you, but 
within my 10 minutes, let us see how far we can go.
    Mr. Mundaca, with reference to the Canada protocol, that 
includes a provision that would broaden the current definition 
of permanent establishment or what is often referred to as the 
183-day rule. I read it a couple of times, and maybe you can 
help me. The--I am sure businesses would like some help as 
well.
    If a U.S. service enterprise doesn't have a fixed place of 
business in Canada, it may still be deemed to have a permanent 
establishment if it meets one of two tests. I won't read them 
because I am sure you are fully, intimately familiar with them. 
But a great many businesses have raised concerns with us about 
this provision, suggesting that particularly in relationship to 
Canada, it will be very hard for them to administrate.
    Now I understand we have included such a provision in other 
treaties with developing nations, and in fact, the Bulgaria 
treaty includes such a provision. But as noted in Ms. McMahon's 
testimony, this is the first time such a provision has been 
included in a tax treaty with a developed nation like Canada.
    Can you talk a little bit about this provision, explain why 
you think it works, and why was it included in this protocol? 
And we will start there, and I have a few other questions in 
this regard.
    Mr. Mundaca.  Thank you, Senator.
    We do--I should begin by saying we do understand the 
concerns with administering this provision. We have already 
begun discussions with Canada in the context of both in coming 
to an agreement on the technical explanation of the treaty that 
goes into a little bit more detail on what the provision 
provides, and we will continue those discussions to try to 
provide some further guidance to make this easier to 
administer.
    As you note, this is not a new provision. It has been in 
treaties in the past, but never with a developed country and 
never with a country with whom we have such a great cross-
border trade and services. And again, we do understand that we 
will need to provide more guidance so that companies know if 
they do trip the 183-day rule.
    Some of the complexities of this that we know we need to 
address are with respect to whether projects are connected, 
when you have to count together certain periods of time in 
which you are providing services to see if you reach the 183 
day. There also are some issues with determining when it is 
that you cross this threshold and if you will cross it in a 
year, if you haven't planned on doing that.
    If, for example, the project takes longer than you might 
have thought and you wind up providing services in excess of 
183 day, you may not have had the proper withholding 
mechanisms, estimated tax payments in place. We do understand 
those--those complexities.
    As you may know, this is an issue that is not just between 
ourselves and Canada. The OECD, the 30 larger economies in the 
world have been wrestling with this issue as well. There are 
many countries who do feel that this provision is appropriate, 
that if someone does provide services in excess of 6 months in 
a 12-month period that they should be subject to tax even if 
they don't trip the fixed-base rule that is standard in our 
treaties.
    That is not our view. That is not our treaty policy. We do 
not intend to extend this beyond those cases in which another 
country has offered a package of benefits with respect to this 
provision that we feel makes this in the best interest of the 
U.S.
    Senator Menendez.  Well, you answered my next question, 
whether this was a change in policy. And I am glad to hear that 
it is not.
    But let me go back to the challenge, the test that is 
devised here presents a number of challenges. For one thing, 
the sheer amount of effort and resources that would presumably 
have to be spent on keeping track of one's employees, its 
customers, its revenue stream from each country. It is pretty 
daunting.
    In addition, what is the 12-month period? It is not 
necessarily tied to a fiscal year. And so, that a business 
would have to keep continuous records in order to determine if 
during any consecutive 12-month period--it is like a revolving 
12-month period--they had crossed the line.
    And Joint Tax, I think, has raised concerns regarding how 
this provision interacts with amendments made under the 
protocols of Article 15 of the treaty in relation to the 
treatment of employees.
    So have you thought about these challenges as we move 
forward?
    Mr. Mundaca.  We have, and we have been in discussions with 
Canada regarding how best to address them. We also welcome 
input from your committee or from the business community about 
the best ways to make this administerable for all of us. As you 
mentioned, this is a rolling 12-month period. It is not tied to 
a fiscal year. It will require record keeping.
    One of the issues we think we need to address that could 
provide some clarity around these issues is, again, what the 
definition is of the connected projects for which you do have 
to aggregate periods. So I think a clear definition of that 
will provide some relief to taxpayers so they do know when they 
can cut off counting days with respect to a particular 
provision of services.
    I should also note that some other variants of this 
provision, one that the OECD is considering is broader than we 
have provided here. They do not have the restriction we have in 
our provision regarding the geographic coherence. That is, if 
you are not providing services in one place, our rule doesn't 
apply. THE OECD rule is broader in that extent.
    So we have tried to build in some safeguards for 
overbreadth, but we do recognize that we do have more work to 
do. There is a delayed effective date on this. We will work 
this year and next year to provide further guidance on this.
    Senator Menendez.  One last thing, I will just stick with 
you for one more concern. And I hope you take this concern back 
to the department seriously because I think the committee had 
it in its report. I raised it in the last meeting that I 
chaired on the question of some other treaties that we had. I 
want to talk about the arbitration mechanism that appears in 
the Canada protocol.
    In the last hearing where your colleague, Mr. Harrington, 
was here, a concern about the fact that the arbitration 
mechanism in both the Germany and Belgium treaties did not 
provide for direct taxpayer input to the arbitration board 
during an arbitration proceeding. Now this--notwithstanding 
raising those issues in those treaties, this is not changed in 
the Canada protocol. The mechanism still does not provide for 
direct taxpayer input to an arbitration board during an 
arbitration proceeding.
    And I know that the committee report on both of those 
previous treaties raised other issues, including concerns 
regarding treaty interpretation and the selection of 
arbitrators, but, you know, I haven't seen the department be 
responsive. And I hope you can address--can we expect to see 
some of these concerns that have been raised dealt with in 
future track's treaties with similar arbitration mechanisms 
because if not, speaking as one Senator, I will have 
difficulties in being as supportive as I have been to date.
    Mr. Mundaca.  We understand, and we appreciate your past 
support, and we understand the concerns. They were not taken 
onboard with respect to the Canada provision, as you point out. 
Not because we didn't regard them as valid or important, but 
simply because that had been agreed to before we got the input 
with respect to Germany and Belgium. Those provisions, all of 
them were negotiated approximately the same time, and we had 
locked down that issue with Canada.
    But we do take those concerns seriously. They will be 
reflected in future arbitration provisions. We will certainly 
raise them with treaty partners we talk to about this 
provision. Again, it is a negotiation. What their reaction will 
be to the issues you raised with respect to taxpayer input, 
precedential value of decisions, the authorities for the 
arbitration board to consider, and the choice of the arbiters, 
please know we will raise all those issues with people we 
negotiate with in the future.
    Senator Menendez.  All right. Ambassador Balton, let me 
just take one or two questions with you in the time I have 
remaining.
    Did the U.S. industry groups that are affected by these 
environmental treaties that we are considering before the 
committee today participate in the negotiations? And to the 
extent that they did, did they support the treaties, and have 
they voiced any specific concerns?
    Ambassador Balton.  Let me take each of the treaties 
separately.
    Senator Menendez.  Yes, if you could put your microphone 
on?
    Ambassador Balton.  Thank you, Senator. Let me take you to 
those treaties separately on that question.
    With respect to the London protocol, the American 
Association of Ports and Harbors was involved in the 
negotiations of this, and indeed, this group attends the 
meetings of both the London convention and now the London 
protocol regularly.
    The U.S. industry group that is most affected or would be 
most affected by U.S. ratification is actually our dredging 
industry. And the U.S. industry association in this field, the 
Dredging Contractors of America, have indicated that they are 
fully aware of the protocol and support its objectives.
    With respect to the anti-foulants convention, here, the 
U.S. anti-fouling paint industry favors this convention. Why? 
Because it promotes a single regulatory program for all 
countries. That will likely increase the use of environmentally 
friendly anti-foulants that they, the U.S. industry, have 
developed. U.S. shipyards are also interested in the single 
international standard because it provides a more level playing 
field as between them and shipyards in other countries.
    And finally, the U.S. ship owners and operators, what they 
most want is an effective set of anti-fouling systems that do 
not increase their costs. They have already moved on, away from 
the anti-foulants that are prohibited under the convention to 
use the environmentally friendly anti-foulants that are 
permitted for use, both under the convention and U.S. law. So 
they support our moving forward, too.
    Finally, with respect to the LBS protocol, the land-based 
sources protocol, I should start by saying that our entire 
approach to the negotiation of this treaty was to create a set 
of environmental standards that the United States was already 
meeting or exceeding. The idea was to bring our neighbors in 
the Caribbean region, most of whom are developing countries, up 
to or at least close to U.S. standards.
    And because of this approach, which was successful, U.S. 
industry was not directly involved in the negotiations. U.S. 
ratification of this treaty will not have a significant bearing 
on their activities. We have not heard and are not aware of any 
opposition to U.S. ratification from dischargers, agricultural 
interests, or other similar U.S. industry stakeholders.
    We fully expect that a wide variety of other U.S. 
industries who will stand to benefit from stronger 
environmental protection of the oceans support ratification of 
the protocol. Here, I am thinking of the U.S. fishing industry, 
the U.S. tourism industry, among others.
    Finally, I would note that U.S. negotiators of this 
protocol did consult throughout the negotiations with officials 
from the U.S. States and territories that border this region. 
Those include Texas, Louisiana, Mississippi, Alabama, Florida, 
as well as the Commonwealth of Puerto Rico and the territory of 
the Virgin Islands.
    Senator Menendez.  So all of the industries that did 
participate with you, they are, as I hear your answer, 
supportive and raise no concerns?
    Ambassador Balton.  That is a fair summary, sir.
    Senator Menendez.  Thank you very much.
    Senator Lugar?
    Senator Lugar.  Thank you, Mr. Chairman.
    Mr. Beaird, I would like to just query this point about 
this particular timing for the ITU treaties. My understanding 
is that revisions to the ITU radio regulations were concluded 
in 1992 and 1995, respectively. They were submitted to the 
Senate for advice and consent in 2002 and 2004.
    Now why did nearly a decade elapse before the executive 
branch sought Senate advice and consent on these instruments? 
And given the significant passage of time and the vast changes 
in the telecommunications sector and innovating period, why 
does the administration consider important that the Senate act 
upon these instruments now?
    Mr. Beaird.  Thank you very much, Senator Lugar.
    We are quite aware of the time lapse that has occurred 
between the final acts of the treaty--these final acts of these 
conferences and the present submission for advice and consent. 
We are reviewing that process within the department. We are 
aware that oftentimes priorities within the department do not 
elevate telecommunications treaties to the position that, in 
some cases, we would prefer in the Economic and Energy Bureau, 
but we are talking with colleagues about that to remedy the 
situation.
    Secondly, Mr. Chairman--Senator Lugar and Mr. Chairman, the 
implementation of these final acts do take place within the 
Administrative Procedures Act of the FCC and the National 
Telecommunications and Information Administration. As such, we 
rely upon them to tell us the timing of the implementation of 
the final act. So we work closely with those agencies to make 
sure that no one is disadvantaged.
    However, we also--and thirdly, we also are having 
conversations with the staff of your committee to assess how we 
can best move forward so that we can shorten the length of time 
between the final acts and their submission for advice and 
consent.
    Senator Lugar.  I appreciate that response, and you have 
been very candid that sometimes, as you say, the priorities 
within the department have not elevated this perhaps in such a 
timely way. This is, I suppose, one of the problems with the 
treaties, all of them that we are discussing today. These are 
of vast significance to American business, to those who are 
innovating an American society.
    And yet at the same time, they do not have frequently the 
currency of warfare or threatened international conflagrations 
and so forth, even though the amount of money involved--the 
jobs and so forth--are vast and not really recognized. That is 
why I pursued this because in telecommunications, as you would 
testify and would know more about it than I would, the amount 
of innovation, extraordinary changes in this period of time 
really would tax the abilities of everyone who was trying to 
get their arms around the problem and bring about equity, 
fairness, accessibility, all the things that telecommunications 
people are interested in.
    This leads me to sort of the second question. To what 
extent the new treaties lead to more private industry 
participation with the ITU? In other words, are you informed in 
a timely way by people who are on the frontiers, figuring out 
new ways of communicating so that the regulations with which 
you are entrusted not only are enforced, but there is some 
relevance to what you are enforcing as compared to what is 
actually occurring in the world?
    Mr. Beaird.  Senator Lugar, we made, as a fundamental 
purpose of the 1998 Plenipotentiary in Minneapolis, the goal to 
enhance the role of the private sector in the ITU, and we think 
we have accomplished that in a number of areas.
    First of all, we have given an opportunity to participate 
in leadership positions in the ITU, to chair committees at 
conferences that they--the conferences that have a bearing upon 
the future of their businesses and an opportunity for them to 
have an input into the innovative process of the ITU to bring 
these new services to the marketplace.
    Secondly, we have given them a wider opportunity to 
participate in actual meetings of the ITU as in the sense that 
they are now observers at the council meetings of the ITU, the 
governing board of the ITU.
    Our assessment is that if you look at the U.N. system as a 
whole, we believe that we have achieved a balance between the 
intergovernmental organization that the ITU is and the need to 
bring to that organization a private sector participation and 
leadership. We think we have set the bar very high for the U.N. 
system, but we are also continuing to review the situation in 
the ITU, to make sure that other opportunities, as appropriate, 
can be given to the private sector.
    Senator Lugar.  Are the companies and the industries 
involved supportive of these treaties? If they were sitting at 
the table with you, would they be testifying enthusiastically 
or strongly, or how would you characterize their feelings?
    Mr. Beaird.  Well, I am confident, having spent many years 
working very closely with them, that they would be very 
supportive of these treaties. They would only underscore your 
comment as to the need to get them up here quicker than we 
have, and we are also consulting with industry on that point.
    Senator Lugar.  Thank you.
    Mr. Mundaca, let me just explore for a moment this term 
treaty shopping, which arises whenever we have one of these 
treaties, and the fact that the new Iceland treaty closes a 
much-exploited loophole. Now, what was the loophole? Describe 
why the problems of the Iceland situation were difficult and 
why Americans should be concerned about that?
    Mr. Mundaca.  Thank you, Senator.
    The concern is that when we negotiate treaties, we 
negotiate them based on reciprocal benefits provided by, for 
example, Iceland to our residents and for us to provide 
benefits to Iceland residents. Through treaty shopping, through 
various techniques, residents of third countries can access 
those benefits.
    So, for example, we saw in the case of Iceland, and we are 
seeing it with respect to Hungary as well, is that third 
country residents set up corporations or other entities in 
those jurisdictions. Those entities then derive interest 
payments, for example, from the United States. They claim zero 
withholding on that, and that income is not subject to tax in 
the jurisdiction, either Iceland or Hungary, and the owners are 
able to access the U.S. treaty, achieve zero withholding, not 
pay tax in the other jurisdiction, and get the benefits of the 
treaty when, in fact, they should not.
    The inclusion of limitation on benefits provisions prevents 
that. We have other mechanisms to go after some of these 
structures, some of the anti-concurrent rules that we have, et 
cetera. But limitation on benefits provisions are the best way 
to prevent the treaties by being accessed by third country 
residents.
    We saw huge debt flows. We delivered a report to Congress 
at the end of 2007 that reported on some of these issues. And 
again, although they are not some of our leading trading 
partners, both Iceland and Hungary were within the top 10 of 
recipients of interest payments out of the U.S. And again, we 
think primarily because of these loopholes in the treaties.
    Senator Lugar.  Well, how, as a practical matter, do you 
identify these third countries? For example, is Iceland under 
the treaty responsible for saying the people taking advantage 
of this treaty are our citizens, they are Icelanders. In other 
words, there are no Swedes or Norwegians or what have you?
    Mr. Mundaca.  Right.
    Senator Lugar.  Or front companies. In other words, an 
Iceland representative, but really behind it is the capital 
flow coming in from somewhere else, taking advantage of the 
namesake on the door there.
    Mr. Mundaca.  And that is the issue is under the current 
treaty, there is no such obligation to determine who the owners 
are of these entities in order to grant that entity benefit. So 
the Icelandic entity can be owned by just about anybody in the 
world and claim benefits under our treaty. With the inclusion 
of the limitation on benefits provision, that would end. And it 
would have to be reporting and proving of the owners of the 
companies before they could claim benefits.
    Senator Lugar.  So you are relying on the reporting system 
and the integrity of the country that we are dealing with.
    Now how does the information sharing business work in this 
case? In other words, how deeply can we probe down in the weeds 
as to who is doing what in what country? To what extent are 
there privacy issues involved in these probes?
    Mr. Mundaca.  There are privacy issues, and the privacy 
issues with respect to confidentiality are dealt with in the 
treaty. So there is no chance of the information that is gained 
in exchange being used inappropriately or being released. On 
the other hand, in the Iceland treaty, there is full exchange 
of information. There is no hiding behind bank secrecy laws or 
other laws of either the U.S. or Iceland to shield from the 
ownership information that is required.
    Also, because we do require that information be provided in 
order for U.S. withholding agents, for example, to grant the 
lower withholding, we don't have to necessarily go out and get 
that information. That has to be provided to us in order for 
the lower withholding rate to apply.
    Senator Lugar.  But the U.S. could send auditors to Iceland 
and sort of go through the books?
    Mr. Mundaca.  Yes, that is right. Under the treaty, that 
sort of investigation is permitted.
    Senator Lugar.  Thank you very much.
    Thank you, Mr. Chairman.
    Senator Menendez.  Thank you, Senator Lugar.
    I just have another--we will do another round if necessary. 
I just have a few more questions that I would like to get on 
the record.
    Ambassador Balton, with reference to the reverse list 
approach taken in the London dumping protocol, which is an 
improvement of the 1972 London Convention to which the U.S. is 
now a party, why is it that we consider it an improvement?
    And secondly, while I understand that it is more 
restrictive, are we worried that we may find and identify other 
items, like carbon sequestration, as something that we think 
should be dumped and then find ourselves engaged in a very 
lengthy negotiation to amend the treaty?
    Ambassador Balton.  Thank you, Senator.
    We do agree that the reverse list approach represented by 
the protocol is better than the sort of black list approach of 
the convention to which we are now bound. It is simpler and 
more effective, in our view, and we do not foresee conflicts 
between the approach of the protocol and the U.S. pollution 
dumping program as it stands.
    The list on the protocol, the white list, already includes 
a broad range of substances that may be considered for dumping. 
And this list reflects more than 35 years of worldwide 
experience in determining which substances may cause harm to 
the marine environment if dumped.
    To the extent that another substance not previously 
considered may need to be added in the future, the London 
protocol parties have already shown their agility in responding 
to new and emerging technologies. They, in fact, amended the 
list once already precisely on the topic you raised, Senator. 
The list now includes carbon dioxide streams for purposes of 
sub seabed geological sequestration.
    The U.S., though not a party to the protocol, supported 
this amendment very much. The process was quick. It took less 
than a year from start to finish.
    There are other protections under the protocol as well. I 
note that there are a variety of activities that are not 
defined as dumping for purposes of the protocol. These include 
disposal into the sea of substances derived from normal 
operations of vessels and other craft, placement of substances 
in the sea for purposes other than mere disposal.
    The protocol also does not cover disposal or storage of 
substances arising from or related to the exploration, 
exploitation, or processing of offshore oil, gas, or other 
resources. And finally, the protocol gives parties significant 
flexibility to dump substances in emergency or force majeure 
situations.
    I raise these because for all these reasons, we believe 
that the reverse list approach does not constrain the 
legitimate needs of the United States or other nations on this 
range of issues of ocean disposal and waste management.
    Senator Menendez.  And one last question on the protocol. 
What if we find an emergent situation in which something that 
is prohibited needs to be dumped? Is there some mechanism that 
deals with that?
    Ambassador Balton.  Yes, sir. Article 8 of the protocol is 
a good example of the sophistication of this treaty in 
providing flexibility. There are two different situations it 
allows for.
    First, it allows a party to issue a permit and thus create 
an exception to the protocol's general rules on dumping in 
situations of emergencies posing an unacceptable threat to 
human health, safety, or the marine environment when there is 
no other feasible alternative. This provision, the emergency 
permit, is actually broader than the one of the original 
convention to which we are now bound.
    And then there is the second provision as well, which is 
replicated from the original convention. It contains a 
provision for situations of force majeure caused by weather or 
other immediate threats to human life or the marine environment 
where there is no other alternative. In these situations, 
dumping or incineration at sea may proceed even without the 
permit, although a party should conduct these things in a 
manner so as to minimize harm to human or marine life.
    So, in light of these provisions, once again we believe the 
protocol provides the necessary flexibility we would need as a 
party.
    Senator Menendez.  Thank you.
    Mr. Mundaca, one last question. I am going back to the 
protocol with London. What sorts of disputes do you think are 
most likely to be arbitrated through the mandatory arbitration 
mechanism provided for in the protocol? And will that mandatory 
arbitration provision be applicable to disputes that have 
already arisen? How do you see this working?
    Mr. Mundaca.  Based on the experience we have of the 
pending cases, I would guess--and it is just a guess--is that 
transfer pricing disputes would be the ones that will proceed 
to arbitration. Those are the ones that we have seen, in our 
experience, are the most difficult at this point to come to an 
agreement with in a timely manner.
    And therefore, I would expect, looking at the types of 
cases that are currently pending, that those are the ones that 
would likely be the predominant cases that are moving to 
arbitration.
    Regarding the coverage of current cases, they are covered. 
The 2-year trigger for a case moving out of the negotiation 
phase of the competent authority process to the arbitration 
phase, the trigger date will be the entry into force of the 
treaty, and then 2 years after that, pending cases can move 
into arbitration.
    We are working with Canada on a mechanism for identifying 
cases that are currently beyond the 2-year mark that could be 
moved into arbitration more quickly. And we hope over the next 
months to get that process in place so that the taxpayers don't 
have to wait the full 2 years that they have already had a case 
in competent authority that has been unable to be resolved.
    Senator Menendez.  All right. Thank you.
    Mr. Beaird, one question for you--two questions. One is one 
of our key concerns in negotiating radio regulations is the 
ability to obtain the high-frequency bands necessary to 
broadcast Voice of America throughout the world. In instances 
where the United States has not obtained enough of the spectrum 
to meet its needs, it has entered reservations stating that it 
will take appropriate actions to maintain broadcasting.
    When other countries accuse the United States of causing 
harmful interference and attempt to jam our broadcasts, what is 
our response, and how does the ITU manage these situations?
    Mr. Beaird.  Thank you very much, Mr. Chairman.
    In instances in which this has occurred, and it has 
occurred certainly in the last 30 years and in more than one 
instance, the United States complains to the ITU in a filing 
indicating the signal's origin and its strength and the extent 
of time and time and duration of the interference. That 
complaint is then referred to the Radio Regulations Board, 
which makes a finding.
    We have a situation currently where we have filed a 
complaint against a country neighboring to us, and the board 
has found that the origin of the signal was, in fact, from that 
country and has asked, pursuant to the radio regulations, that 
the harmful interference be resolved through the cooperation of 
the two countries.
    Now that is an approach that is undertaken by the ITU. The 
ITU is not an adjudicative body. It can only recommend a 
solution or a resolution of the harmful interference. But the 
United States always, when it occurs, registers the complaint 
to make it known to the ITU that there is such an interference 
occurring.
    Senator Menendez.  So it is not a binding determination?
    Mr. Beaird.  That is correct.
    Senator Menendez.  All right. And one last question. The 
ITU was not in the best financial shape a few years ago, and I 
am wondering have the amendments to the budget process improved 
the situation, and what are the current challenges the entity 
faces in this area?
    Mr. Beaird.  Thank you, Mr. Chairman.
    We believe we have made great progress at the ITU. In 2002, 
at the plenipotentiary in Marrakesh, for the first time we had 
a resolution adopted that called for a balanced budget at the 
ITU. It resulted in some--and we also indicated we wanted at 
least 10 percent cuts in the expenditures of the union.
    There were follow-up actions. Staff levels were reduced, 
new software introduced, budget transparency brought about. And 
in 2007, at the ITU council, which adopts its budget, I am 
pleased to report that a balanced budget was adopted at that 
council.
    We believe we have made great improvements at the ITU, but 
it is an ongoing task for us and the other member states and 
the sector members--that is, say, the private sector--to 
monitor the financial situation of the union. But we believe, 
at this time, the union is in far better financial shape than 
it was certainly in 2002.
    Senator Menendez.  Thank you.
    Senator Lugar?
    Senator Lugar.  Mr. Balton, you have touched upon this, but 
amplify a bit more about the land-based sources protocol. 
Because this protocol, as you pointed out, was concluded in 
1999, which is 9 years or so ago. And so, there is a track 
record by this time of what kind of pollution may have been 
abated in the Caribbean to some extent. But can you give us 
sort of a mind's eye map?
    How many States are a part of that protocol now, and how 
would you characterize the pollution situation? What is under 
control and what is not under control due to non-adherents or 
non-membership?
    Ambassador Balton.  Thank you, Senator.
    I am sorry to say that as we sit here today only four 
nations have ratified the protocol. It is not yet in force. It 
requires a minimum of nine to enter into force. The four that 
have--
    Senator Lugar.  This is after 9 years, only 4 states? I 
see.
    Ambassador Balton.  The four that are are France, which 
does have territories in--other parts of France in the area, 
Panama, St. Lucia, Trinidad and Tobago. My supposition, 
Senator, is that a number of other countries of the region are 
waiting for the United States.
    Senator Lugar.  I see.
    Ambassador Balton.  We were among the driving forces behind 
the protocol. We are one of the few developed countries in the 
region. We are a leader, and we have not yet ratified.
    Some of that is due to other priorities. We are sorry it 
took as long as it has to get the protocol to the Senate. We 
are, nevertheless, hopeful that the protocol can go through, 
and we can become a party and encourage other countries in the 
region to become party and to bring their environmental 
standards up to those of the United States in this area.
    The situation is not good overall. The problems of marine 
pollution in the Caribbean region are very real. Effluents of 
many sorts--agricultural runoff, domestic wastewater, other 
types of pollutants from land-based activities--are causing 
real harm. And we believe the protocol, once it is in force, 
can serve as a vehicle to find collective solutions to a region 
that we, in fact, share with many countries.
    So that is our hope, and that is the reason we are seeking 
Senate advice and consent.
    Senator Lugar.  Well, I appreciate your candor, and I 
appreciate even more your bringing the treaty to this point 
and, likewise, the Chairman holding the hearing. One of the 
dilemmas, and we touched upon this a little bit with the ITU 
situation, is that these affairs have been rumbling out there 
for many, many years. And I think you make a very good point 
that the rest of the world, in some cases, waits upon the 
United States to offer leadership. Or to the contrary, if we 
don't, others say, well, why should we care?
    Now, still in the conservation mode that so many Americans, 
I would hope a majority, are in with concerns that are 
addressed by this, and I think that is shared by other 
countries. It is interesting that France would be one of the 
four, clearly not a place of residence in the Caribbean, 
although interests in the various countries, as you say. But in 
terms of the actual citizens of that area, this is really 
significant.
    But this is not a time to complain why was there no 
priority. It is a time to celebrate the fact that we finally 
have come to the table, have a session of this variety attended 
at least by two members of the committee who are deeply 
interested in what is going on here, as well as a good number 
of citizens who have come to hear what you had to say today and 
to see whether progress was going to occur. So I appreciate 
that.
    Let me just raise one more question with regard to the tax 
treaties. And I will ask you again, Mr. Mundaca, I am just--I 
am curious, for instance, why some people in the business 
community that I have heard from are very appreciative of the 
Canadian treaty in particular. They think this really has very 
substantial significance.
    Now, in part, I can understand this from a parochial 
standpoint. My State of Indiana has--is just seventh, I have 
found, in terms of trade between Indiana and Canada. But even 
then we are exporting about $10 billion worth of goods and 
services from Indiana to Canada. We are importing $6 billion. 
So we are producing a balance of trade of $4 billion in one 
State with barely 2.5 percent of the population of the country.
    So this is a very significant treaty in terms of income for 
people in Canada and Indiana, for that matter. So I can 
understand why they would be interested in it. But they are 
saying beyond that apparently there were the questions that we 
were just discussing before of this binding arbitration is 
especially significant, maybe because there are so many 
elements of trade. Maybe it is so many more deals or 
sophisticated questions or entities that come into this.
    I am wondering whether that has been the case as you have 
found it from testimony around the country, that because really 
of our trading relationship with Canada, a sizable amount, that 
this is not necessarily overwhelming, but at the same time it 
could be. The number of cases stacking up that are unresolved, 
justice denied for years. So that then there gets to be a good 
bit of indecision about the tax code.
    Back here in the Congress, we change the tax code, or we 
don't really change it. But meanwhile, all these cases are out 
there. What is the caseload, just out of curiosity? And is this 
one reason why there is such business support for this 
particular treaty?
    Mr. Mundaca.  I think that is exactly right that the level 
of trade we have with Canada, the nearness of Canada and, 
therefore, the opportunities for many taxpayers--not just large 
multi-nationals, but small businesses and individuals to engage 
in cross-border activity with Canada--has led to many more tax 
disputes than we see with other countries. And there has 
developed a backlog of cases with Canada people are eager to 
see resolved on a more timely basis.
    And we are very optimistic this mechanism will speed to 
resolution through the negotiation process pending cases, and 
if they can't be settled in that--in that phase, then moved to 
arbitration so the taxpayers get the certainty that they 
deserve.
    Oftentimes, taxpayers, although they always mind paying 
taxes, they really mind paying taxes twice. And what they 
really do want is certainty about where their tax needs to go 
and have the other country respect that determination, and that 
is what we hope that this mechanism will provide in this 
context.
    There are probably more pending cases between the U.S. and 
Canada than we have with any other jurisdiction at this point. 
We get complaints about the timeliness of the resolution of 
those disputes, and again, we are very optimistic this 
mechanism can speed those along.
    Senator Lugar.  Now from the standpoint outside of the 
business community of taxpayers in both countries, what 
confidence do taxpayers have generally that these businesses 
finally are paying taxes properly, either in Canada or the 
United States? Do you note a good bit of evasion through all 
this delay or maybe through a lack of definition to begin with?
    Mr. Mundaca.  Actually, from what we have seen, at least 
with respect to Canada, it mostly goes the other way. Is that 
companies are concerned that they have a tax liability with 
respect to the same income stream to both Canada and the United 
States due to the lack of resolution of some of these large 
pending cases.
    So at least in my experience, I have not seen cases where 
the issue is that neither country is seeing the income and, 
therefore, it goes untaxed. The issue we see more are cases in 
which taxpayers come forward, and there are clear double tax 
cases that need to be resolved.
    Senator Lugar.  Thank you very much.
    Thank you, Mr. Chairman.
    Senator Menendez.  Thank you, Senator Lugar.
    Let me thank you all for your testimony and the hard work 
you put into treaties over many years. I specifically want to 
thank Avril Haines from the committee staff, who has done a 
tremendous service preparing the materials for this hearing and 
making them understandable to some of us who are not 
intricately engaged in this work.
    The record will remain open for 1 day so that committee 
members may submit additional questions to the witnesses, and 
we ask the witnesses to respond expeditiously to these 
questions.
    And seeing no other member seeking recognition, the hearing 
is adjourned.
    [Whereupon, at 4:00 p.m., the hearing was adjourned.]


