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114th Congress    }                               {     Exec. Rept.
                                 SENATE
 2d Session       }                               {      114-2

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



 
                       PROTOCOL AMENDING THE TAX 
                         CONVENTION WITH SPAIN

                                _______
                                

                February 8, 2016.--Ordered to be printed

                                _______
                                

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

                                 REPORT

                    [To accompany Treaty Doc. 113-4]

    The Committee on Foreign Relations, to which was referred 
the Protocol Amending the Convention between the United States 
of America and the Kingdom of Spain for the Avoidance of Double 
Taxation and the Prevention of Fiscal Evasion with Respect to 
Taxes on Income and its Protocol, signed at Madrid on February 
22, 1990, and a related Memorandum of Understanding signed on 
January 14, 2013, at Madrid, together with correcting notes 
dated July 23, 2013, and January 31, 2014 (together the 
``Protocol'') (Treaty Doc. 113-4), having considered the same, 
reports favorably thereon with one declaration, 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.................................................3
  V. Implementing Legislation.........................................3
 VI. Committee Action.................................................3
VII. Committee Comments...............................................4
VIII.Text of Resolution of Advice and Consent to Ratification.........5

 IX. Annex 1.--Technical Explanation..................................8

                               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 Spain. The proposed Protocol 
provides an exemption from source-country withholding on 
certain direct dividend payments and limits source-country 
taxation on all other dividends and branch profits, consistent 
with the U.S. Model Tax Treaty. The proposed protocol also 
exempts from source-country withholding cross-border payments 
of interest, royalties, and capital gains in a manner 
consistent with the U.S. Model. The Protocol contains rigorous 
protections designed to protect against ``treaty shopping,'' 
which is the inappropriate use of a tax treaty by third-country 
residents, and provisions to ensure the exchange of information 
between tax authorities in both countries. While the proposed 
Protocol generally follows the 2006 U.S. Model Income Tax 
Treaty (the ``U.S. Model''), it deviates from the U.S. Model in 
certain respects discussed below.

                             II. Background

    The United States has a tax treaty with Spain that is 
currently in force, which was concluded in 1990 (Convention 
between the United States of America and the Kingdom of Spain 
for the Avoidance of Double Taxation and the Prevention of 
Fiscal Evasion with Respect to Taxes on Income and its 
Protocol, signed at Madrid on February 22, 1990). The proposed 
Protocol was negotiated to bring U.S.-Spain tax treaty 
relations into closer conformity with each country's current 
tax treaty policies. For example, the proposed Protocol 
contains updated provisions designed to address ``treaty-
shopping.'' The proposed Protocol also includes updated 
exchange of information articles and a mandatory binding 
arbitration provision to resolve disputes between the revenue 
authorities of the United States and Spain.

                         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 June 19, 2014, which is included 
at Annex 1 to this report. In addition, the staff of the Joint 
Committee on Taxation prepared an analysis of the Protocol, 
JCX-67-14 (June 17, 2014), 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.

                         LIMITATION ON BENEFITS

    Consistent with current U.S. tax treaty policy, the 
proposed Protocol includes a ``Limitation on Benefits'' (LOB) 
provision, which is designed to avoid treaty-shopping by 
limiting the indirect use of a treaty's benefits by persons who 
were not intended to take advantage of those benefits. The 
limitation of benefits provision states that a corporation or 
similar entity resident in a contracting state (i.e., the 
United States or Spain) is not entitled to the benefits of the 
treaty unless that entity meets certain tests, such as carrying 
on an active trade or business, or being a publicly-traded 
company on certain specified stock exchanges. The provision is 
designed to identify entities that have established residency 
for tax-abuse purposes.
    The Protocol's limitation of benefits provision generally 
reflects the anti-treaty-shopping provisions included in the 
U.S. Model treaty and more recent U.S. income tax treaties, but 
differs in a few respects that may permit some companies to 
qualify for treaty benefits under tests not found in the Model. 
For instance, the proposed Protocol contains a derivative 
benefits test under which a company could qualify for treaty 
benefits if at least 95 percent of the aggregate voting power 
and value of its shares (and at least 50 percent of any 
disproportionate class of shares) are held by seven or fewer 
``equivalent beneficiaries.'' The proposed Protocol also 
contains a headquarters company test, under which a resident 
company would qualify if it meets the criteria to be considered 
a headquarters company of a multinational group. The proposed 
Protocol would also restrict the discretionary grant of tax 
treaty benefits that allows companies that do not pass one of 
the LOB tests but demonstrate that they have no treaty shopping 
purpose to claim treaty benefits.

                        EXCHANGE OF INFORMATION

    The proposed Protocol provides authority for the two 
countries to exchange tax information that is foreseeably 
relevant to carrying out the provisions of the existing 
Convention. The proposed Protocol allows the United States is 
allowed to obtain information (including from financial 
institutions) from Spain regardless of whether Spain needs the 
information for its own tax purposes.

                         MANDATORY ARBITRATION

    The Protocol incorporates mandatory, binding arbitration 
for certain cases where the competent authorities of the United 
States and Spain have been unable to resolve after within two 
years under the mutual agreement procedure. A mandatory and 
binding arbitration procedure is not included in the U.S. Model 
treaty, but has recently been included in the U.S. income tax 
treaties with Belgium, Canada, Germany, France, and 
Switzerland.