                                APPENDIX

                              ----------                              

 responses to additional questions for the record submitted to deputy 
  assistant secretary michael mundaca by senator joseph r. biden, jr.


    Question. The President's Letter of Transmittal for the proposed 
Iceland Tax Treaty notes that because the existing treaty with Iceland 
from 1975 does not contain a Limitation on Benefits (``LOB'') 
provision, which is intended to prevent so-called treaty shopping, 
there has been ``substantial abuse of the existing Treaty's provisions 
by third country investors.'' See Treaty Doc. 110-17 at III. Please 
describe the evidence upon which this statement is based.

    Answer. A Treasury Department report to Congress, ``Earning 
Stripping, Transfer Pricing and U.S. Income Tax Treaties,'' released in 
November 2007 (2007 Treasury Report), describes abuses of the U.S. tax 
treaty network by third-country investors, particularly through 
inappropriate reductions in withholding tax. The 2007 Treasury Report 
presented data, gathered from U.S. tax returns, on deductible payments 
such as interest made by U.S. companies to related foreign companies 
located in treaty jurisdictions. The data suggested that tax treaties 
that have no LOB provision and a zero rate of withholding tax on 
deductible payments, such as our treaties with Iceland and Hungary, had 
begun to be abused by third-country investors. In particular, the 2007 
Treasury Report notes that while in 1996 almost no U.S.-source interest 
was paid by foreign-controlled U.S. companies to related parties in 
Iceland and Hungary, payments of such interest had increased by 2004 to 
over $2 billion. In addition, publicly available information indicates 
that many of those related parties were ultimately owned by 
corporations from third countries. This evidence strongly suggests the 
existence of treaty abuse by third-country residents.


    Question. Please explain how the LOB provision will be enforced 
against third-country investors that attempt to benefit from the 
treaty's provisions, should the new treaty be ratified. In addition, 
please describe specific enforcement challenges, if any, that the 
United States has faced in the past when attempting to enforce LOB 
provisions in other tax treaties.

    Answer. The Internal Revenue Service has a multi-pronged approach 
to enforcing compliance with treaty LOB provisions.
    With respect to payments of amounts subject to withholding, such as 
interest, royalties, and dividends, U.S. withholding agents (e.g., 
banks, brokers) are obligated to obtain, from each foreign payee, 
documentation on which the withholding agents can rely to treat a 
payment as made to a foreign person entitled to a reduced rate of 
withholding tax under the treaty. Absent such documentation, 
withholding at 30 percent is required. More specifically, foreign 
taxpayers who derive and beneficially own the payment must complete a 
Form W-8BEN (Certificate of Foreign Status of Beneficial Owner for U.S. 
Tax Withholding) to claim a reduced rate of withholding tax. Part II of 
the W-8BEN is entitled ``Claim of Tax Treaty Benefits.'' On line 9 the 
beneficial owner must identify its country of residence and, if the 
person is not an individual, represent that it meets the LOB article of 
the relevant treaty.
    With respect to claiming treaty benefits other than withholding tax 
reductions, such as a claim that a taxpayer does not have a permanent 
establishment in the United States, the taxpayer must file Form 8833 
(Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b)) 
attached to a Form 1120-F (U.S. Income Tax Return of a Foreign 
Corporation) or Form 1040 NR (U.S. Nonresident Alien Income Tax 
Return). Line 4 of Form 8833 requires the taxpayer to identify the LOB 
provision that the taxpayer relies upon to be eligible to take the 
treaty-based return position.
    In addition, the Internal Revenue Service audits LOB compliance as 
part of its general assessment of whether a foreign taxpayer is 
eligible to claim treaty benefits. The Treasury Department understands 
that the IRS' audit experience indicates that LOB issues most often 
arise in the context of audits of U.S. corporations that makes payments 
of interest, dividends, or royalties to related foreign persons.
    In the end, however, the simple inclusion of a LOB article in a 
treaty may by itself be largely responsible for limiting treaty 
shopping. The 2007 Treasury Report provides evidence that the mere 
inclusion of a comprehensive LOB provision is a deterrent against 
treaty shopping.


    Question. As set forth in Article 27(3) of the proposed treaty with 
Iceland, an unusual year-long transition period is provided for 
investors that are entitled to greater benefits under the 1975 treaty 
than the new treaty, during which they can elect to continue to benefit 
from the application of the 1975 treaty, rather than have the new 
treaty's provisions applied to them. Why was this provision included? 
How does this provision benefit the United States? Is this provision 
one that might be included in future treaties?

    Answer. The transition rule coordinating the entry into force of 
the proposed Iceland treaty and the termination of benefits of the 1975 
treaty is not an uncommon practice when an existing treaty is being 
replaced by a new agreement or is being amended by a new protocol. For 
instance, similar provisions were included in the U.S.-Belgium tax 
treaty (signed November 27, 2006), the U.S.-Germany protocol (signed 
June 1, 2006), the U.S.-U.K. tax treaty (signed July 24, 2001), and the 
U.S.-Denmark tax treaty (signed August 19, 1999). In order to reach 
agreement in 2007 with Iceland regarding inclusion of a LOB provision, 
we agreed to this election.


    Question. U.S. income tax treaties with Hungary and Poland provide 
an exemption from withholding on cross-border interest payments and, as 
in the case of the 1975 tax treaty with Iceland, these treaties do not 
include an LOB provision. Is the Treasury Department negotiating 
protocols with Hungary and Poland in order to rectify the omission of 
an LOB provision? If not, why not? If so, please describe the status of 
those negotiations.

    Answer. Updating the agreements with Hungary and Poland is a key 
part of the Treasury Department's effort to protect the U.S. tax treaty 
network from abuse. The Treasury Department has had two rounds of 
negotiations with Hungary already in 2008 with the aim of concluding a 
new agreement as soon as possible. The next round of negotiations is 
scheduled for September 2008, and an additional round is also 
scheduled, if necessary, for December 2008.
    As shown in the 2007 Treasury Report, it does not appear that the 
U.S.-Poland tax treaty has yet been extensively exploited by third-
country residents. Nevertheless, the Treasury Department has had 
preliminary discussions with Poland and anticipates continuing those 
discussions in 2008 with the goal of commencing negotiations to 
conclude a new agreement to update the 1976 agreement. The United 
States places a very high priority on bringing the proposed treaty with 
Iceland into force and on concluding as soon as possible negotiations 
with Hungary and Poland.
    Beyond renegotiating the treaties with Hungary and Poland, the 
Treasury Department reviews the current U.S. tax-treaty network on a 
continuing basis to identify deficiencies in existing agreements and 
areas where more beneficial terms for the United States and U.S. 
taxpayers could be negotiated. As part of this process, anti-treaty-
shopping provisions are given special scrutiny to ensure that they are 
functioning appropriately. Those treaties with LOB provisions that are 
out of date or need strengthening are given higher priority in the 
Treasury Department's plan for negotiations.


    Question. The proposed treaty with Iceland includes special anti-
abuse rules intended to deny benefits in certain circumstances in which 
an Icelandic-resident company earns U.S.-source income attributable to 
a third-country permanent establishment and is subject to little or no 
tax in the third jurisdiction and Iceland. Similar anti-abuse rules are 
included in other recent treaties, including the proposed Convention 
with Bulgaria. The U.S. Model Tax Treaty, however, does not include 
rules addressing so-called ``triangular arrangements.'' Why? Is this a 
provision that might be added to the U.S. Model Tax Treaty?

    Answer. The Treasury Department's current policy is to incorporate 
the so-called ``triangular rule'' into tax treaties in which the treaty 
partner exempts from tax certain foreign source income such that a tax 
treaty may be used inappropriately in conjunction with certain branch 
structures to exempt fully from tax certain U.S.-source payments. The 
Treasury Department is considering whether it is appropriate to include 
such a rule in the next update of the U.S. Model tax treaty.


    Question. The Committee on Taxation of Business Entities of the New 
York City Bar has written to the Committee on Foreign Relations in 
reference to the so-called ``derivative benefits''' test contained in, 
for example, Article 21(3) of the LOB provision in the proposed treaty 
with Iceland. In particular, the Bar's Committee on Taxation of 
Business Entities has stated that they ``believe that there is a need 
for guidance in determining the scope of the dividend payment relief 
under such derivative provisions, due to the uncertainties involved in 
calculating the relevant stock ownership.'' Has the Office of Tax 
Policy considered whether it would be useful to publish guidance on 
this topic?

    Answer. The New York City Bar Association's Committee on Taxation 
of Business Entities, in its May 2008 report (the NYCBA Report), 
suggests that there is need for guidance clarifying how ownership is 
calculated for purposes of the derivative-benefits rule in our recent 
tax treaties. The Office of Tax Policy recognizes the importance of 
providing published guidance with respect to income tax treaties 
generally, and is currently considering this and other recommendations 
made by the NYCBA Report.


    Question. Under the U.S. Model Tax Treaty child support payments 
paid to a resident of a treaty country is exempt from tax in either 
country. The proposed treaty with Iceland, however, makes no mention of 
the tax treatment of child support payments. Why is that?

    Answer. The absence of a special rule governing the taxation of 
child support payments in the proposed Iceland treaty means that the 
taxation of such payments would be governed by Article 20 (Other 
Income), which assigns the exclusive right to tax to the country of 
residence of the recipient. During the course of the negotiations, the 
Treasury Department learned that under Iceland's domestic law, most 
child support payments are not subject to tax. Accordingly, leaving the 
treatment of child support payments to Article 20 (Other Income) 
achieves a tax result very similar to the result under the U.S. Model 
rule; that is, the residence country will have the exclusive right to 
tax child support, but such payments are in most cases exempt from tax 
under the domestic laws of both the United States and Iceland.


    Question. Why doesn't the proposed treaty with Iceland address the 
tax treatment of cross-border pension contributions?

    Answer. The proposed treaty with Iceland does not address the tax 
treatment of cross-border pension contributions primarily for two 
reasons. First, the U.S. Model pension funds provision provides for 
deductibility in one State of contributions to a pension fund of the 
other State only where the pension fund ``generally corresponds'' to a 
pension fund in the first state. The provision is, therefore, only 
appropriate if the two countries have pension systems that are similar. 
During the course of negotiations, it became clear that Iceland and the 
United States have very different pension systems. As a result, the 
provision was not appropriate to include in the proposed treaty. 
Second, Iceland had limited flexibility in changing by tax treaty its 
rules for taxing pensions, because those rules are technically under 
Iceland's pension law, not its tax law.


    Question. Like the U.S. Model Tax Treaty, the Iceland Treaty 
provides that pension distributions owned by a resident of a 
contracting country are taxable in the recipient's country of 
residence. The U.S. Model Tax treaty, however, contains an exception to 
this provision under which a pension beneficiary's country of residence 
must exempt from tax a pension amount or other similar remuneration 
that would be exempt from tax in the other contracting country where 
the pension fund is established, as if the beneficiary had been a 
resident of that other country. Why doesn't the proposed treaty with 
Iceland contain such an exception?

    Answer. Like other departures from the U.S. Model, the omission in 
the U.S.-Iceland tax treaty of the exemption from tax for pension 
benefits that would be exempt from tax in the source country was the 
result of the negotiation process. Moreover, Iceland had limited 
flexibility in changing by tax treaty its rules for taxing pensions, 
because those rules are technically under Iceland's pension law, not 
its tax law.


    Question. The U.S. Model Tax Treaty allows recipients of ``income, 
gains, or profits'' from an entity that is fiscally transparent under 
the tax laws of the recipient's residence to enjoy the same treaty 
benefits on that income as they would have if the ``income, gains, or 
profits'' had been received by them directly, so long as the income 
coming to them through the entity is treated no differently by their 
resident country than it would have been had it been received directly 
by them. The provision in the Iceland Treaty for fiscally transparent 
entities closely parallels the provision in the U.S. Model Tax Treaty. 
Yet, rather than referring to such entities as ``fiscally 
transparent,'' the Iceland Treaty refers instead to entities that are 
either ``a partnership, trust, or estate.'' See Article 1(6). 
Treasury's Technical Explanation makes clear that this is intended to 
include U.S. limited liability companies (``LLCs'') that are treated as 
partnerships or as disregarded entities for U.S. tax purposes, 
including LLCs with only one member. Although the meaning appears to be 
equivalent, why wasn't the phrase ``fiscally transparent'' used in 
Article 1(6)?

    Answer. Paragraph 6 of Article 1 of the proposed treaty with 
Iceland does not use the U.S. Model's phrase ``fiscally transparent'' 
because that term does not have meaning under the domestic law of 
Iceland. During the course of the negotiations, the Treasury Department 
obtained agreement in principle with Iceland over the intent and 
application of paragraph 6 of Article 1. Accordingly, the Treasury 
Department believes that the rule will be interpreted and applied by 
Iceland consistent with the language in the U.S. Model Tax Treaty.


    Question. The Convention Between the United States and the Republic 
of Bulgaria for the avoidance of Double Taxation and the Prevention of 
Fiscal Evasion With Respect to Taxes on Income, with accompanying 
Protocol, was signed on February 23, 2007. Before transmitting this 
treaty to the Senate, however, a Protocol amending the 2007 treaty was 
negotiated with Bulgaria. This Protocol was signed on February 26, 2008 
and only after its completion, did the Executive Branch transmit the 
original treaty to the Senate for advice and consent. Why was the 2008 
Protocol needed? What changed between February 2007 and February 2008 
to necessitate amending the 2007 treaty? What is the most important 
correction made by the 2008 Protocol to the underlying treaty?

    Answer. The 2008 Protocol made certain technical corrections to the 
2007 Convention and accompanying Protocol, and addressed features of 
the Bulgarian tax system and treaty network that could result in a 
Bulgarian tax exemption for U.S. source income attributable to offshore 
branches of the Bulgarian company receiving the U.S. source income. To 
address the potential ``double exemption'' issue, the proposed 2008 
Protocol would add a so-called ``triangular rule'' to the LOB provision 
of the proposed treaty, which is the most important addition to be made 
by the 2008 Protocol.


    Question. Under the Bulgaria Convention, with limited exceptions, 
the withholding tax on cross-border royalty and interest payments would 
be imposed at a maximum rate of five percent. Under the accompanying 
protocol, the United States and Bulgaria are to reconsider source-
taxation of interest and royalties arising in Bulgaria and beneficially 
owned by a resident of the United States, at a time that is 
``consistent with the conclusion of the transition period'' under a 
European Union Council Directive applicable to interest and royalties 
deemed to arise in Bulgaria and beneficially owned by a resident of the 
European Union. The conclusion of the transition period is due to occur 
on December 31, 2014. Please explain the reason for including this 
commitment to reconsider source-taxation of interest and royalties 
arising in Bulgaria and beneficially owned by a resident of the United 
States. Is it fair to say that when you consult, you expect to 
negotiate an amendment to the Bulgaria Convention that would further 
reduce the maximum rate of withholding that can be imposed on cross-
border interest and royalties arising in Bulgaria and beneficially 
owned by a resident of the United States?

    Answer. At the conclusion of the transition period under the 
European Union Council Directive, Bulgaria is expected to adopt rates 
of withholding on cross-border interest and royalties for residents of 
European Union member states that are lower than the rate provided for 
in the proposed treaty. The provision of the 2007 Protocol is intended 
to memorialize the understanding between Bulgaria and the United States 
that the United States will have the opportunity at the conclusion of 
the transition period to negotiate a further protocol to the proposed 
treaty with Bulgaria that could reduce the maximum rate of withholding 
that may be imposed on cross-border interest and royalties arising in 
Bulgaria.


    Question. Both the Bulgaria Convention and the Canada Protocol 
include a special rule that broadens the typical definition of a 
``Permanent Establishment'' such that a service enterprise may still be 
deemed to have a Permanent Establishment in a treaty country, even if 
it does not have a fixed place of business in that country (the 
``services country''). See Article 5(8) of the Bulgaria Convention and 
Article 3(2) of the Canada Protocol.
    A number of the terms used in this rule are somewhat ambiguous and 
although the Technical Explanations for the Bulgaria Convention and the 
Canadian Protocol help to resolve some of that ambiguity, there is 
still work to be done. Please describe the steps you are taking with 
Canada, Bulgaria, and internally to further clarify the application and 
operation of this provision, including the specific terms you are 
focused on clarifying. In particular, is work being done to further 
clarify what constitutes ``presen[ce]'' in the services country and 
what constitutes a ``connected project''? What about the ``provision of 
services''? Is this term, for example, intended to include preparatory 
work or the collection of data from an office in one country in order 
to provide services in the other country?


    Question. In preparing the agreed Technical Explanation of the 
proposed Protocol with Canada, the Treasury Department had many 
discussions with Canada regarding the interpretation and application of 
the new rule concerning the taxation of services.

    Answer. If the proposed Protocol is approved by the Senate, the 
Treasury Department will continue these discussions with Canada. The 
Treasury Department's discussions with Canada to date have encompassed 
the interpretation of a number of terms, including ``presen[ce]'' in 
the services country, what constitutes "connected projects," and the 
meaning of ``provision of services.'' For example, the Technical 
Explanation to the proposed Protocol clarifies that paragraph 6 of 
Article V (Permanent Establishment) of the existing U.S.-Canada treaty 
applies notwithstanding the new rule for taxation of services. 
Paragraph 6 identifies activities with respect to which a fixed place 
of business will not give rise to a permanent establishment, which 
includes activities that have a preparatory or auxiliary character. 
Accordingly, days spent on preparatory or auxiliary activities shall 
not be taken into account for purposes of applying the services rule 
described in subparagraph 9(b) of Article V.
    The Treasury Department recognizes that additional guidance with 
respect to the services rule included in both the proposed Canada 
Protocol and the Bulgaria Convention is needed to provide more 
certainty to taxpayers, and we welcome further input regarding 
application of the rule.