                      MEMORANDUM OF UNDERSTANDING

    The Memorandum of Understanding commits the United States 
and Spain to initiate discussions within six months after the 
proposed Protocol enters into force to extend the benefits of 
the Protocol to investments between Puerto Rico and Spain.

                          IV. Entry Into Force

    Article XV states that the proposed Protocol shall enter 
into force three months after the United States and Spain have 
notified each other that they have completed all required 
internal procedures for entry into force. The Memorandum of 
Understanding enters into force on the same date as the 
proposed Protocol.

                      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 Convention on 
October 29, 2015. Testimony was received from Robert Stack, 
Deputy Assistant Secretary (International Tax Affairs) at the 
U.S. Department of the Treasury and Thomas Barthold, Chief of 
Staff of the Joint Committee on Taxation. A transcript of the 
hearing is included in Annex 2 of Executive Report 114-1.
    On November 10, 2015, the committee considered the Protocol 
and ordered it favorably reported by voice vote, with a quorum 
present and without objection.
    In the 113th Congress, on April 1, 2014, the committee 
considered the Protocol and ordered it favorably reported by 
voice vote, with a quorum present and without objection.

                        VII. Committee Comments

    The Committee on Foreign Relations believes that the 
Protocol will stimulate increased trade and investment, reduce 
treaty shopping incentives, and promote closer co-operation 
between the United States and Spain. 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. LIMITATION ON BENEFITS

    The committee applauds the Treasury Department's 
significant efforts to address treaty shopping both in this 
Convention and in other bilateral tax treaties. After careful 
examination of this Protocol, as well as testimony and 
responses to questions for the record from the Treasury 
Department, the committee is of the view that the Convention's 
protections against treaty-shopping are robust and will 
substantially deny treaty shoppers the benefit of the 
Convention. The committee believes that it is critical for the 
Treasury Department to closely monitor and keep the committee 
informed on the effectiveness of the above-mentioned provisions 
in discouraging and eliminating treaty-shopping under the 
Convention.

                        B. INFORMATION EXCHANGE

    The Protocol would replace the existing Convention's tax 
information exchange provisions with updated rules that are 
consistent with current U.S. tax treaty practice. The provision 
would allow the tax authorities of each country to exchange 
information relevant to carrying out the provisions of the 
Convention or the domestic tax laws of either country. It would 
also enable the United States to obtain information (including 
from financial institutions) from Spain whether or not Spain 
needs the information for its own tax purposes.
    After careful examination of this Protocol, as well as 
witness testimony and responses to questions for the record, 
the committee believes that the exchange of information 
provisions will substantially aid in the full and fair 
enforcement of United States tax laws. According to witness 
testimony, the ``foreseeably relevant'' standard used in the 
Protocol does not represent a lower threshold than the standard 
found in earlier U.S. tax treaties. Witnesses also testified 
that the ``foreseeably relevant'' standard has been extensively 
defined in internationally agreed guidance to which no country 
has expressed a dissenting opinion to date. The committee is 
also of the view that the Protocol provides adequate provisions 
to ensure that any information exchanged pursuant to the 
Convention is treated confidentially. In sum, the committee 
believes these provisions on information exchange are important 
to the administration of U.S. tax laws and the Protocol 
provides adequate protection against the misuse of information 
exchanged pursuant to the Convention.

     C. DECLARATION ON THE SELF-EXECUTING NATURE OF THE CONVENTION

    The committee has included one declaration in the 
recommended resolution of advice and consent. The declaration 
states that the Convention is self-executing, as is the case 
generally with income tax treaties. Prior to the 110th 
Congress, the committee generally included such statements in 
the committee's report, but in light of the Supreme Court 
decision in Medellin v. Texas, 128 S. Ct. 1346 (2008), the 
committee 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. Text of 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

    The Senate advises and consents to the ratification of the 
Protocol Amending the Convention between the United States of 
America and the Kingdom of Spain for the Avoidance of Double 
Taxation and the Prevention of Fiscal Evasion With Respect to 
Taxes on Income and its Protocol, signed at Madrid on February 
22, 1990, and a related Memorandum of Understanding signed on 
January 14, 2013, at Madrid, together with correcting notes 
dated July 23, 2013, and January 31, 2014 (the ``Protocol'') 
(Treaty Doc. 113-4), subject to the declaration of section 2 
and the conditions of section 3.

SECTION 2. DECLARATION

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

SECTION 3. CONDITIONS

    The advice and consent of the Senate under section 1 is 
subject to the following conditions:
          (1) Not later than 2 years after the Protocol enters 
        into force and prior to the first arbitration conducted 
        pursuant to the binding arbitration mechanism provided 
        for in the Protocol, the Secretary of the Treasury 
        shall transmit to the Committees on Finance and Foreign 
        Relations of the Senate and the Joint Committee on 
        Taxation the text of the rules of procedure applicable 
        to arbitration panels, including conflict of interest 
        rules to be applied to members of the arbitration 
        panel.
          (2)(A) Not later than 60 days after a determination 
        has been reached by an arbitration panel in the tenth 
        arbitration proceeding conducted pursuant to the 
        Protocol or any of the treaties described in 
        subparagraph (B), the Secretary of the Treasury shall 
        prepare and submit to the Joint Committee on Taxation 
        and the Committee on Finance of the Senate, subject to 
        laws relating to taxpayer confidentiality, a detailed 
        report regarding the operation and application of the 
        arbitration mechanism contained in the Protocol and 
        such treaties. The report shall include the following 
        information:
                  (i) For the Protocol and each such treaty, 
                the aggregate number of cases pending on the 
                respective dates of entry into force of the 
                Protocol and each treaty, including the 
                following information:
                          (I) The number of such cases by 
                        treaty article or articles at issue.
                          (II) The number of such cases that 
                        have been resolved by the competent 
                        authorities through a mutual agreement 
                        as of the date of the report.
                          (III) 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 the Protocol and each such treaty, 
                including the following information regarding 
                each case:
                          (I) The commencement date of the case 
                        for purposes of determining when 
                        arbitration is available.
                          (II) Whether the adjustment 
                        triggering the case, if any, was made 
                        by the United States or the relevant 
                        treaty partner.
                          (III) Which treaty the case relates 
                        to.
                          (IV) The treaty article or articles 
                        at issue in the case.
                          (V) The date the case was resolved by 
                        the competent authorities through a 
                        mutual agreement, if so resolved.
                          (VI) The date on which an arbitration 
                        proceeding commenced, if an arbitration 
                        proceeding commenced.
                          (VII) The date on which a 
                        determination was reached by the 
                        arbitration panel, if a determination 
                        was reached, and an indication as to 
                        whether the panel 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 panel pursuant 
                to the Protocol or any such treaty, the 
                following information:
                          (I) In the case of a dispute 
                        submitted under the Protocol, an 
                        indication as to whether the presenter 
                        of the case to the competent authority 
                        of a Contracting State submitted a 
                        Position Paper for consideration by the 
                        arbitration panel.
                          (II) An indication as to whether the 
                        determination of the arbitration panel 
                        was accepted by each concerned person.
                          (III) 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.
                          (IV) The proposed resolutions 
                        (income, expense, or taxation) 
                        submitted by each competent authority 
                        to the arbitration panel.
          (B) The treaties referred to in subparagraph (A) 
        are--
                  (i) 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, done at 
                Berlin June 1, 2006 (Treaty Doc. 109-20) (the 
                ``2006 German Protocol'');
                  (ii) 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, done at Brussels July 9, 
                1970 (the ``Belgium Convention'') (Treaty Doc. 
                110-3);
                  (iii) the Protocol Amending the Convention 
                between the United States of America and Canada 
                with Respect to Taxes on Income and on Capital, 
                signed at Washington September 26, 1980 (the 
                ``2007 Canada Protocol'') (Treaty Doc. 110-15); 
                or
                  (iv) the Protocol Amending the Convention 
                between the Government of the United States of 
                America and the Government of the French 
                Republic for the Avoidance of Double Taxation 
                and the Prevention of Fiscal Evasion with 
                Respect to Taxes on Income and Capital, signed 
                at Paris August 31, 1994 (the ``2009 France 
                Protocol'') (Treaty Doc. 111-4).
          (3) The Secretary of the Treasury shall prepare and 
        submit the detailed report required under 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 panel, and noted as such in prior 
        reports may be omitted.
          (4) The reporting requirements referred to in 
        paragraphs (2) and (3) supersede the reporting 
        requirements contained in paragraphs (2) and (3) of 
        section 3 of the resolution of advice and consent to 
        ratification of the 2009 France Protocol, approved by 
        the Senate on December 3, 2009.
                  IX. Annex 1.--Technical Explanation


DEPARTMENT OF THE TREASURY TECHNICAL EXPLANATION OF THE PROTOCOL SIGNED 
 AT WASHINGTON ON JANUARY 14, 2013 AMENDING THE CONVENTION BETWEEN THE 
UNITED STATES OF AMERICA AND THE KINGDOM OF SPAIN FOR THE AVOIDANCE OF 
 DOUBLE TAXATION AND THE PREVENTION OF FISCAL EVASION WITH RESPECT TO 
 TAXES ON INCOME AND ITS PROTOCOL, WHICH FORMS AN INTEGRAL PART OF THE 
           CONVENTION, SIGNED AT MADRID ON FEBRUARY 22, 1990

    This is a Technical Explanation of the Protocol signed at 
Washington on January 14, 2013, the related Memorandum of 
Understanding signed the same day, and a subsequent Exchange of 
Notes dated July 23, 2013 (hereinafter the ``Protocol'', 
``Memorandum of Understanding'' and ``Exchange of Notes'' 
respectively), amending the Convention between the United 
States of America and the Kingdom of Spain for the avoidance of 
double taxation and the prevention of fiscal evasion with 
respect to taxes on income, signed at Madrid on February 22, 
1990 (hereinafter the ``existing Convention'') and the 
Protocol, which forms an integral part of the existing 
Convention, signed at Washington on November 6, 2003 
(hereinafter the ``Protocol of 1990'').
    Negotiations took into account the U.S. Department of the 
Treasury'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.
    This Technical Explanation is an official guide to the 
Protocol, Memorandum of Understanding and Exchange of Notes. It 
explains policies behind particular provisions, as well as 
understandings reached during the negotiations with respect to 
the interpretation and application of the Protocol, Memorandum 
of Understanding and the Exchange of Notes.
    References 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, Memorandum of Understanding 
and Exchange of Notes. The Technical Explanation is not 
intended to provide a complete guide to the existing Convention 
as amended by the Protocol, Memorandum of Understanding and 
Exchange of Notes. To the extent that the existing Convention 
and Protocol of 1990 have not been amended by the Protocol, 
Memorandum of Understanding and Exchange of Notes, the 
technical explanation of the existing Convention and the 
Protocol of 1990 remains the official explanation. 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 of 1986, as amended. 
References to a ``Treas. Reg.'' are to regulations issued by 
the Treasury Department.