    Question. Article 14(1) of the Bulgaria Convention, with certain 
exceptions, sets forth a general rule that if an employee who is a 
resident of one treaty country (the ``residence country'') is working 
in the other treaty country (the ``employment country''), his or her 
salaries, wages, and other remuneration derived from the exercise of 
employment in that country may be taxed by that country--i.e., the 
employment country. Notwithstanding this general rule, Article 14(2) of 
the treaty provides that the remuneration derived by the employee from 
the exercise of employment in the employment country shall be taxed 
only by the residence country (and not the employment country) if 1) 
the employee is present in the employment country for 183 days or less 
in any 12-month period commencing or ending in the taxable year 
concerned; 2) the remuneration is paid by, or on behalf of, an employer 
who is not a resident of the employment country; and 3) the 
remuneration is not ``borne'' by a permanent establishment that the 
employer has in the employment country. The Canada Protocol has a 
variation of this provision in Article 10(2), which amends Article XV 
of the Canada Tax Treaty. In both treaties, the final requirement 
(i.e., that the remuneration is not ``borne'' by a permanent 
establishment that the employer has in the employment country), 
interacts with the special rule expanding the definition of a permanent 
establishment in a potentially problematic way.
    For example, in the case of the Bulgaria Convention, it appears 
that the salaries, wages, and other remuneration derived by an employee 
performing services through a permanent establishment arising under 
Article 5(8) of the treaty would be subject under Article 14 to being 
taxed by the employment country, even if the other requirements of the 
test in Article 14(2) had been met (i.e., the employee had been present 
in the employment country for less than 183 days during any 12-month 
period commencing or ending in the taxable year concerned and the 
employee's remuneration was paid by an employer who is a resident of 
the other country). Is this correct? If so, the interaction of these 
two provisions would increase the complexities associated with the 
special rule contained in Article 5(8). For example, such a scenario 
would mean that an employer and the relevant employees would need to 
fulfill several tax-related obligations, including obtaining tax 
identification numbers and providing for the withholding of income 
taxes and other taxes as appropriate that would cover the period 
beginning on the first day such services were performed by such 
employee during the affected year. Please explain how the Department 
intends to address the problems presented by this result for taxpayers 
that may not know whether they will be deemed to have a permanent 
establishment under the treaty until perhaps 6 months into the relevant 
12-month period, and will therefore be subject to various taxes, 
including employment taxes, by the services country reaching back to 
the beginning of the relevant 12-month period.

    Answer. It is correct that a permanent establishment arising under 
Article 5(8) of the proposed Bulgaria Convention is a permanent 
establishment for purposes of Article 14 of the Convention, and 
therefore the salaries, wages, and other remuneration of an employee 
borne by a permanent establishment of the employer arising under 
Article 5(8) of the treaty would be subject under Article 14 to being 
taxed by the source country, even if the other requirements of the test 
in Article 14(2) had been met.
    The Treasury Department recognizes that the rule for taxation of 
services in the proposed Canada Protocol raises compliance and 
administrative concerns for companies and their employees. The Treasury 
Department and Internal Revenue Service have met with a number of U.S. 
taxpayers, including professional services firms, to discuss the 
interpretation and application of this rule, focusing on administrative 
issues. The Treasury Department has discussed with Canada and, if the 
proposed Protocol is approved by the Senate, will continue to discuss 
with Canada, possible methods of easing the administrative burden on 
businesses associated with complying with this new rule, the effective 
date of which is delayed until the third taxable year ending after the 
proposed Protocol enters into force. The Technical Explanation to the 
proposed Canada Protocol, the contents of which the Government of 
Canada has subscribed to, provides that ``[t]he competent authorities 
are encouraged to consider adopting rules to reduce the potential for 
excess withholding or estimated tax payments with respect to employee 
wages that may result from the application of [the services rule].''


    Question. A version of this special rule appears in the 2008 OECD 
draft update to the OECD Model Tax Convention as an alternative 
services permanent establishment provision. There are, however, a few 
differences in language between the OECD rule and the one used in the 
Bulgaria Convention and the Canada Protocol. In particular, the OECD 
language clarifies that services performed by an individual on behalf 
of an enterprise may be considered as performed by that enterprise only 
if the enterprise supervises, directs, or controls the manner in which 
the services are performed by the individual. The language in the text 
of the Bulgaria Convention and the Canada Protocol are silent on this 
point, apparently leaving open the question of whether, and if so, 
under what circumstances, the use of a subcontractor might give rise to 
a permanent establishment of a general contractor. Is it Treasury's 
view that services performed by an individual on behalf of an 
enterprise may be considered as performed by that enterprise only if 
the enterprise supervises, directs, or controls the manner in which the 
services are performed by the individual? Does Canada share this view? 
Does Bulgaria?

    Answer. For a number of years, the OECD has debated whether to 
include an alternative rule for the taxation of services in the OECD 
Model or its Commentary. The 2008 Update to the OECD Model, released on 
July 18, 2008, includes a version of the services rule as an 
alternative in the Model Commentary. The language of the OECD provision 
does not match in all respects the language of provision included in 
the proposed Bulgaria Convention and the Canada Protocol. For example, 
the language of the Bulgarian and Canadian provision requires that the 
services be provided ``for customers who are either residents of that 
other State or who maintain a permanent establishment in that other 
State.'' That language regarding the provision of services to customers 
is not included in the OECD provision, and thus the issue of whether 
the use of a subcontractor might give rise to a permanent establishment 
is especially important in applying the OECD provision. If the Senate 
approves the proposed the Bulgaria Convention and Canada Protocol, the 
Treasury Department will continue to discuss with Bulgaria and Canada 
the interpretation and application of the version of the rule for 
taxation of services included in our agreements.


    Question. One aspect of the rule in both the Bulgaria Convention 
and the Canada Protocol that would appear to be difficult to manage is 
the fact that the 12-month period isn't tied to a fiscal year. Is this 
something you considered and rejected during the course of 
negotiations? Is this something that might be considered in the future, 
should you include this special rule in future treaties?

    Answer. The rule for taxation of services in the proposed 
agreements with Bulgaria and Canada refers to an aggregate of 183 days 
or more in ``any 12-month period'' as opposed to, for example, 183 days 
or more in a fiscal or calendar year. The reference to ``any 12-month 
period'' addresses potential situations in which, for example, work has 
been artificially divided into two separate fiscal years in order to 
avoid meeting the 183-day threshold. For instance, a taxpayer could 
circumvent a threshold based on 183 days in a fiscal year by providing 
services in the other state for the last five months of one fiscal year 
and the first five months of the following fiscal year.
    The Treasury Department recognizes the administrative and 
compliance concerns of companies and their employees regarding the 
rule's reference to ``any 12-month period.'' If the proposed agreements 
with Bulgaria and Canada are approved by the Senate, the Treasury 
Department will continue to discuss the interpretation and application 
of this rule with Bulgaria and Canada in the context of exploring ways 
to alleviate administrative and compliance burdens.
    The inclusion of a rule for taxation of services in the proposed 
agreements with Bulgaria and Canada does not reflect a change in U.S. 
tax treaty policy, and inclusion of such a provision in the U.S. Model 
is not being considered. However, it is a provision that the Treasury 
Department will consider in the context of negotiating a particular 
agreement in exchange for significant concessions in other areas, and 
the inclusion of such a provision in the proposed agreements with 
Bulgaria and Canada was a key element to achieving overall agreements 
that provide benefits to the United States and to U.S. taxpayers. At 
the same time, the Treasury Department recognizes the concerns raised 
by the Joint Committee on Taxation's ``Explanation of Proposed Protocol 
to the Income Tax Treaty between the United States and Canada'' about 
the appropriateness of including a services rule in a tax treaty with a 
developed country.
    In the context of negotiating a particular agreement in the future, 
the Treasury Department may consider referring to an alternative 12-
month period. The Treasury Department welcomes input concerning this 
issue.


    Question. Mandatory arbitration was included in the Protocol with 
Canada, but not in the treaty with Iceland or Bulgaria. Please explain 
why. In negotiating future treaties, what are the factors considered by 
Treasury when deciding whether or not to include binding arbitration in 
a new tax treaty or in an amendment to an existing tax treaty? Are you 
currently negotiating mandatory arbitration mechanisms with other 
countries? If so, which countries?

    Answer. The Treasury Department believes that mandatory binding 
arbitration, as an extension of the competent authority process, is an 
effective tool to strengthen the Mutual Agreement Procedure in the U.S. 
treaty network as a whole. Even in the best competent authority 
relationships, there are, on occasion, difficult treaty interpretation 
questions and disputes that arise. The Treasury Department believes 
that the arbitration mechanism included in the proposed agreement with 
Canada will help resolve cases in a timely manner and enhance the 
working relationship of the competent authorities.
    The Treasury Department has been discussing mandatory binding 
arbitration in general terms with our treaty partners, and intends to 
continue to raise inclusion of a mandatory binding arbitration 
provision with our treaty partners in future negotiations. The Treasury 
Department welcomes further input from the committee concerning the 
factors that should be taken into account when considering whether to 
include an arbitration provision in the context of the negotiation of a 
particular agreement, as well as ways that the arbitration provision in 
future agreements might be improved or varied.


    Question. When considering the mandatory arbitration provisions in 
the Belgium and Germany tax treaties, which were approved by the Senate 
last year, the committee focused on, among other things, the selection 
of fair, objective, and independent arbiters. In answer to a question 
for the record regarding your process for selecting arbiters, it was 
noted that the Treasury Department ``expect[s] to have further 
discussions with our treaty partners concerning the [selection of 
arbiters], with a view toward achieving the best balance of the 
concerns expressed and providing to taxpayers an efficient and 
effective resolution of their double taxation.'' Please describe the 
status of such discussions with Belgium and Germany. Does the 
Department expect to have discussions with Canada on this topic as 
well? Specifically, what work has been done to ensure that the United 
States and all three treaty partners will select fair, objective, and 
independent arbiters for service on arbitration boards constituted by 
the mechanisms provided in these treaties?

    Answer. The U.S. competent authority has formally begun discussions 
with Belgium and Germany on a number of procedural matters to ensure 
the effective implementation of the arbitration provision, including 
regarding the qualifications for arbiters, especially those 
qualifications required to ensure that arbiters are sufficiently 
independent. In those discussions, the U.S. competent authority has 
expressed the concerns raised by the committee in its considerations of 
the Belgian and German agreements regarding the selection of Government 
employees as arbiters. We hope that similar discussions with Canada 
begin soon. While we do not yet have formal agreements with any of 
these treaty partners, they understand and agree with the need for 
fair, objective, and independent arbitration boards.


    Question. The Canada Protocol, as in the case of the Belgium and 
Germany tax treaties, does not identify the procedural rules that will 
be used by arbitration boards constituted in accordance with the 
mandatory arbitration provision included in each treaty. In answer to a 
question for the record on this topic in relation to the Belgium and 
Germany tax treaties, the Treasury Department noted that ``after 
studying the details of the [procedural] rules commonly used in 
commercial arbitration, we concluded that most of these rules relate to 
evidentiary procedures not relevant to the simplified arbitration 
format proposed in the agreements with Belgium and Germany, primarily 
because the decision of the arbitration board is to be based upon a 
record rather than a presentation of evidence.'' Has the Treasury 
Department had discussions with Canada, Belgium, and Germany regarding 
what procedural rules would be appropriate for the arbitration format 
provided for in these treaties? In particular, has there been any 
discussion regarding conflict of interest rules that might apply to 
arbiters?

    Answer. The U.S. competent authority has formally begun discussions 
with Belgium and Germany, and informally with Canada, on a number of 
procedural matters to ensure the effective implementation of the 
arbitration provision. The objective of these discussions is to have 
the procedures in place with respect to Belgium and Germany no later 
than December 31, 2008. As part of the discussions with Belgium and 
Germany, the U.S. competent authority has also begun discussing the 
need for conflict-of-interest rules to govern arbiters. For example, 
the U.S. competent authority has discussed whether safeguards might be 
built into the necessary procurement arrangements between the United 
States and the arbiter. While the U.S. competent authority does not yet 
have formal agreements with any of these treaty partners, they 
understand and agree with the need for fair, objective, and independent 
arbitration boards.


    Question. The committee Report on the Germany and Belgium treaties 
raised certain concerns regarding the mandatory arbitration mechanism, 
including concerns regarding treaty interpretation and the selection of 
arbiters. Other Members have indicated related concerns regarding these 
provisions. None of these are addressed in the Canada Protocol 
arbitration provision, but presumably that is because the Canada 
Protocol was already negotiated when these concerns were raised. Can 
you, however, confirm that these concerns will be considered and 
addressed in future tax treaties with similar arbitration mechanisms?

    Answer. The arbitration provision in the proposed Protocol with 
Canada was already negotiated at the time the Senate considered the 
agreements with Germany and Belgium in 2007. It is for this reason that 
the concerns expressed by the committee on the agreements with Germany 
and Belgium are not reflected in the proposed Canada Protocol.
    The Treasury Department greatly appreciates the input received from 
the committee on several aspects of the German and Belgian arbitration 
provisions, and similarly with the Canadian Protocol. The committee's 
concerns have been and will continue to be considered in any 
arbitration negotiations the Treasury Department conducts.


    Question. The exchange of notes between the United States and 
Canada that accompanies the Canada Protocol includes many of the 
details that would govern the binding arbitration mechanism to be 
included in the treaty. Among other things, the notes make clear that 
the arbitration mechanism would only apply to certain articles in the 
treaty, which are listed, unless otherwise agreed to by the parties.
    How were the articles to which arbitration applies, selected?

    Answer. The Treasury Department believes that mandatory binding 
arbitration, as an extension of the competent authority process, is an 
effective tool to strengthen the Mutual Agreement Procedure in the U.S. 
treaty network as a whole. However, the scope of an arbitration 
provision in a particular agreement is a matter that must be negotiated 
with the treaty partner. Some countries may be willing to cover only 
specific articles in the treaty. It should be noted that while the 
mandatory binding arbitration provision in the proposed Canada Protocol 
is limited to certain articles, other issues are eligible for 
arbitration if the competent authorities agree that the particular case 
is suitable for arbitration.


    Question. Why isn't Article 3 (Definitions) among the articles 
included in this list?

    Answer. Article III of the existing Canada treaty provides 
definitions and general rules of interpretation for the treaty. 
Paragraph 1 of Article III defines a number of terms for purposes of 
the treaty. Certain other terms are defined in other articles of the 
treaty. Paragraph 2 of Article III provides that, in the case of a term 
not defined in the treaty, the domestic tax law of the Contracting 
State applying the treaty shall control, unless the context in which 
the term is used requires a definition independent of domestic tax law 
or the competent authorities reach agreement on a meaning.
    To the extent that an issue concerning the definition of a term is 
part of a case regarding the application of one or more articles 
explicitly within the scope of the mandatory arbitration provision, 
such definitional issue will be considered during the arbitration 
process.


    Question. If a dispute focuses on a term that is defined in Article 
3 and appears in another Article that is within the scope of the 
arbitration mechanism, would such a dispute be subject to arbitration 
under the Protocol?

    Answer. To the extent that an issue concerning the definition of a 
term defined in Article III is part of a case regarding the application 
of one or more articles explicitly within the scope of the mandatory 
arbitration provision, such definitional issue will be considered 
during the arbitration process


    Question. Article 2(1) of the proposed Canada Protocol addresses 
the issue of so-called ``dual-resident corporations.'' It provides that 
if such a company is created under the laws in force in a treaty 
country but not under the laws in force in the other treaty country, 
the company is deemed to be a resident only of the first treaty 
country. Have you considered whether this rule is equitable, for 
example, in circumstances in which a corporation was organized under 
the laws of the United States many years ago and has long since ceased 
to have significant contacts with the United States, but instead is 
managed and controlled in Canada? Have you considered whether it might 
be appropriate to provide discretion to the Competent Authorities in 
such a case to determine, for example, that the company is in fact a 
resident of Canada?

    Answer. To address abuses of the existing treaty by U.S. companies 
continuing into Canada, the proposed Protocol replaces the existing 
treaty's rule for resolving dual-residency conflicts for corporations 
with an updated rule that is similar to the rule in the U.S. Model. It 
has been a longstanding treaty policy of the United States to place 
significant weight on the place of incorporation when addressing 
questions of dual corporate residence. However, we have included in 
other agreements, for example in our agreement with the United Kingdom 
and the proposed Bulgaria and Iceland agreements, provisions directing 
the Competent Authorities to endeavor to determine for treaty purposes 
the residence of dual resident corporations.


    Question. Article 2(2) of the Canada Protocol would amend Article 
IV of the Canada Tax Treaty to include a new paragraph 6 and 7, setting 
forth specific rules for the treatment of certain income, profit, or 
gain derived through or paid by fiscally transparent entities. The new 
paragraph 6 would set forth a ``positive'' rule, which identifies 
scenarios in which ``income, profit or gain shall be considered to be 
derived by a person who is a resident of a Contracting State.'' The new 
paragraph 7 would set forth a ``negative'' rule intended to prevent the 
use of such entities to claim the benefits where the investors are not 
subject to tax on the income in their state of residence. In 
particular, paragraph 7 is aimed largely at curtailing the use of 
certain legal entity structures that include hybrid fiscally 
transparent entities, which, when combined with the selective use of 
debt and equity, may facilitate the allowance of either 1) duplicated 
interest deductions in the United States and Canada, or 2) a single, 
internally generated, interest deduction in one country without 
offsetting interest income in the other country. As noted by the Joint 
Committee on Taxation in its explanation of the Canada Protocol, 
commentators have raised a question as to whether subparagraph 7(b) is 
too broad, because it could prevent legitimate business structures that 
are not engaging in potentially abusive transactions from taking 
advantage of benefits that would otherwise be available to them under 
the treaty. Please explain whether you agree or disagree with the 
assertion that subparagraph 7(b) is overbroad. If so, has there been 
any discussion regarding what might be done to improve the situation? 
In addition, does the Treasury Department expect to include such a rule 
in future tax treaties? If so, has the Treasury Department considered 
alternate versions that might provide for a narrower exception from the 
rule in paragraph 6?