                               ARTICLE I

    Article I of the Protocol revises Article 1 (General Scope) 
of the existing Convention by deleting references to Article 20 
of the existing Convention, by adding new paragraphs 5 and 6.

New Paragraph 5 of Article 1

    New paragraph 5 relates to non-discrimination obligations 
of the Contracting States under the GATS. The provisions of 
paragraph 5 are an exception to the rule provided in paragraph 
2 of Article 1 under which the Convention shall not restrict in 
any manner any benefit now or hereafter accorded by any other 
agreement between the Contracting States.
    Subparagraph 5(a) provides that, unless the competent 
authorities determine that a taxation measure is not within the 
scope of the Convention, the national treatment obligations of 
the GATS shall not apply with respect to that measure. Further, 
any question arising as to the interpretation or application of 
the Convention, including in particular whether a measure is 
within the scope of the Convention, shall be considered only by 
the competent authorities of the Contracting States, and the 
procedures under the Convention exclusively shall apply to the 
dispute. Thus, paragraph 3 of Article XXII (Consultation) of 
the GATS may not be used to bring a dispute before the World 
Trade Organization unless the competent authorities of both 
Contracting States have determined that the relevant taxation 
measure is not within the scope of Article 25 (Non-
Discrimination) of the Convention.
    The term ``measure'' for these purposes is defined broadly 
in subparagraph 5(b). It would include a law, regulation, rule, 
procedure, decision, administrative action or any other similar 
provision or action.

New Paragraph 6 of Article 1

    New paragraph 6 addresses special issues presented by the 
payment of items of income, profit or gain to entities that are 
either wholly or partly fiscally transparent, such as 
partnerships, estates and trusts. Because countries may take 
different views as to when an entity is wholly or partly 
fiscally transparent, the risk of both double taxation and 
double non-taxation is relatively high. The provision, and the 
corresponding requirements of the substantive rules of the 
other Articles of the Convention, should be read with two goals 
in mind. The intention of paragraph 6 is to eliminate a number 
of technical problems that could prevent investors using such 
entities from claiming treaty benefits, even though such 
investors would be subject to tax on the income derived through 
such entities. Paragraph 1 of the Memorandum of Understanding 
sets forth the understanding of the Contracting States that 
paragraph 6 applies to identify the person that derives an item 
of income, profit or gain paid to a fiscally transparent entity 
for purposes of applying the Convention to that first mention 
person. The provision also prevents a resident of a Contracting 
State from claiming treaty benefits in circumstances where the 
resident investing in the entity does not take into account the 
item of income paid to the entity because the entity is not 
fiscally transparent in its State of residence.
    In general, the principles incorporated in this paragraph 
reflect the regulations under Treas. Reg. 1.894-1(d). Treas. 
Reg. 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 by the 
interest holder. Entities falling under this description in the 
United States include partnerships, corporations that have made 
a valid election to be taxed under Subchapter S of Chapter 1 of 
the Code (``S corporations''), common investment trusts under 
section 584, simple trusts and grantor trusts. This paragraph 
also applies to payments made to other entities, such as U.S. 
limited liability companies (``LLCs''), that may be treated as 
either partnerships or as disregarded entities for U.S. tax 
purposes.
    New paragraph 6 provides that, for purposes of applying the 
Convention, an item of income, profit or gain derived through 
an entity that is fiscally transparent under the laws of either 
Contracting State, and that is formed or organized in either 
Contracting State, or in a state that has an agreement in force 
containing a provision for the exchange of information on tax 
matters with the Contracting State from which the income, 
profit or gain is derived, shall be considered to be derived by 
a resident of a Contracting State to the extent that the item 
is treated for purposes of the taxation law of such Contracting 
State as the income, profit or gain of a resident. For example, 
if a company that is a resident of Spain pays interest to an 
entity that is formed or organized either in the United States 
or in a country with which Spain has an agreement in force 
containing a provision for the exchange of information on tax 
matters, and that entity is treated as fiscally transparent for 
U.S. tax purposes, the interest will be considered derived by a 
resident of the United States, but only to the extent that the 
taxation laws of the United States treat one or more U.S. 
residents (whose status as U.S. residents is determined, for 
this purpose, under U.S. tax law) as deriving the interest for 
U.S. tax purposes. Where the entity is a partnership, the 
persons who are, under U.S. tax laws, treated as partners of 
the entity would normally be the persons whom the U.S. tax laws 
would treat as deriving the interest income through the 
partnership. Also, it follows that persons whom the United 
States treats as partners but who are not U.S. residents for 
U.S. tax purposes may not claim a benefit under the Convention 
for the interest paid to the partnership, because such third-
country partners are not residents of the United States for 
purposes of claiming this benefit. If, however, the country in 
which the third-country partners are treated as residents for 
tax purposes, as determined under the laws of that country, has 
an income tax convention with the other Contracting State, they 
may be entitled to claim a benefit under that convention (these 
results would also follow in the case of an entity that is 
disregarded as an entity separate from its owner under the laws 
of one jurisdiction but not the other, such as a single-owner 
entity that is viewed as a branch for U.S. tax purposes and as 
a corporation for tax purposes under the laws of the other 
Contracting State). In contrast, where the entity is organized 
under U.S. laws and is classified as a corporation for U.S. tax 
purposes, interest paid by a company that is a resident of 
Spain to the U.S. corporation will be considered derived by a 
resident of the United States since the U.S. corporation is 
treated under U.S. taxation laws as a resident of the United 
States and as deriving the income.
    The same result would be reached even if the tax laws of 
Spain would treat the entity differently (e.g., if the entity 
were not treated as fiscally transparent in Spain in the first 
example above where the entity is treated as a partnership for 
U.S. tax purposes). Similarly, the characterization of the 
entity by a third country is also irrelevant, even if the 
entity is organized in that third country, although in such 
cases, subparagraph 6(b) requires that an agreement containing 
a provision for the exchange of information be in force between 
the source State and the third country.
    These principles also apply to trusts to the extent that 
they are wholly or partly fiscally transparent in either 
Contracting State. For example, suppose that X, a resident of 
Spain, creates a revocable trust in the United States and names 
persons resident in a third country as the beneficiaries of the 
trust. If, under the laws of Spain, X is treated as taking the 
trust's income into account for tax purposes, the trust's 
income would be regarded as being derived by a resident of 
Spain. In contrast, since the determination of deriving an item 
of income, profit or gain is made on an item by item basis, it 
is possible that, in the case of a U.S. non-grantor trust, the 
trust itself may be able to claim benefits with respect to 
certain items of income, such as capital gains, so long as it 
is a resident liable to tax on such gains, but not with respect 
to other items of income that are treated as income of the 
trust's interest holders.
    As noted above, paragraph 6 is not an exception to the 
saving clause of paragraph 4. Accordingly, paragraph 6 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. LLC with members who are residents of Spain 
elects to be taxed as a corporation for U.S. tax purposes, the 
United States will tax that LLC on its worldwide income on a 
net basis, without regard to whether Spain views the LLC as 
fiscally transparent.
    Paragraph 1 of the Memorandum of Understanding sets forth 
the understanding of the Contracting States regarding the 
relationship of paragraph 6 with the other provisions of the 
Convention. In order to obtain the benefits of the Convention 
with respect to an item of income, the person who according to 
paragraph 6 derives an item of income must satisfy all 
applicable requirements specified in the Convention, including 
other applicable requirements of Article 1, the requirements of 
Article 4 (Residence), Article 17 (Limitation on Benefits) and 
the concepts of beneficial ownership found in Articles 10 
(Dividends), 11 (Interest) and 12 (Royalties).