    Answer. Subparagraph 7(b) essentially denies benefits in cases in 
which the residence country treats a payment differently than the 
source country and other conditions are met. The rule is broader than 
an analogous rule in Treasury regulations issued pursuant to section 
894 of the Internal Revenue Code. The Treasury Department is aware that 
the scope of subparagraph 7(b) is potentially overbroad, especially in 
the case of non-deductible payments. The Treasury Department has been 
discussing, and will continue to discuss with Canada, whether to 
address this issue. The Treasury Department does not contemplate 
incorporating such a rule in future tax treaties.


    Question. The Treasury Department's Technical Explanation provides 
several examples of the application of subparagraph 7(b) to certain 
legal entity structures. But, the Technical Explanation does not 
provide an example of a payment made by a U.S. domestic reverse hybrid 
entity that is treated as a partnership for Canadian tax purposes to 
one of its owners. Although the partnership example in the Technical 
Explanation should apply reciprocally to a payment treated as a 
dividend for U.S. tax purposes and a partnership distribution for 
Canadian tax purposes, the Technical Explanation does not state so 
explicitly. Can you confirm that this is the case?
    In addition, the Technical Explanation does not include examples 
relating to a deductible interest (or royalty) payment from a hybrid 
partnership entity to one of its owners. In the case of such a payment 
from a Canadian hybrid partnership entity, the U.S. recipient of the 
payment would generally treat it as a payment of interest (or 
royalties) for U.S. tax purposes.\1\ One might expect that subparagraph 
7(b) would not apply in this case because the fiscal transparency of 
the partnership would generally not be relevant for residence-country 
tax purposes, but there is no discussion of this case in the Technical 
Explanation. Can you confirm that this is a reasonable reading of 
subparagraph 7(b)? Also, please clarify whether subparagraph 7(b) 
applies with respect to deductible payments by a domestic reverse 
hybrid partnership entity to one of its Canadian owners.
---------------------------------------------------------------------------
    \1\Under section 707(a) and Treas. Reg. section 1.707-1(a), if a 
partner engages in a transaction with a partnership other than in the 
capacity as a member of the partnership, the transaction is, in 
general, considered as occurring between the partnership and one who is 
not a partner. See Rev. Rul. 73-301, 1973-2 C.B. 215.

    Answer. Page 10 of the agreed Technical Explanation provides an 
---------------------------------------------------------------------------
example of the application of subparagraph 7(b):


          [Assume] in the above example, USCo (as well as other 
        persons) are owners of CanCo, a Canadian entity that is 
        considered under Canadian tax law to be a corporation that is 
        resident in Canada but is considered under U.S. tax law to be a 
        partnership (as opposed to being disregarded). Assume that USCo 
        is considered under Canadian tax law to have received a 
        dividend from CanCo. Such payment is viewed under Canadian tax 
        law as a dividend, but under U.S. tax law is viewed as a 
        partnership distribution. In such a case, Canada views USCo as 
        receiving income (i.e., a dividend) from an entity that is a 
        resident of Canada (CanCo), CanCo is viewed as fiscally 
        transparent under the laws of the United States, the residence 
        State, and by reason of CanCo being treated as a partnership 
        under U.S. tax law, the treatment under U.S. tax law of the 
        payment (as a partnership distribution) is not the same as the 
        treatment would be if CanCo were not fiscally transparent under 
        U.S. tax law (as a dividend). As a result, subparagraph 7(b) 
        would apply to provide that such amount is not considered paid 
        to or derived by the U.S. resident.


    The provisions of subparagraph 7(b) apply reciprocally. Assume, for 
example, that CanCo (as well as other persons) are owners of USCo, a 
U.S entity that is considered under U.S. tax law to be a corporation 
resident in the United States, but is considered under Canadian tax law 
to be a partnership (a so-called ``domestic reverse hybrid''). Assume 
that CanCo is considered under U.S. tax law to have received a dividend 
from USCo. Such payment is viewed under U.S. tax law as a dividend, but 
under Canadian tax law is viewed as a partnership distribution. In such 
a case, the United States views CanCo as receiving income (i.e., a 
dividend) from an entity that is a resident of the United States 
(USCo), USCo is viewed as fiscally transparent under the laws of 
Canada, the residence State, and by reason of USCo being treated as a 
partnership under Canadian tax law, the treatment under Canadian tax 
law of the payment (as a partnership distribution) is not the same as 
the treatment would be if USCo were not fiscally transparent under 
Canadian tax law (as a dividend). As a result, subparagraph 7(b) would 
apply to provide that such amount is not considered paid to or derived 
by the Canadian resident.
    As noted in the agreed Technical Explanation: ``Paragraphs 6 and 7 
apply to determine whether an amount is considered to be derived by (or 
paid to) a person who is a resident of Canada or the United States. If, 
as a result of paragraph 7, a person is not considered to have derived 
or received an amount of income, profit or gain, that person shall not 
be entitled to the benefits of the Convention with respect to such 
amount. Additionally, for purposes of application of the Convention by 
the United States, the treatment of such payments under Code section 
894(c) and the regulations thereunder would not be relevant.'' Thus, 
subparagraph 7(b) applies with respect to deductible payments by a 
domestic reverse hybrid to its Canadian owners.
    Although not specifically addressed in the Technical Explanation, 
the Treasury Department and Canada agree that subparagraph 7(b) does 
not apply to deny benefits to interest and royalty payments by an 
entity that is treated as a partnership by one country and a 
corporation by the other if the treatment of such amount by the country 
of the person deriving the income would be the same if such amount had 
been derived directly by such person (interest or royalties).


    Question. Does the Treasury Department intend to formally share its 
Technical Explanation regarding the Bulgaria and Iceland Treaties with 
each country, as a courtesy?

    Answer. As a courtesy, the Treasury Department has sent copies of 
its Technical Explanation to each country. Unlike the Technical 
Explanation to the proposed Canada Protocol, however, the Technical 
Explanations to the proposed Bulgaria and Iceland Conventions have not 
been reviewed by or subscribed to by the relevant country.

                               __________

 responses to additional questions for the record submitted to deputy 
    assistant secretary michael mundaca by senator richard g. lugar


    Question. Please give an overview of current cases that have not 
been resolved and the anticipated case load that would be addressed by 
the Arbitration Provision in the Protocol with Canada, including number 
of cases, length of time unresolved, and country of origin breakdowns.

    Answer. There are currently 192 active cases with Canada. Of those, 
approximately 90 percent are transfer-pricing cases, with the remainder 
involving interpretive issues, such as residency and permanent-
establishment determinations. The Canadian tax authorities initiated 
the adjustment in 85 percent of the cases caused by a transfer pricing 
adjustment.
    Fifty-three of the 192 total cases have been unresolved for over 
two years. Of those 53 cases, the ``oldest'' case is 2,289 days old and 
the ``youngest'' case is 762 days old. Four of the 53 cases involve 
interpretive issues, the oldest of which is 1,657 days and the youngest 
of which is 1085 days.
    We should note that different countries track their outstanding 
competent authority cases differently. For example, concepts such as 
the definition of a case may vary by country. Thus, we have observed 
that where a treaty partner has aggregate information regarding its 
case load with the United States the numbers sometimes notably diverge 
from the numbers used by the United States.


    Question. Traditionally, tax treaties agreements have been seen as 
facilitating cross-border trade and investment of multinational 
businesses. However, increasing globalization also affects small 
businesses. Is the current model for U.S. Tax Treaties clear, 
understandable and usable for smaller businesses? Give examples of how 
small business can take advantage of these treaties.

    Answer. The current U.S. Model Tax Treaty and Technical Explanation 
are available on the Treasury Department website. The Treaty and 
especially the Technical Explanation are drafted to be as clear and 
understandable as possible, but we recognize that technical 
international tax rules and issues may appear opaque to many taxpayers. 
IRS publications, especially Publication 901 on Tax Treaties, provide 
international tax guidance in less technical terms and may be more 
accessible to individuals who do not have significant tax experience.
    We further recognize that in our increasingly global economy, small 
businesses and individuals may, and perhaps must, address cross-border 
tax issues. Because our tax treaties provide generally uniform and 
clear rules regarding such important issues as withholding tax rates 
and tax jurisdictional thresholds, we think they can be especially 
useful to small businesses and individuals, who may not have access to 
multi-national advisors or foreign tax advice. More specifically, tax 
treaties generally allow U.S. businesses to engage in trade in goods 
and services of greater value and duration with foreign clients without 
incurring foreign taxes than would be the case in the absence of 
treaties. Treaties may also facilitate access to foreign skilled 
workers and researchers, and to foreign capital via reduced withholding 
rates.
    We welcome further input from the committee regarding how best to 
serve small businesses in this regard.


    Question. Please describe the current U.S. position on reciprocal 
elimination of withholding taxes on cross-border dividends paid between 
a subsidiary and its parent company. Has there been a change in the 
U.S. policy position?

    Answer. The policy of the Treasury Department continues to be that 
the elimination of source-country taxation of dividends should be 
considered only on a case-by-case basis. Such a provision is not part 
of the U.S. Model because we do not believe that it is appropriate to 
include in every treaty. We must consider the interaction of our tax 
system with our treaty partner's, as well as the overall balance of the 
treaty before deciding whether inclusion is appropriate.

                               __________

 responses to additional questions for the record submitted to senior 
 deputy u.s. coordinator richard beaird by senator joseph r. biden, jr.


    Question. Please provide a list of recent accomplishments of the 
International Telecommunications Union (``ITU'') that have had a 
significant impact on U.S. interests, with a particular focus on 
national security, public diplomacy, and economic interests.

    Answer. In terms of National Security, the ITU has been a leader in 
the development of Standards for Emergency Telecommunications (and 
related standards for Telecommunications for Disaster Relief). This is 
important because emerging telecommunications networks are based on 
fundamentally different switching technologies from the legacy Public 
Switched Telecommunications Networks.
    In terms of public diplomacy, the ITU Development (D) Sector has 
made one of its primary goals developing a ``cybersecurity best 
practices'' report for use by the developing world. The U.S. has a 
leadership role in this effort. The draft report on cybersecurity best 
practices has been well received by developing nations, and already 
constitutes a success story at the ITU for both the U.S. (which 
developed the basic materials), and the institution.
    In terms of economic interest, the 2007 World Radiocommunication 
Conference (WRC-07) addressed some 30 agenda items related to almost 
all terrestrial and space radio services and applications. These 
included future generations of mobile telephony, aeronautical telemetry 
and telecommand systems, satellite services including meteorological 
applications, maritime distress and safety signals, digital 
broadcasting, and the use of radio in the prediction and detection of 
natural disasters.


    Question. Please provide a list of current and future priorities of 
the ITU that are of importance to the United States.

    Answer. The United States supports the ITU's approach of focusing 
on the theme of convergence in providing a range of services over a 
single network. As legacy telecommunication systems transition to 
Internet Protocol-based platforms that support expanded information and 
communication technologies (ICTs), the U.S. believes it is necessary to 
examine the potential of ICTs to address significant global issues. One 
such issue is ICT and its effect on the environment.
    The U.S. also supports the ITU's efforts to coordinate the needs of 
developing and developed countries to expand Digital Inclusion. The ITU 
is also urging Regional Groups to fully collaborate to identify the 
necessary spectrum for International Mobile Telecommunications (IMT), 
which will allow use of advanced broadband mobile technology on a 
global basis. In October 2007, at the World Radiocommunication 
Assembly, the ITU added a WiMAX-derived technology to the IMT-2000 set 
of global standards. This paves the way for the world-wide deployment 
of voice, data and multimedia services to stationary and mobile 
devices, at higher speeds and across wider areas.


    Question. Many of the amendments made to the ITU Constitution and 
the ITU Convention that are now under consideration (Treaty Docs. 108-
5, 109-11, and 110-16), are designed to facilitate private sector 
participation in the work of the ITU.
    Please describe how the increased private sector participation has 
changed the dynamic at the ITU.

    Answer. There are a number of trends in ITU participation since the 
year 2000 that have changed the landscape in the ITU. Since 2000, the 
private sector has shown increased interest in participating in ITU 
activities (as ITU Sector Members) and in partnering with the ITU in 
order to interface with relevant governmental decision-makers (and 
other potential partners) that are involved in addressing the 
constantly changing and evolving telecommunication environment. The 
increased participation of ITU Sector Members has assisted the ITU in 
developing innovative agendas to encourage access to Information and 
Communication Technologies (ICTs) in developing countries. It has also 
provided Sector Members with new business opportunities.


    Question. Does more need to be done to facilitate private sector 
participation?

    Answer. We continue to look for ways to make the ITU a more 
attractive forum for private sector participation. At the last 
Plenipotentiary Conference in Antalya, the U.S. was successful in 
keeping the Conference from increasing the minimum contribution for 
Sector Members. We believe that maintenance of the current levels of 
contribution will encourage private sector participation in the ITU. We 
are encouraged that major corporations have recently broadened their 
participation in the ITU.


    Question. At what point does private sector participation become 
concerning? What are the challenges that the ITU faces in balancing 
Member States' rights with the involvement of the private sector?

    Answer. Private sector participation in the ITU's activities is 
crucial to the future success of the ITU. More participation per se by 
the private sector is never a threat. However, if changes were made in 
the ITU's procedural rules that resulted in Sector Members gaining 
control over the ITU's processes, such changes would be a concern 
because they could prevent Member States from exercising their 
appropriate role as guardians of the public interest and national 
security. No such changes are currently envisioned.


    Question. One of the most important aspects of the 1998 amendments 
to the Constitution and the Convention was a clarification of the roles 
of Member States of the ITU and private sector participants in the ITU, 
which include ``Sector Members'' and ``Associates.''

    Answer. Please provide information on the role and importance of 
Sector Members within the ITU.

    Answer. Sector Members have an important role to play in all three 
ITU Sectors, but their participation relative to that of Member States 
varies from Sector to Sector. In the ITU-T, since national networks 
have been privatized, Member States generally no longer engage in 
technical work (with some exceptions where there are national interests 
at stake, such as priority of communications in times of national 
disasters and emergencies, or identity management). Consequently, 
Sector Members are largely responsible for preparing technical 
contributions for telecommunications standards. In the ITU-R, both 
Sector Members and Member States have major stakes in obtaining and 
protecting radio spectrum. In the ITU-D, with some notable exceptions, 
the private sector has historically been much less involved. This may 
be because the business case for assisting developing countries is much 
less obvious than the need to obtain spectrum for a new service (in 
ITU-R), or to establish an international standard for 
telecommunications equipment (in ITU-T).


    Question. Why did the United States decide not to authorize the 
direct application procedures that were added to Article 19 of the 
Convention in an effort to streamline the application process for 
Sector Members?

    Answer. The U.S. has chosen to maintain minimal oversight over 
which U.S. entities are allowed to apply for ITU membership for a 
number of reasons. One is that the U.S., which has more Sector Members 
than any other country, wants to be kept informed about what U.S. 
entities are participating in the ITU. Another is that the U.S. may 
incur some de facto responsibilities as a result of a U.S. company 
becoming an ITU member. For example, the ITU turns to the U.S. to 
assist in seeking payment from a U.S. entity when that U.S. entity does 
not meet its ITU obligations, such as failure to pay its contributory 
share.


    Question. Please provide information on the role and importance of 
Associates, including their role in ITU study groups.

    Answer. Associates are entitled to attend and participate in a 
specific Study Group or Groups, whereas Sector Members are entitled to 
attend and participate in all the Study Groups in a given Sector. 
Associates play an important role in the ITU standards development 
process. Creation of an Associate category has increased private sector 
participation in the ITU and brought into the ITU process entities with 
specialized expertise in particular fields of telecommunications. The 
private sector has benefited from the Associate category because it has 
allowed entities that have expertise in a particular telecommunications 
subject to participate in that part of the work of the ITU that is of 
interest to them, at a lower rate than they would have to pay to as 
Sector Members.


    Question. Is there any overlap between Sector Members and 
Associates?

    Answer. Sector Membership entitles a private sector member to 
attend all the Study Groups in a Sector. An Associate can only 
participate in the specific Study Group(s) for which it is an 
Associate. If an entity is a Sector Member, it would make no sense for 
it also to be an Associate in the same sector.
    We are aware that several entities have chosen to be a Sector 
Member in one Sector but an Associate in another Sector.


    Question. How many U.S. Sector Members and U.S. Associates 
participate in the ITU's work? Is there a list that is publicly 
available?

    Answer. Yes.
    There is a publicly available list of Sector Members on the ITU's 
website at--

www.itu.int/cgi-bin/htsh/mm/scripts/mm.list?_search=sec&_languageid=1

    And Associates at--

www.itu.int/cgi-bin/htsh/mm/scripts/
mm.list?_search=associates&_languageid=1

    There are currently 568 Sector Members and 153 Associate Members 
listed, in addition to 191 Member States.


    Question. The 1998 amendments to Article 28 of the Constitution 
provide that the Secretary General should notify the Member States of 
the provisional values of contributory units before the beginning of 
the Plenipotentiary Conference and that Member States, in turn, should 
determine their final choice of contributory unit, their allocation 
level, before the end of the Conference. The United States 
unsuccessfully opposed the change in the time allowed for Member States 
to notify the Secretary General of their final allocation level, 
arguing that it needed more time for Congressional input. Has this 
change in the time-line for contributions created any problems for the 
United States?

    Answer. The time-line has not created any problems for the U.S.


    Question. There has been considerable discussion relating to the 
role that the ITU should play in governing the Internet. The Report of 
the U. S. Delegation to the Plenipotentiary Conference of the 
International Telecommunications Union in Marrakesh (2002) stated that 
``while Member States have become significantly more interested in the 
issues related to Internet governance, the U.S. successfully worked to 
ensure that three ITU resolutions concerning management of the Internet 
reaffirmed private sector leadership in this area and limited the ITU 
involvement to its core competencies.'' See pg. 2. The Report of the 
United States Delegation to the Plenipotentiary Conference of the 
International Telecommunication Union in Antalya, Turkey (2006) 
indicated that the role of the ITU in internet governance was discussed 
and was affirmed insofar as it related to cyber security, consistent 
with the existing mandate of the ITU. See pg. 16.
    What is the role that the ITU currently plays in Internet 
governance? Which ITU bodies are most involved in this work?

    Answer. The Administration believes that the term ``Internet 
governance'' covers a wide range of public policy-related issues and 
serves as a ``catch-all'' for a multitude of topics related to the 
Internet including spam, e-commerce, e-literacy, universal 
connectivity, management of the domain name and addressing system 
(DNS), etc. Given the breadth of topics potentially encompassed under 
the rubric of ``Internet governance,'' the Administration believes that 
no single venue can appropriately address the subject in its entirety. 
As a general matter and consistent with its mandate, the ITU has a role 
with respect to the telecommunications infrastructure over which the 
Internet operates. All three ITU Sectors (ITU-D, ITU-R, and ITU-T) are 
involved in this work.
    While the Administration recognizes that the current private-sector 
led system for management of the Internet is working, we continue to 
encourage an ongoing dialogue with all stakeholders around the world in 
the various entities (including the ITU) that are involved in various 
aspects of the Internet (pursuant to their expertise, core 
competencies, and governing agreements), as a way to facilitate 
discussion and to advance our shared interest in the ongoing robustness 
and dynamism of the Internet.


    Question. Going forward, what role should the ITU play in Internet 
governance? Have public statements been made, which reflect the 
Administration's position on this question? If so, where?

    Answer. The advancement and proliferation of the Internet is 
dependent upon the continued interworking of the underlying 
telecommunication infrastructure that the ITU has historically 
addressed. The Administration supports continuation of this work, as 
well as the ITU's technical involvement in Internet Protocol-based 
networks through its membership-driven study group process on issues 
such as spam, cybersecurity, etc., to the extent such work is 
consistent with the historical core competencies of the ITU. We do not 
support an expanded scope for the ITU into other issues related to 
``Internet governance'' and we have strived to ensure that ITU work 
programs are not duplicative of work ongoing in other international and 
intergovernmental institutions. This view is routinely conveyed in 
written contributions to ITU as well as speeches and testimony of 
senior Administration officials.


    Question. The Report of the United States Delegation to the 
Plenipotentiary Conference of the International Telecommunication Union 
in Antalya, Turkey (2006) indicated that ``the ITU Council should 
establish a working group to consider the range of issues associated 
with the participation of all relevant stakeholders in the activities 
of the Union related to [World Summit on the Information Society].'' 
See pg. 16. The World Summit on the Information Society (WSIS) is 
focused on ensuring that the benefits of the Internet are accessible to 
everyone. Did the ITU Council establish a working group, as envisioned 
in the 2006 Report? If so, what were the recommendations of this group?

    Answer. On November 24, 2006 at an extraordinary session, the ITU 
Council created the Council Working Group on the Study on the 
Participation of All Relevant Stakeholders in ITU Activities Related to 
the WSIS (WG-WSIS), as called for in Resolution 141of the 
Plenipotentiary Conference in Antalya, Turkey. The group, which will 
present a final report to the 2009 session of Council, has met four 
times thus far and is scheduled to meet again September 29-30, 2008 in 
Geneva. The upcoming meeting will review the results of questionnaires 
developed by the Working Group to seek input of ITU Member States as 
well as entities that were accredited to the WSIS regarding the 
effectiveness of existing mechanisms for participation in the ITU.


    Question. Please explain to what extent the Executive Branch 
regards the ITU instruments under consideration to be self-executing.

    Answer. The ITU instruments under consideration are not of their 
own force intended to be judicially enforceable. Implementation by the 
United States is authorized by the Communications Act of 1934, 47 
U.S.C. Sec. 151, et seq., as amended, and by the National 
Telecommunications and Information Administration Organization Act, 47 
U.S.C. Sec. 901 et seq., as amended. No new U.S. legislation is needed 
to implement these amendments.


    Question. The 1998 amendments to the Constitution increased the 
number of members of the Radio Regulations Board (RRB) from nine to not 
more than 12 or a number corresponding to six percent of the total 
number of Member States, whichever is greater. See Article 14 of the 
Constitution. Article 9 of the Constitution of the ITU provides that 
each Member State may propose only one candidate to the RRB. What is 
the current make-up of the RRB? How does this amendment to Article 14 
affect, if at all, the United States' chance of having its candidate 
elected to the RRB?

    Answer. The RRB is currently comprised of representatives from 
twelve countries. They are the USA (Chair for 2008), Cameroon, Canada, 
France, India, Kyrgyzstan, Lithuania, Malaysia, Morocco, Nigeria, 
Pakistan and Poland. The RRB members perform their duties independently 
and on a part-time basis, normally meeting up to four times a year in 
Geneva, and are elected at the Plenipotentiary Conference. The twelve 
candidates receiving the most votes at the Plenipotentiary Conference 
are elected to the RRB. Under such rules, the chances of a country 
having its candidate elected are increased as the size of the Board 
increases.


    Question. The 2006 amendments to the Convention included the 
deletion of a provision in the Convention that gave the representative 
of each Member State of the Council the right to attend, as an 
observer, all meetings of the ITU Sectors. See Article 4(7) of the 
Convention (SUP 58). Moreover, the Convention was amended to clarify 
that Sector Members may attend (and not merely be represented at) 
meetings of the Council, its committees, and its working groups, 
subject to certain conditions. See Article 4(9ter). Please explain why 
each of these amendments were made and whether the United States 
supported these amendments.

    Answer. A practical difficulty preceding the 2006 amendments was 
the status of observer Member States attending ITU Council meetings. 
The specific issue was whether such observer Member States could 
participate at committees and working groups of Council. This issue 
consumed significant energy, particularly in that vocal observer Member 
States sought entrance to committee meetings and working groups of the 
Council that some Member States already represented on the Council 
thought were not authorized. The United States' view was that, subject 
to the rules in force, all participants at Council meetings and working 
groups should be afforded the opportunity to make their views known. In 
the view of the United States, affording participants at lower level 
meetings the opportunity to generally voice their views is the best 
method of achieving a consensus on the eventual outcomes. Accordingly 
the U.S. supported the amendments in question.

                               __________

 responses to additional questions for the record submitted to senior 
    deputy u.s. coordinator richard beaird by senator richard lugar
Questions Relating to Treaty Docs. 108-5, 109-11, and 110-16 Generally


    Question. What is the current status of the amendments to the ITU 
Constitution and Convention contained in these documents?
    In the case of each set of amendments, how many ITU Member States 
have ratified or acceded to the amendments, and how many have not done 
so?

    Answer. All of the amendments are in force for those ITU Member 
States that have deposited their instrument of ratification, acceptance 
or approval of the amendments with the ITU.


----------------------------------------------------------------------------------------------------------------
                                                                                Member States     Member States
                                                                                  that have       that have not
                     Treaty Doc Number                      Total ITU Member      ratified,         ratified,
                                                                 States          acceded or        acceded or
                                                                                  approved          approved
----------------------------------------------------------------------------------------------------------------
108-5.....................................................              189                81               108
109-11....................................................              189                63               126
110-16....................................................              191                 8               183
----------------------------------------------------------------------------------------------------------------



    Question. To the extent that the amendments have entered into force 
for some ITU Member States, and not for others, what rules govern when 
an issue addressed by the amendments arises?

    Answer. As the ITU Constitution and Convention and their amending 
instruments are silent on this question, customary rules of 
international law govern the ITU legal relations between ITU Member 
States that are parties to such amendments and those that are not. 
Pursuant to those customary rules, as between any two such Member 
States, only the amendments to the ITU Constitution and Convention to 
which both states are parties apply to their mutual relations. For the 
United States, this is the ITU Constitution and Convention, as amended 
in 1992 and 1994.


    Question. Is the United States currently enjoying rights provided 
for in these amendments even though it has not yet ratified them? If 
so, please indicate what rights the United States is enjoying and on 
what legal basis it is enjoying them?

    Answer. In general terms, we believe that the various amendments to 
the Constitution and Convention, many of which have been voluntarily 
implemented by Member States that have not yet ratified them, have 
improved the management, functioning and finances of the ITU so as to 
make the ITU a more transparent, nimble and accountable organization 
that better serves the interests of its Member States, including the 
United States.


    Question. Is the United States currently complying with obligations 
of ITU Member States provided for in these amendments even though it 
has not yet ratified them? If so, please indicate what such obligations 
the United States is currently complying with and on what legal basis 
it is doing so?

    Answer. As indicated in the public testimony and in our response to 
General Question 1c above, many of the amendments to the ITU 
Constitution and Convention that are pending for Senate advice and 
consent to ratification concern the management, functioning and 
finances of the ITU. The United States has voluntarily supported 
implementation of these amendments, even though it has not yet ratified 
them. For example, in 1998 and 2006, the ITU Plenipotentiary 
Conferences adopted amendments to the ITU Constitution to require 
Member States to announce their class of contribution by particular 
deadlines so that the ITU could develop a realistic budget. The United 
States has voluntarily sought to adhere to those deadlines in order to 
improve the management and finances of the ITU, even though it is not 
yet required to do so.


    Question. Are U.S. private sector entities currently able to enjoy 
rights with respect to participation in the ITU provided for in these 
amendments even though the United States has not ratified them? If so, 
please indicate on what legal basis such entities are able to enjoy 
such rights?

    Answer. We believe that the U.S. private sector has gained 
significant benefits from these amendments, in terms of its 
participation in the ITU. The 1998 ITU Plenipotentiary Conference 
adopted amendments to enhance the status of ITU Sector Members, 
including recognition that Sector Members may provide chairs and vice 
chairs at sector assemblies and meetings and at World Telecommunication 
Development Conferences and establishing a new category of ITU 
Associate that can participate in the work of a particular ITU Study 
Group. The 2002 and 2006 ITU Plenipotentiary Conference adopted 
amendments to allow private ITU Sector Members may attend meetings of 
the ITU Council, its committees and working groups under certain 
conditions. All of these amendments have enhanced the ability of the 
private sector to participate in the work of the ITU. The legal basis 
for that participation is the various ITU amendments that have entered 
into force, even though the United States has not yet ratified those 
amendments. Thus, U.S. private sector entities are able to enjoy these 
benefits even though the U.S. has not yet ratified the amendments.


    Question. Does the Administration believe it is sound policy for 
the ITU to amend its governing rules every four years? What impact does 
this practice have on the stability of the ITU's activities and the 
legal certainty of the rules governing them?

    Answer. The ITU reviews its governing rules every four years. The 
governing rules are changed only when necessary, on the basis of 
consensus. This practice provides for a flexible organization with the 
ability to adapt to emergent technologies and yet offers stability to 
the multiplicity of ITU Member States and ITU Sector Members. While 
various amendments are made to the ITU Constitution and Convention as 
part of this process, those amendments do not fundamentally change the 
basic structure of the ITU. Hence, the technical changes to the ITU 
governing rules do not disrupt the stability of the ITU's activities 
and the legal certainty of the rules governing those activities.


    Question. The United States made a number of declarations and 
reservations to the instruments contained in these documents at the 
time it signed the Final Acts of the relevant Plenipotentiary 
Conferences, and is seeking advice and consent to those declarations 
and reservations. Please indicate whether and when the Executive Branch 
consulted with the Senate prior to making these declarations and 
reservations?

    Answer. While the Executive Branch did not formally consult with 
the Senate prior to making these declarations and reservations, the 
Executive Branch sought in its declarations and reservations to 
preserve the prerogatives of the Senate in providing advice and consent 
to ratification of these instruments amending the Constitution and 
Convention. In particular, the Executive Branch made clear in each case 
that it reserved the right of the United States to make additional 
declarations and reservations to each instrument at the time of deposit 
of its instrument of ratification of the amendments with the ITU, so as 
to preserve the right of the Senate to provide additional declarations 
and reservations at the time of advice and consent to ratification. 
Also, because certain provisions of the 1992/1994 ITU Constitution 
provide for implied consent to be bound by revisions of the 
Administrative (Radio) Regulations adopted either before or after 
amendments to the ITU Constitution and Convention have been adopted, 
the Executive Branch has also included specific declarations in each 
instance specifying that the United States has not consented to be 
bound by those revisions without specific notification to the ITU of 
the United States' consent to be bound. These declarations and 
reservations will be found at Treaty Doc. 110-16, at X-XI; Treaty Doc. 
109-11, at 8-9; and Treaty Doc. 108-5, at X. Further, the declarations 
and reservations in these instruments are consistent with those made in 
earlier instruments to which the Senate has previously given its advice 
and consent. See Treaty Doc. 104-34, at IX.
Questions Relating to Treaty Doc. 108-5


    Question. The transmittal package for Treaty Doc. 108-5 describes 
amendments relating to the Rules of Procedure of Conferences and 
Meetings of the ITU as follows:


          The 1998 Conference adopted amendments to the Convention that 
        removed the Rules of Procedure of Conferences and Meetings of 
        the ITU, with the exception of provisions relating to 
        reservations and the right to vote, from the Convention and 
        transferred them to a separate legal instrument. (See 
        Convention, Article 32B, SUP 341-467.) This separate legal 
        instrument entered into force on January 1, 2000, for those 
        Member States that, as of that date, had submitted their 
        instrument of ratification, acceptance, approval or accession 
        to the 1998 Amendments. It will enter into force for all other 
        Member States, including the United States, on the date on 
        which they deposit their instruments of ratification, 
        acceptance, approval or accession to the 1998 Amendments. 
        Unless otherwise agreed to by a plenipotentiary conference, 
        amendments to this separate legal instrument shall enter into 
        force on the date of signature of the Final Acts of the 
        plenipotentiary conference at which they are adopted. (See 
        Rules of Procedure of Conferences and Other Meetings of the 
        International Telecommunication Union, 25.)
          What was the source of the Rules of Procedure that governed 
        the United States participation in the 2002 and 2006 ITU 
        Plenipotentiary Conferences?

    Answer. Prior to 1998, the Rules of Procedure for ITU Conferences 
and other meetings were contained in Article 32 (## 340406, 410-444, 
447-467) of the 1992/1994 ITU Convention, which entered into force for 
the United States on October 26, 1997. As noted above above, the 
relations of an ITU member state that has not ratified, acceded or 
approved later amendments (such as the United States) with an ITU 
member state that has ratified, acceded or approved the later 
amendments is governed by the earlier version of the ITU Constitution 
and Convention to which both ITU Member States are parties, without the 
amendments. Hence, for the United States, the Rules of Procedure found 
in the 1992/1994 version of the ITU Convention governed United States 
participation at the 2002 and 2006 ITU Plenipotentiary Conferences.


    Question. Was the source of these rules different than that of the 
Rules of Procedure that governed the participation of ITU Member States 
that ratified the 1998 Amendments prior to January 1, 2000?