                               ARTICLE II

    Article II of the Protocol amends Article 3 (General 
Definitions) of the existing Convention.

Paragraph 1

    Paragraph 1 adds a new subparagraph (j) to paragraph 1 of 
Article 3. Subparagraph 1(j) defines the term ``pension fund''. 
Clause 1(j)(i) provides that in the case of Spain, the term 
means any scheme, fund, mutual benefit institution or other 
entity established in Spain that satisfies two criteria. First, 
as provided in clause 1(j)(i)(A), the person must be operated 
principally to manage the right of its beneficiaries to receive 
income or capital upon retirement, survivorship, widowhood, 
orphanhood, or disability. Second, contributions to the pension 
fund must be deductible from the taxable base of personal 
taxes.
    Subparagraph 3(a) of the Memorandum of Understanding as 
corrected by the Exchange of Notes sets forth a non-exhaustive 
descriptive list of those U.S. entities that will be regarded 
as pension funds for purposes of the Convention. The list 
includes: a trust providing pension or retirement benefits 
under an Internal Revenue Code section 401(a) qualified pension 
plan (which includes a Code section 401(k) plan), a profit 
sharing or stock bonus plan, a Code section 403(a) qualified 
annuity plan, a Code section 403(b) plan, a trust that is an 
individual retirement account under Code section 408, a Roth 
individual retirement account under Code section 408A, a simple 
retirement account under Code section 408(p), a trust providing 
pension or retirement benefits under a simplified employee 
pension plan under Code section 408(k), a trust described in 
section 457(g) providing pension or retirement benefits under a 
Code section 457(b) plan, and the Thrift Savings Fund (section 
7701(j)). A group trust described in Revenue Ruling 81-100, as 
amended by Revenue Ruling 2004-67 and Revenue Ruling 2011-1, 
shall qualify as a pension fund only if it earns income 
principally for the benefit of one or more pension funds that 
are themselves entitled to benefits under the Convention as 
residents of the United States.
    Subparagraph 3(b) of the Memorandum of Understanding sets 
forth a non-exhaustive descriptive list of those Spanish 
entities that will be regarded as pension funds for purposes of 
the Convention. The list includes: 1) any fund regulated under 
the Amended Test of the Law on pension funds and pension 
schemes (Texto Refundido de la Ley sobre Fondos y Planes de 
Pensiones), passed by Legislative Royal Decree 1/2002 of 
November 29; 2) any entity defined under Article 64 of the 
Amended Text of the Law on the regulation and monitoring of 
private insurances (Texto Refundido de la Ley de Ordenacion y 
Supervision de los Seguros Privados) passed by Legislative 
Royal Decree 6/2004 of October 29, provided that in the case of 
mutual funds all participants are employees; promoters and 
sponsoring partners are the companies, institutions or 
individual entrepreneurs to which the employees are engaged; 
and benefits are exclusively derived from the social welfare 
agreement between both parties, as well as any other comparable 
entity regulated within the scope of the political subdivisions 
(Comunidades Autonomas); and 3) insurance companies regulated 
under the Amended Text of the Law on the regulation and 
monitoring of private insurances passed by Legislative Royal 
Decree 6/2004 of October 29 whose activity is the coverage of 
the contingencies provided for in the Amended Text of the Law 
on pension funds and pension schemes.
    Clause 1(j)(ii) of new subparagraph 1(j) of Article 3 
provides that in the case of the United States, the term 
``pension fund'' means any person established in the United 
States that is generally exempt from income taxation in the 
United States, and is operated principally either to administer 
or provide pension or retirement benefits, or to earn income 
principally for the benefit of one or more persons established 
in the same Contracting State that are generally exempt from 
income taxation in that Contracting State and are operated 
principally to administer or provide pension or retirement 
benefits.
    The definition, as it applies in the case of the United 
States, recognizes that pension funds sometimes administer or 
provide benefits other than pension or retirement benefits, 
such as death benefits. However, in order for the fund to be 
considered a pension fund for purposes of the Convention, the 
provision of any other such benefits must be merely incidental 
to the fund's principal activity of administering or providing 
pension or retirement benefits. The definition also ensures 
that if a fund is a collective fund that earns income for the 
benefit of other funds, then substantially all of the funds 
that participate in the collective fund must be residents of 
the same Contracting State as the collective fund and must be 
entitled to benefits under the Convention in their own right.