    Answer. Yes. The ITU Rules of Procedure are now found in a separate 
legal instrument entitled ``General Rules of Conferences, Assemblies 
and Meetings of the Union.'' Since these rules, however, originated in 
Article 32 of the 1992/1994 ITU Convention and were extracted from the 
1992/1994 Convention to form the separate legal instrument, the 
substance of the rules, in large part, is the same as that found in 
Article 32 of the 1992/1994 ITU Convention.


    Question. To date, have any changes been made to the Rules of 
Procedure contained in the ``separate legal instrument'' provided for 
in these amendments?

    Answer. Yes, minor amendments.


    Question. If so, is United States participation in ITU meetings 
currently governed by such changes even though it has not yet ratified 
the amendments providing for the ``separate legal instrument''?

    Answer. No.


    Question. If so, what is the legal basis for the application of 
such changes to the United States?

    Answer. See answers above.


    Question. To the extent that different Rules of Procedure have 
applied to different ITU Member States at ITU meetings subsequent to 
the entry into force for some states of these amendments, how were 
matters addressed in the case of conflicts between the varying sets of 
rules?

    Answer. To our knowledge, no such conflicts have arisen. If they 
did, they should be resolved as indicated in General Question 1b above 
and Question 1a immediately above.


    Question. Amendments to Article 20 of the ITU Convention provide 
for the establishment of Business Study Groups which may adopt certain 
questions and recommendations without the formal consultation of ITU 
Member States.
    Please provide a list of topics on which Business Study Groups have 
adopted questions or recommendations without formal consultation with 
ITU Member States.

    Answer. Article 20 of the Convention provides for the ``Conduct of 
Business of Study Groups.'' Pursuant to Article 20 (in particular, 
paragraph CV 246-A and 246-D), Member States have established 
procedures for both study Questions and Recommendations to be adopted 
without formal consultation of the Member States where there is no 
doubt that the Questions and Recommendations involved lack policy or 
regulatory implications. In the ITU Telecommunication Standardization 
Sector, Questions may be adopted at Study Group meetings where there is 
consensus (see WTSA Resolution 1, Section 7.2.2). Recommendations may 
also be adopted without formal Member State consultation pursuant to 
the streamlined process set forth in ITU-T Recommendation A.8.
    Twenty-two Questions were adopted during the 2004-2008 period 
without formal Member State consultation.
    In the ITU Telecommunication Standardization Sector, most 
Recommendations are highly technical and do not involve regulatory or 
policy issues, and are therefore approved under the streamlined 
process, i.e., by the Member States and Sector Members present at the 
Study Group meeting without further formal consultation of all Member 
States. In the period from 2004-2008, there were 840 ITU-T 
Recommendations approved using this process; a list of these can be 
provided if requested. It is estimated that this constitutes over 90% 
of the ITU-T's recommendations during this period. However, even in 
these cases, Member States may call for a formal Member State 
consultation process where they believe policy or regulatory issues are 
involved.


    Question. Please indicate whether there have been any disputes 
within the ITU over whether particular questions or recommendations 
required formal consultation with ITU Member States under these 
amendments and how any such disputes were resolved.

    Answer. The process adopted by Member States for approval of 
Questions without formal Member State consultation is set forth in WTSA 
Resolution 1 at Section 7.2. It permits study groups to approve 
Questions if there is consensus of those present (including Member 
States) at the meeting (Section 7.2.2). However, if there is no 
consensus, a formal Member State consultation process may be initiated 
(Section 7.2.3). It has never been necessary to apply this formal 
consultation process.
    From time to time the issue of whether a given Recommendation 
should be approved according to the streamlined approval process or by 
formal consultation with Member States has arisen. If there is no 
consensus at the study group meeting at which the issue arises, ITU-T 
Recommendation A.8, Section 8.1.1 calls for Member States present to 
decide the issue by majority vote, but it has never been necessary to 
apply this voting procedure.


    Question. The transmittal package for Treaty Doc. 108-5 (1998 
Plenipotentiary Conference) indicates that the United States 
unsuccessfully sought an amendment to Article 33 of the ITU Convention 
that would have eliminated the requirement that interest be paid on 
arrears to the ITU.
    Is the United States currently in arrears to the ITU?

    Answer. The U.S. has paid all the assessed contributions except for 
the 2008 assessment of Swiss francs (CHF) 9,540,000 ($9,376,321). 
Because of a funding shortfall in the Contributions to International 
Organizations (CIO) account, U.S. payments to ITU, along with eight 
other organizations, became partially deferred in FY 2006. The assessed 
contribution to ITU for calendar year 2008 will be paid from two 
different fiscal years: thirty percent from FY08 funds and seventy 
percent from FY09 funds.


    Question. Has the United States been in arrears to the ITU at any 
point in the past? Please indicate the amounts and dates of any such 
arrears.

    Answer. Yes, the 1997 assessment for ITU was short by CHF 
1,419,594. ($1,394,932)


    Question. Has the ITU sought to invoke Article 33 to collect 
interest payments from the United States? If so, please indicate the 
amounts and dates of any such efforts.

    Answer. Yes, per article 33 outstanding amounts bear interest from 
the beginning of the fourth month of the financial year (April 1) at 3% 
then at 6% from the beginning of the seventh month (July 1.) As a 
result, the U.S. has been invoiced as follows:


------------------------------------------------------------------------

-----------------------------------------------------------------------
1996 CHF                155,158 ($152,480)     interest on arrears
1997 CHF                1,483,476              shortfall on 1997
                         ($1,457,585)           assessment and interest
                                                on arrears
1998 CHF                88,050 ($86,538)       interest on arrears
1999 CHF                92,971 ($91,394)       interest on arrears
2000 CHF                98,475 ($96,808)       interest on arrears
2001 CHF                104,301 ($102,536)     interest on arrears
2002 CHF                100,202 ($98,507)      interest on arrears
2003 CHF                37,587 ($36,948)       interest on arrears
2004 CHF                310,672 ($305,328)     interest on arrears
2005 CHF                173,293 ($170,299)     interest on arrears
2006 CHF                456,286 ($448,403)     interest on arrears
2007 CHF                321,180 ($315,601)     interest on arrears
------------------------------------------------------------------------
The current balance for interest on arrears as of January 2008 is CHF
  1,369,380 ($1,345,728).



    Question. Has the United States made any payments of interest on 
arrears to the ITU? If so, please indicate the dates and amounts of any 
such interest payments.

    Answer. Yes, CHF 602,837 ($592,402) on November 14, 2002 to 
partially pay the accumulated interest on arrears owed.


    Question. The transmittal package for Treaty Doc. 108-5 states that 
``for domestic policy reasons'' the United States will require U.S. 
private Sector Members to continue to apply for ITU Sector Membership 
using procedures requiring the direct involvement of the U.S. 
Government, rather than through alternative procedures providing for 
direct applications through the ITU.
    Please explain the domestic policy reasons for this decision.

    Answer. The U.S. has chosen to maintain minimal oversight over 
which U.S. entities are allowed to apply for ITU membership for a 
number of reasons. One is that the U.S., which has more Sector Members 
than any other country, wants to be kept informed about what U.S. 
entities are participating in the ITU. Another is that the U.S. may 
incur some de facto responsibilities as a result of a U.S. company 
becoming an ITU member. For example, the ITU turns to the U.S. to 
assist in seeking payment from a U.S. entity when that U.S. entity does 
not meet its ITU obligations, such as failure to pay its contributory 
share.
    Please give an assessment of how the direct application procedures 
have worked in practice for those states that have utilized them, and 
of the impact on the work of the ITU of the participation of Sector 
Members admitted through such procedures.

    Answer. Although other Member States do not disclose the benefits 
of their direct application procedures, for the U.S., the application 
process has worked very well. The endorsement process is not 
complicated for either the U.S. or for the ITU. This is evident in the 
large number of public and private companies that have joined the ITU 
(568 Sector Members, of which 86 are from the U.S., and 153 Associate 
members).
Questions Related to Treaty Doc. 109-11


    Question. Please indicate how much money the ITU is expected to 
save on an annual basis as a result of the amendments to Article 4 of 
the Convention with regard to the payment of travel expenses of Member 
State representatives in connection with meetings of the ITU Council. 
Please also indicate how much money the ITU currently spends on such 
expenses on an annual basis.

    Answer. Using today's conversion rate of U.S. Dollar to Swiss Franc 
(CHF) ($1 US = .97 CHF), the expected savings on travel expenses for 
the sixteen ITU Member States that are developed countries (at an 
average cost of $3,931) equals $62,896 per ITU council meeting. The ITU 
Council meets annually. Hence, the expected savings on daily 
subsistence allowance expenses for the sixteen ITU Member States that 
are developed countries (at $491/day over an average of 10 days), 
equals $78,560 per Council session. This results in a total savings of 
$141,456.
    The ITU's annual travel expenditures between 2002 and 2007 amount 
to approximately $2.2 million ($ 3.3 million including fellowships).
Questions Related to Treaty Doc. 110-16


    Question. As described in the transmittal package, amendments to 
Article 5 of the ITU Convention contained in 110-16 provide for the ITU 
Secretary General and other specified ITU officials to participate in 
ITU meetings ``in an advisory, vice consultative, capacity.'' Please 
explain the distinction between these two capacities and the 
significance of this change.


    Question. The distinction between the two terms relates to the core 
role that is desired of the Secretary General in the ITU. Each sector 
of the ITU (ITU-R, ITU-T and ITU-D) has an advisory group whose output 
is available for consideration by the Member States. Prior to the 
Antalya Plenipotentiary Conference, the term ``consultative,'' as 
applied to the Secretary-General's participation, was deemed to give 
the Secretary General too strong a role in the conduct of what is 
fundamentally an inter-governmental organization. The ITU Member States 
did not regard the Secretary-General as properly being on a par with 
the Member States. Accordingly, the Antalya Plenipotentiary Conference 
made clear that the Secretary-General and other ITU officials provide 
advice to the Member States but Member States need not consult them.
Questions Related to Treaty Docs. 107-17 and 108-28


    Question. The revisions to the ITU radio regulations contained in 
Treaty Docs. 107-17 and 108-28 were concluded in 1992 and 1995, 
respectively.
    Is the United States already implementing or acting in accordance 
with these revisions? If so, please indicate the authorities on which 
the Executive Branch has relied in order to do so.

    Answer. In the exercise of their statutory and regulatory 
authority, the Federal Communications Commission (FCC) and the National 
Telecommunications and Information Administration (NTIA) have generally 
been able to implement revisions to the Radio Regulations through 
notice and comment rulemaking under the Administrative Procedure Act 
(APA). Both the FCC and NTIA have broad authority over their respective 
spheres of telecommunication regulation, the FCC for non-governmental 
telecommunications and the NTIA for governmental telecommunications. 
The FCC's basic authority is found in 47 U.S.C. Sec. Sec. 152(a), 301 
and 303. The NTIA exercises delegated Presidential authority over all 
governmental telecommunications found in 47 U.S.C. 305 under 
Reorganization Plan No. 1 of 1977 and E.O.12046, as set forth in 47 
U.S.C. 902(b). 47 U.S.C. 303(r) specifically authorizes the FCC to make 
rules and regulations, not inconsistent with law, necessary to carry 
out the provisions of any international radio or wire communications 
treaty or convention to which the United States is or may hereafter 
become a party. 47 U.S.C. 902(b)(2)(A) & (K) authorize the NTIA to 
assign frequencies and establish policies concerning spectrum use by 
radio stations belonging to the U.S. Pursuant to this law, NTIA 
implements amendments to the ITU instruments regarding 
telecommunications spectrum for governmental stations.


    Question. Given the significant changes in telecommunications 
sector in the intervening period since the adoption of these revisions, 
please explain why these revisions remain relevant and why the 
Administration considers their ratification to be important.

    Answer. We are making an earnest effort to bring the United States 
up-do-date with all ITU instruments because we believe, among other 
things, that this would continue to support the United States' strong 
presence in the ITU, which hopefully will assist in furthering the 
USG's telecommunications goals within that organization. It is 
important that the United States not be seen as picking and choosing 
ITU Final Acts to ratify since it would send a signal internationally 
that the U.S. has moved away from its historical practice of managing 
international telecom and spectrum policy. Further, these earlier 
revisions provide the foundation for more recent amendments to the 
radio regulations, and thus it is important for the United States to 
ratify them in a comprehensive fashion.
 responses to additional questions for the record submitted to deputy 
  assistant secretary david a. balton by senator joseph r. biden, jr.


    Question. How will joining these three environmental treaties (The 
Anti-Fouling Convention, the London Dumping Protocol, and the Land-
Based Sources Protocol) benefit the United States? Why should the 
Senate act on them now?

    Answer. Prompt action to facilitate ratification of these treaties 
will allow the United States to reinforce and maintain its leadership 
role on oceans issues at the international and regional levels. 
Ratification would enhance our ability to work with other States to 
promote effective implementation of these treaties. As a Party to these 
treaties, the United States would be able to participate fully in 
meetings of States Parties and, thereby, more directly affect the 
implementation and interpretation of these treaties. Further, after the 
United States ratifies a treaty, other nations are more likely to 
ratify as well, resulting in greater overall protection of the oceans 
from marine pollution.
    With respect to the Anti-Fouling Systems Convention, the United 
States has an obvious interest in protecting its marine environment and 
ecosystems from the harmful effects of anti-fouling systems, 
particularly hazardous leaching of organotin in our ports and other 
waters. U.S. ratification and enactment of the proposed implementing 
legislation will together require foreign vessels entering U.S. ports 
and certain other waters to stop using harmful anti-foulants containing 
organotins. Since the United States already has significant existing 
prohibitions against organotin use, this will help create a ``level 
playing field'' on this issue. Ratification would also allow the United 
States to participate in decisions on inclusion of other harmful anti-
fouling systems in the future.
    The Caribbean region covered by the Land-Based Sources Protocol is 
of crucial importance, as pollution of these waters directly affects 
the United States. For this reason, the United States strongly 
advocated the development of the Land-Based Sources Protocol. 
Ratification by the United States is likely to spur other governments 
in the region to also become Party. This would lead to an overall 
improvement of the marine environment in this neighboring region, 
resulting in improved protection of human health and marine resources, 
as well as a stronger regional economy and tourism industry.
    The London Protocol is increasingly replacing the London Convention 
as the primary international regime for addressing ocean dumping. It is 
therefore crucial that the United States be able to fully participate 
in this forum to advance and protect key U.S. interests such as 
protection of the marine environment and proper regulation of 
legitimate uses of the oceans for disposal purposes.


    Question. What has been the impact of the Cartagena Convention and 
the two Cartagena Protocols that we've joined regarding oil spills and 
specially protected areas and wildlife? Do you have any concerns about 
their operation thus far? Have these instruments been effectively 
implemented?

    Answer. The Cartagena Convention (the Convention for the Protection 
and Development of the Marine Environment of the Wider Caribbean 
Region) serves as an umbrella agreement for addressing marine 
environmental protection in the Caribbean Region. Twenty-three nations 
in the Caribbean participate in this regime and overall the United 
States has been very satisfied with how the Cartagena Convention and 
its Protocols have been implemented.
    The Protocol Concerning Cooperation in Combating Oils Spills has 
been very successful in strengthening oil spill preparedness and 
response capacity of the nations and territories of the region, and in 
facilitating co-operation and mutual assistance to prevent and control 
major oil spill incidents. The United States helps support a regional 
oil spill training and response center in Curacao, and has detailed a 
U.S. Coast Guard officer to this facility to provide technical 
assistance.
    The Protocol Concerning Specially Protected Areas and Wildlife--the 
SPAW Protocol--has served as an important vehicle for promoting greater 
awareness of the threats to marine species in the region. The Protocol 
has made significant progress in helping Caribbean nations and 
territories better protect marine mammals, and has developed guidelines 
to help members evaluate and designate marine protected areas.


    Question. The Land-Based Sources Protocol calls for international 
cooperation and assistance relating to land-based sources of maritime 
pollution. Does the United States already provide such assistance to 
nations in the Caribbean region? Would we be expected to provide 
additional assistance as a Party to the Protocol?

    Answer. The United States already provides substantial assistance 
to nations in the Caribbean region for environmental programs, 
including for control of land-based sources of marine pollution. Much 
of our assistance to the region in this area is through in-kind 
services and the provision of technical expertise.
    The United States provides technical advice on marine environmental 
protection to the Caribbean through USAID, the Department of 
Agriculture, NOAA and EPA. In addition, the United States is a 
principal contributor to the United Nation's Caribbean Environment 
Program (CEP), which supports marine environmental protection 
activities in the region. In recent years we have provided 
approximately $400,000 in annual support to the CEP's Caribbean Trust 
Fund, and an additional $50,000 or so for the CEP's work on land-based 
sources of marine pollution.
    As a party to the Land-Based Sources Protocol, we would not incur 
any new funding obligations. Financing is done on a voluntary basis.
    We nevertheless hope that entry into force of the Protocol may spur 
international donors to provide greater assistance to nations of the 
Caribbean to address these issues.