Paragraph 2

    Paragraph 2 replaces paragraph 2 of Article 3 of the 
existing Convention. Terms that are not defined in the existing 
Convention are dealt with in paragraph 2.
    New paragraph 2 of Article 3 provides that in the 
application of the Convention, any term used but not defined in 
the Convention will have the meaning that it has under the 
domestic law of the Contracting State applying the Convention, 
unless the context requires otherwise, and subject to the 
provisions of Article 26 (Mutual Agreement Procedure). If the 
term is defined under both the tax and non-tax laws of a 
Contracting State, the definition in the tax law will take 
precedence over the definition in the non-tax laws. Finally, 
there also may be cases where the tax laws of a State contain 
multiple definitions of the same term. In such a case, the 
definition used for purposes of the particular provision at 
issue, if any, should be used.
    The reference in paragraph 2 to the domestic law of a 
Contracting State means the law in effect at the time the 
treaty is being applied, not the law as in effect at the time 
the treaty was signed. The use of ``ambulatory'' definitions, 
however, may lead to results that are at variance with the 
intentions of the negotiators and of the Contracting States 
when the treaty was negotiated and ratified. The inclusion in 
both paragraphs 1 and 2 of an exception to the generally 
applicable definitions where the ``context otherwise requires'' 
is intended to address this circumstance. Where reflecting the 
intent of the Contracting States requires the use of a 
definition that is different from a definition under paragraph 
1 or the law of the Contracting State applying the Convention, 
that definition will apply. Thus, flexibility in defining terms 
is necessary and permitted.

                              ARTICLE III

    Article III of the Protocol replaces paragraph 3 of Article 
5 (Permanent Establishment) of the existing Convention. 
Paragraph 3 of Article 5 provides rules to determine whether a 
building site or a construction, assembly or installation 
project, or an installation or drilling rig or ship used for 
the exploration of natural resources constitutes a permanent 
establishment for the contractor, driller, etc. Such a site or 
activity does not create a permanent establishment unless the 
site, project, etc. lasts, or the exploration activity 
continues, for more than twelve months. It is only necessary to 
refer to ``exploration'' and not ``exploitation'' in this 
context because exploitation activities are defined to 
constitute a permanent establishment under subparagraph (f) of 
paragraph 2 of Article 5. Thus, a drilling rig does not 
constitute a permanent establishment if a well is drilled in 
less than twelve months. However, the well becomes a permanent 
establishment as of the date that production begins.
    The twelve-month test applies separately to each site or 
project. The twelve-month period begins when work (including 
preparatory work carried on by the enterprise) physically 
begins in a Contracting State. A series of contracts or 
projects by a contractor that are interdependent both 
commercially and geographically are to be treated as a single 
project for purposes of applying the twelve-month threshold 
test. For example, the construction of a housing development 
would be considered as a single project even if each house were 
constructed for a different purchaser.
    In applying this paragraph, time spent by a sub-contractor 
on a building site is counted as time spent by the general 
contractor at the site for purposes of determining whether the 
general contractor has a permanent establishment. However, for 
the sub-contractor itself to be treated as having a permanent 
establishment, the sub-contractor's activities at the site must 
last for more than twelve months. For purposes of applying the 
twelve-month rule, time is measured from the first day the sub-
contractor is on the site until the last day. Thus, if a sub-
contractor is on a site intermittently, intervening days that 
the sub-contractor is not on the site are counted.
    These interpretations of the Article are based on the 
Commentary to paragraph 3 of Article 5 of the OECD Model, which 
contains language that is substantially the same as that in the 
Convention. These interpretations are consistent with the 
generally accepted international interpretation of the relevant 
language in paragraph 3 of Article 5 of the Convention.
    If the twelve-month threshold is exceeded, the site or 
project constitutes a permanent establishment from the first 
day of activity.

                               ARTICLE IV

    Article IV of the Protocol replaces Article 10 (Dividends) 
of the existing Convention. New Article 10 provides rules for 
the taxation of dividends paid by a company that is a resident 
of one Contracting State to a beneficial owner that is a 
resident of the other Contracting State. The Article provides 
for full residence-State taxation of such dividends and 
limitations on (including, in some cases, a prohibition from) 
taxation by the source State. New Article 10 also provides 
rules for the imposition of a tax on branch profits by the 
State of source. Finally, the Article prohibits a State from 
imposing taxes on a company resident in the other Contracting 
State, other than a branch profits tax, on undistributed 
earnings.

Paragraph 1 of New Article 10

    Paragraph 1 of new Article 10 permits a Contracting State 
to tax its residents on dividends paid to them by a company 
that is a resident of the other Contracting State. For 
dividends from any other source paid to a resident, Article 23 
(Other Income) of the Convention grants the residence country 
exclusive taxing jurisdiction (other than for dividends 
attributable to a permanent establishment in the other State).

Paragraph 2 of New Article 10

    The State of source also may tax dividends beneficially 
owned by a resident of the other State, subject to the 
limitations of paragraphs 2, 3 and 4. Paragraph 2 of new 
Article 10 generally limits the rate of withholding tax in the 
State of source on dividends paid by a company resident in that 
State to 15 percent of the gross amount of the dividend. If, 
however, the beneficial owner of the dividend is a company 
resident in the other State and owns directly shares 
representing at least 10 percent of the voting power of the 
company paying the dividend, then the rate of withholding tax 
in the State of source is limited to 5 percent of the gross 
amount of the dividend. For application of this paragraph by 
the United States, shares are considered voting stock if they 
provide the power to elect, appoint or replace any person 
vested with the powers ordinarily exercised by the board of 
directors of a U.S. corporation.
    The determination of whether the ownership threshold for 
subparagraph 2(a) is met for purposes of the 5 percent maximum 
rate of withholding tax is made on the date on which 
entitlement to the dividend is determined. Thus, in the case of 
a dividend from a U.S. company, the determination of whether 
the ownership threshold is met generally would be made on the 
dividend record date.
    Paragraph 2 does not affect the taxation of the profits out 
of which the dividends are paid. The taxation by a Contracting 
State of the income of its resident companies is governed by 
the domestic law of the Contracting State, subject to the 
provisions of paragraph 4 of Article 25 (Non-Discrimination).
    The term ``beneficial owner'' is not defined in the 
Convention, and is, therefore, generally defined under the 
domestic law of the country imposing tax (i.e., the source 
country). The beneficial owner of the dividend for purposes of 
Article 10 is the person to which the income is attributable 
under the laws of the source State. Thus, if a dividend paid by 
a corporation that is a resident of one of the States (as 
determined under Article 4 (Residence)) is received by a 
nominee or agent that is a resident of the other State on 
behalf of a person that is not a resident of that other State, 
the dividend is not entitled to the benefits of this Article. 
However, a dividend received by a nominee on behalf of a 
resident of that other State would be entitled to benefits. 
These limitations are supported by paragraphs 12-12.2 of the 
Commentary to Article 10 of the OECD Model.
    Special rules apply to shares held through fiscally 
transparent entities both for purposes of determining whether 
the ownership threshold has been met and for purposes of 
determining the beneficial owner of the dividend.
    A company that is a resident of a Contracting State shall 
be considered to own directly the voting stock owned by an 
entity that is considered fiscally transparent under the laws 
of that State and that is not a resident of the other 
Contracting State of which the company paying the dividends is 
a resident, in proportion to the company's ownership interest 
in that entity. This is consistent with the rules of paragraph 
6 of Article 1 (General Scope) as revised by Article I, which 
provides that residence State principles shall be used to 
determine who derives the dividends, to ensure that the 
dividends 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.
    For example, assume that FCo, a company that is a resident 
of the Spain, owns a 50 percent interest in FP, a partnership 
that is organized in Spain. FP owns 100 percent of the sole 
class of stock of USCo, a company resident in the United 
States. Spain views FP as fiscally transparent under its 
domestic law, and taxes FCo currently on its distributive share 
of the income of FP and determines the character and source of 
the income received through FP in the hands of FCo as if such 
income were realized directly by FCo. In this case, FCo is 
treated as deriving 50 percent of the dividends paid by USCo 
under paragraph 6 of Article 1. Moreover, FCo is treated as 
owning 50 percent of the stock of USCo directly. The same 
result would be reached even if the tax laws of the United 
States would treat FP differently (e.g., if FP were not treated 
as fiscally transparent in the United States), or if FP were 
organized in a third state, provided that that state has an 
agreement in force containing a provision for the exchange of 
information on tax matters with Spain, which in this example is 
the Contracting State from which the dividend arises, and as 
long as FP were still treated as fiscally transparent under the 
laws of the United States.
    While residence State principles control who is treated as 
owning voting stock of the company paying dividends through a 
fiscally transparent entity and, consequently, who derives the 
dividends, source State principles of beneficial ownership 
apply to determine whether the person who derives the 
dividends, or another resident of the other Contracting State, 
is the beneficial owner of the dividends. If the person who 
derives the dividends under paragraph 6 of Article 1 would not 
be treated as a nominee, agent, custodian, conduit, etc. under 
the source State's principles for determining beneficial 
ownership, that person will be treated as the beneficial owner 
of the dividends for purposes of the Convention. In the example 
above, FCo is required to satisfy the beneficial ownership 
principles of the United States with respect to the dividends 
it derives. If under the beneficial ownership principles of the 
United States, FCo is found not to be the beneficial owner of 
the dividends, FCo will not be entitled to the benefits of 
Article 10 with respect to such dividends. If FCo is found to 
be a nominee, agent, custodian, or conduit for a person who is 
a resident of the other Contracting State, that person may be 
entitled to benefits with respect to the dividends.