    Question. Do you have any concerns regarding other countries that 
could join the Land-Based Sources Protocol, meeting the standards set 
forth in the Protocol and particularly Annex III of that Protocol?

    Answer. The Land-Based Sources Protocol was negotiated with the aim 
of helping other countries in the region improve their domestic 
standards. We are aware that some of these countries face challenges in 
this regard, and are hopeful that the Land-Based Sources Protocol will 
provide a mechanism for them to raise their standards.


    Question. Article 15 of the London Dumping Protocol states that 
``[i]n accordance with the principles of international law regarding 
State responsibility for damage to the environment of other States or 
to any other area of the environment, the Contracting Parties undertake 
to develop procedures regarding liability arising from the dumping or 
incineration at sea of wastes or other matter.'' Have these procedures 
been developed since the Protocol entered into force? If so, please 
provide a copy for the committee's information. If not, please describe 
their status and indicate whether the United States is involved in the 
process of their development. Does the United States have any concerns 
regarding their development?

    Answer. Article 15 liability procedures have not been developed 
under the London Protocol. Indeed, the second Meeting of Contracting 
Parties held in November 2007 agreed not to embark on the development 
of liability procedures under Article 15 at this stage. It is worth 
noting that the London Convention contains a similar provision in 
Article X regarding the development of liability procedures, but that 
no such procedures have ever been developed.
    Article 15, like Article X of the London Convention, describes a 
process for consideration of this issue rather than mandating a 
specific outcome. Were this process to move forward, which it has not 
yet done, the United States would participate as fully as possible so 
as to advance and protect U.S. interests.


    Question. Have there been any proposals to amend Annex I of the 
London Dumping Protocol since the addition of carbon dioxide streams 
from carbon dioxide capture processes for sequestration? If so, please 
provide information on such proposals, including the U.S. position on 
any such proposals.

    Answer. We are unaware of any current proposals to amend Annex I.


    Question. Article 26 of the London Dumping Protocol allows non-
parties to the 1972 London Convention to declare, when ratifying the 
Protocol, that they require up to five years to comply with specified 
Protocol provisions. Have any such declarations been made thus far?

    Answer. No Article 26 declarations have been made.


    Question. The Anti-Fouling Convention uses the venue of the 
International Maritime Organization's Marine Environmental Protection 
Committee to review proposals to amend Annex 1 to the Convention. Does 
the United States have a seat on the Marine Environmental Protection 
Committee? If so, is it a permanent seat?

    Answer. Pursuant to Article 37 of the Convention on the 
International Maritime Organization, the Marine Environment Protection 
Committee shall consist of all the Members. The United States became a 
Member of the International Maritime Organization in 1950 and plays a 
strong and active role in this committee.


    Question. The Letter of Submittal for the Anti-Fouling Convention 
indicates that Article 5 will be implemented through existing 
provisions of the Solid Waste Disposal Act and the Clean Water Act. 
Please specify which provisions of these two acts will be relied upon 
to implement Article 5. See Treaty Doc. 110-13, Letter of Submittal at 
VII.

    Answer. Article 5 of the Anti-Fouling Systems Convention addresses 
collection, handling, treatment and disposal of wastes associated with 
the application and removal of anti-fouling systems. Certain wastes 
generated during application and removal of anti-fouling paints may be 
considered hazardous wastes, due to their solvent and/or active 
ingredient content. Hazardous wastes are subject to Solid Waste 
Disposal Act (SWDA) requirements, including those addressing 
generation, transport, treatment, storage, and disposal (see SWDA 
Sec. Sec. 3002, 3003, 3004). In addition Sec. 301(a) of the Clean Water 
Act (CWA) regulates the discharge of pollutants into waters of the 
United States. Discharges from industrial facilities such as shipyards 
and dry-docks may be subject to permitting under CWA Sec. 402, and 
those permits would establish technology-based effluent limits for 
discharges of pollutants from such facilities, and where necessary, any 
more stringent limits needed to achieve applicable water quality 
standards adopted by States or EPA under CWA Sec. 303.


    Question. Is it correct that the use of TBT as an anti-fouling 
coating on ships has already been phased out in the United States? When 
was the last FIFRA registration for TBT use on a ship cancelled?

    Answer. The cancellation of the last FIFRA registration for a TBT 
antifouling coating product for hulls of ships and boats became 
effective on December 1, 2005. This is the date after which the 
registrant could no longer legally sell or distribute the product 
except as permitted in a limited existing stocks provision. The 
registrant was allowed until December 31, 2005 to sell any existing 
stocks of its product (produced before 12/1/05). Stocks in the hands of 
users may be used until exhausted. The functional shelf-life of this 
material is also limited, so significant use of the products at this 
time seems unlikely.
    Section 13 of the proposed implementing legislation does allow 
continued use of TBT antifouling product on sonar domes and in 
conductivity sensors in oceanographic instruments.


    Question. Where in the world are TBT-based anti-fouling systems 
still being produced and used?

    Answer. It is our understanding that TBT-based systems are still 
produced in Asia, particularly Southeast Asia and Korea, although the 
extent has not been determined. In the past, there were a small number 
of U.S.-based companies that marketed TBT paint for export to the 
Caribbean, reportedly for use on pleasure craft. This practice may 
continue today on a small scale. A U.S. registration is not a 
requirement for export.
    The European Union has already implemented restrictions for vessels 
bearing TBT on their hulls. The major cruise lines and many shippers 
have switched to non-TBT alternatives. Likely consumers of TBT paints 
would probably include owner/operators of vessels traveling within Asia 
where restrictions do not exist.


    Question. Do any of these three environmental treaties (The Anti-
Fouling Convention, the London Dumping Protocol, and the Land-Based 
Sources Protocol) provide for mandatory technology transfers?

    Answer. No, there are no provisions in these treaties mandating 
technology transfer.


    Question. Do any of these three environmental treaties (The Anti-
Fouling Convention, the London Dumping Protocol, and the Land-Based 
Sources Protocol) provide a private right of action in U.S. courts for 
individuals claiming a violation of any of these treaties?

    Answer. No.

                               __________

 responses to additional questions for the record submitted to deputy 
    assistant secretary david a. balton by senator richard g. lugar
Relating to Multiple Treaties


    Question. Article 3(2) of the Convention on anti-fouling systems 
and Article 10(4) of the marine dumping protocol each exempt from the 
respective instruments' application certain categories of state 
vessels, but these provisions define differently the categories of 
vessels covered by the exemptions. Is there any difference in scope 
between the two exemptions? If so, please explain the difference and 
the rationale for it.

    Answer. The London Protocol Article 10.4 language was taken from 
Article VII(4) of the 1972 London Convention. The Anti-Fouling Systems 
Convention Article 3.2 language was modeled after Article 3(3) of the 
International Convention on the Prevention of Pollution from Ships, 
1973, and Article 236 of the United Nations Convention on the Law of 
the Sea. The language in these provisions effectively excludes the same 
vessels from coverage by the treaties. (It should be noted that the 
London Protocol also includes a reference to aircraft, which is 
explained by the fact that it covers aircraft within the scope of its 
obligations, while the Anti-Fouling Systems Convention does not.)
Relating to Treaty Doc. 110-13 (Anti-Fouling)


    Question. Article 11 of the Convention refers to guidelines to be 
developed by the International Maritime Organization for the inspection 
of ships for the purpose of determining whether they are in compliance 
with the Convention.

          a. Have such guidelines been developed? If so, please provide 
        a copy of the guidelines.

          b. If such guidelines have not yet been developed, please 
        describe the status of the process for developing them and 
        indicate when the guidelines are expected to be finalized.

          c. Please indicate whether ship owners and operators have had 
        or will have the opportunity to participate in the development 
        of these guidelines, and describe the process allowing for such 
        participation.

    Answer. Article 11 guidelines under the Anti-Fouling Systems 
Convention have been developed in the form of MEPC.102(48) (see 
Attachment 1), MEPC.104(49) (see Attachment 2) and MEPC.105(49) (see 
Attachment 3). Additionally, work continues at the International 
Maritime Organization (IMO) to integrate this guidance into the more 
general Survey Guidelines under the Harmonized System of Survey and 
Certification (A.948(23)) and the Procedures for Port State Control 
(A.787(19), as amended), which are presently under consideration for 
revision. Enhancements to the existing guidelines are likely to result 
from this ongoing work, within the next two to three years.
    Ship owner and operator representatives have been, and continue to 
be, very active in the development of these guidelines. They 
participate at the relevant IMO Committee and Sub-committee meetings, 
both as members of national delegations and as members of non-
governmental organization observer delegations such as International 
Chamber of Shipping, International Shipping Federation, and INTERTANKO. 
Further, they have made, and continue to make, their perspectives known 
to the United States delegation. They can do this on an ad hoc basis 
and via the Shipping Coordination Committee, in preparation for the 
relevant IMO meetings. The Shipping Coordination Committee is a public 
forum whose meetings are conducted as recorded proceedings, under the 
cognizance of the Department of State.


    Question. The transmittal package for the Convention indicates that 
the Coast Guard has adequate existing authorities to compensate any 
meritorious claims with respect to undue delay or detention of ships 
raised pursuant to Article 13.

          a. Please identify the authorities on which the Coast Guard 
        would rely to address such cases.

          b. Please indicate what standard would be used to determine 
        the amount of damages in such cases, and the potential extent 
        of damages that could arise.

    Answer. The Coast Guard has existing authorities, such as the Suits 
in Admiralty Act and the Military Claims Act, which provide 
compensation mechanisms for meritorious claims of this nature. In the 
case where liability is found, the amount of damages would be subject 
to proof by the claimant of the type of damages payable in a civil 
action in admiralty if a private person had caused the same kind of 
injury. Damages might involve fixed costs like crew wages, dockage 
fees, and indemnification or contribution for losses to cargo interests 
for which the carrier would be responsible.
Relating to Treaty Doc. 110-5 (Marine-Dumping)


    Question. Article 8(1) provides a force majeure exception to the 
protocol's prohibitions which applies, inter alia, in cases of a ``real 
threat to vessels, aircraft, platforms or other man-made structures at 
sea.'' What is the meaning of the word ``real'' as used in this 
context? Does it have a substantive effect on the scope of the force 
majeure exception?

    Answer. The force majeure exception under the London Protocol 
closely parallels the one found in London Convention Article V(1). It 
is intended to cover threats of an immediate nature to the safety of 
human life or of vessels, aircraft, platforms, or other man-made 
structures at sea. The term ``real,'' which also is used in the London 
Convention provision, should be interpreted in the sense of ``actual'' 
and ``imminent.'' Article 8(1) may be invoked only if dumping appears 
to be the only way of averting the threat and if there is every 
probability that the damage consequent upon such dumping will be less 
than would otherwise occur.


    Question. Article 11 specifies that no later than two years after 
the protocol's entry into force, the Meeting of Contracting Parties 
shall establish procedures and mechanisms to assess and promote 
compliance with the protocol.

          a. Have such procedures and mechanisms been finalized? If so, 
        please provide a copy of the procedures and mechanisms. If not, 
        please indicate the status of efforts to establish them.

          b. What rules apply to the adoption of such procedures and 
        mechanisms by the parties to the protocol? Must such procedures 
        and mechanisms be adopted by consensus, or may they be adopted 
        over the objection of one or more parties?

          c. What legal effect will these procedures and mechanisms 
        have for parties to the protocol? Will parties be legally 
        obligated to comply with them?

    Answer. The rules and procedures on compliance mandated by Article 
11 of the London Protocol were adopted at the 2nd Meeting of 
Contracting Parties in November 2007 (LC 29/17 Annex 7, see Attachment 
4). They were adopted by consensus.
    The compliance procedures create a facilitative process that will 
not lead to binding consequences for Parties.


    Question. Article 12 provides for parties to the protocol to engage 
in regional efforts consistent with the protocol to reduce and, where 
practicable, eliminate pollution caused by dumping or incineration at 
sea of wastes or other matter. Are any such efforts currently underway 
or anticipated with respect to regions of which the United States is a 
part? If so, please indicate the status and objectives of such efforts.

    Answer. For more than thirty years, the U.S. has been a leader in 
the control of marine pollution from ocean disposal, and our technical 
experts are in high demand for advising other nations on managing their 
dredging programs and other ocean disposal activities. The United 
States has been an active participant in regional cooperation 
activities to improve management of ocean dumping, especially within 
the Western Hemisphere. In recent years, U.S. technical experts from 
EPA and the Army Corps have participated in regional workshops on ocean 
disposal in Ecuador, China, and Bahrain. We engaged with countries in 
the wider Caribbean to encourage them to join the London Convention and 
Protocol through UNEP's Caribbean Environment Programme. We are also an 
active member of the South Pacific Regional Environment Programme, and 
leader within that organization on preventing marine pollution from 
ocean dumping in the Pacific.
    U.S. technical experts played a leading role in the London 
Convention/Protocol Scientific Group in developing ``Waste Assessment 
Guidance'' for evaluating various types of material for ocean disposal. 
This year EPA is providing the London Convention/Protocol Secretariat 
at the IMO with $80,000 to develop guidance for developing countries on 
dredged material management, and to promote training and capacity 
building in ocean dumping regulation. Over the next two years, we plan 
to contribute additional funds to this effort with a focus on Latin 
America and the Caribbean. Should we become Party to the London 
Protocol, we would expect to continue our leadership role in promoting 
cooperation and providing technical assistance on ocean dumping.


    Question. Article 15 provides for parties to the protocol to 
develop procedures regarding liability arising from the dumping or 
incineration at sea of wastes or other matter.

          a. What is the status of efforts to develop such procedures?

          b. What rules apply to the adoption of such procedures by the 
        parties to the protocol? Must such procedures be adopted by 
        consensus, or may they be adopted over the objection of one or 
        more parties?

          c. What legal effect will such procedures have for parties to 
        the protocol? Will parties be legally obligated to comply with 
        them?

    Answer. Article 15 liability procedures have not been developed 
under the London Protocol. Indeed, the second Meeting of Contracting 
Parties held in November 2007 agreed not to embark on the development 
of liability procedures under Article 15 at this stage. It is worth 
noting that the London Convention contains a similar provision in 
Article X regarding the development of liability procedures, but that 
no such procedures have ever been developed. The rules of procedure of 
the Protocol apply to adoption of all decisions and contain provisions 
on voting.
    Article 15, like Article X of the London Convention, describes a 
process for consideration of this issue rather than mandating a 
specific outcome. Were this process to become active and were it to 
lead to the development of new legally binding obligations, there is 
nothing in the treaty that would authorize the automatic imposition of 
such obligations on Parties. A further instrument would be required 
and, were the United States to be interested in joining, it would need 
to obtain appropriate authority prior to becoming bound by any such 
obligations.


    Question. Please explain why the Administration believes that the 
procedures in Article 16 for the resolution of disputes are appropriate 
to this protocol.

    Answer. Article 16 and Annex 3 of the London Protocol set forth the 
process for settling any disputes that may arise. In the first 
instance, Parties are to resolve any such dispute through negotiation, 
mediation, conciliation or other peaceful means of their choice. If no 
resolution is reached, the dispute shall, at the request of any Party, 
be settled by arbitration, using procedures contained in Annex 3, 
unless the Parties to the dispute agree on a different mechanism. The 
Annex 3 arbitration procedures are identical to a proposed amendment to 
the London Convention that the U.S. ratified in the 1980's, but which 
never entered into force.
    Given our experience under our environmental treaties, compliance 
issues are unlikely to be of a bilateral nature such that these kinds 
of procedures would be relevant. Rather, compliance issues have tended 
to be treated under multilateral, consultative compliance procedures. 
Nevertheless, the existence of the procedure may promote compliance by 
other Parties, which is an important U.S. objective.


    Question. Please indicate what additional costs the International 
Maritime Organization is expected to incur in connection with the 
performance of Secretariat duties provided for in Article 19. Please 
also indicate what portion of any such additional costs will be 
assessed to the United States as an IMO member.

    Answer. London Convention and London Protocol meetings are held 
jointly, and the programs and activities performed by the Secretariat 
in support of the London Protocol are effectively the same as those 
performed in support of the Convention. In 1996 the IMO Council agreed 
that the Secretariat would accept the functions assigned by the 
Protocol ``on the understanding that additional functions shall not 
result in additional costs to the Organization.'' It is not possible to 
separate out the Secretariat's costs for supporting the Protocol from 
what it costs to support the Convention, but it would be no more than 
any additional costs incurred by additional Parties joining the 
Convention. The United States will bear no additional costs than it 
would as merely a Convention Party, since our IMO assessment is based 
on flag-state member ship tonnage.