Paragraph 3 of New Article 10

    Paragraph 3 of new Article 10 provides exclusive residence-
country taxation (i.e., an elimination of withholding tax) with 
respect to certain dividends distributed by a company that is a 
resident of one Contracting State to a resident of the other 
Contracting State. As described further below, this elimination 
of withholding tax is available with respect to certain inter-
company dividends and with respect to certain pension funds.
    Subparagraph 3(a) provides for the elimination of 
withholding tax on dividends beneficially owned by a company 
that has owned, directly or indirectly through one or more 
residents of either Contracting State, 80 percent or more of 
the voting power of the company paying the dividend for the 
twelve-month period ending on the date entitlement to the 
dividend is determined. The determination of whether the 
beneficial owner of the dividends owns at least 80 percent of 
the voting power of the company is made by taking into account 
stock owned both directly and indirectly through one or more 
residents of either Contracting State.
    Eligibility for the elimination of withholding tax provided 
by subparagraph 3(a) is subject to additional restrictions 
based on, and supplementing, the rules of Article 17 
(Limitation on Benefits) as that Article has been modified by 
Article IX. Accordingly, a company that meets the holding 
requirements described above will qualify for the benefits of 
paragraph 3 only if it also: (1) meets the ``publicly traded'' 
test of subparagraph 2(c) of Article 17, (2) meets the 
``ownership-base erosion'' and ``active trade or business'' 
tests described in subparagraph 2(e) and paragraph 4 of Article 
17, (3) meets the ``derivative benefits'' test of paragraph 3 
of Article 17, or (4) is granted the benefits of paragraph 3 of 
Article 10 at the discretion of the competent authority of the 
source State pursuant to paragraph 7 of Article 17.
    For example, assume that ThirdCo is a company resident in a 
third country that does not have a tax treaty with the United 
States providing for the elimination of withholding tax on 
inter-company dividends. ThirdCo owns directly 100 percent of 
the issued and outstanding voting stock of USCo, a U.S. 
company, and of SCo, a Spanish company. SCo is a substantial 
company that manufactures widgets. USCo distributes those 
widgets in the United States. If ThirdCo contributes to SCo all 
the stock of USCo, dividends paid by USCo to SCo would qualify 
for treaty benefits under the active trade or business test of 
paragraph 4 of Article 30. However, allowing ThirdCo to qualify 
for the elimination of withholding tax, which is not available 
to it under the third state's treaty with the United States (if 
any), would encourage treaty shopping.
    In order to prevent this type of treaty shopping, paragraph 
3 requires SCo to meet the ownership-base erosion requirements 
of subparagraph 2(e) of Article 17 as revised by Article IX in 
addition to the active trade or business test of paragraph 4 of 
Article 17. Because SCo is wholly owned by a third country 
resident, SCo could not qualify for the elimination of 
withholding tax on dividends from USCo under the combined 
ownership-base erosion and active trade or business tests of 
subparagraph 3(b). Consequently, SCo would need to qualify 
under another test in paragraph 3 or obtain discretionary 
relief from the competent authority under Article 17 paragraph 
7. For purpose of subparagraph 3(b), it is not sufficient for a 
company to qualify for treaty benefits generally under the 
active trade or business test or the ownership-base erosion 
test unless it qualifies for treaty benefits under both.
    Alternatively, companies that are publicly traded or 
subsidiaries of publicly-traded companies will generally 
qualify for the elimination of withholding tax. Thus, a company 
that is a resident of Spain and that meets the requirements of 
subparagraph 2(c) of Article 17 will be entitled to the 
elimination of withholding tax, subject to the ownership and 
holding period requirements.
    In addition, under subparagraph 3(c), a company that is a 
resident of a Contracting State may also qualify for the 
elimination of withholding tax on dividends if it satisfies the 
derivative benefits test of paragraph 3 of Article 17, subject 
to the ownership and holding period requirements. Thus, a 
Spanish company that has owned all of the stock of a U.S. 
corporation for the twelve-month period ending on the date on 
which entitlement to the dividend is determined may qualify for 
the elimination of withholding tax if it is wholly-owned by a 
company that falls within the definition of ``equivalent 
beneficiary'' in subparagraph 8(g) of Article 17.
    The derivative benefits test may also provide benefits to 
U.S. companies receiving dividends from Spanish subsidiaries 
because of the effect of the Parent-Subsidiary Directive in the 
European Union. Under that directive, inter-company dividends 
paid within the European Union are free of withholding tax. 
Under subparagraph 8(h) of Article 17 that directive will be 
taken into account in determining whether the owner of a U.S. 
company receiving dividends from a Spanish company is an 
equivalent beneficiary. Thus, a company that is a resident of a 
member state of the European Union will, by virtue of the 
Parent-Subsidiary Directive, satisfy the requirements of 
Article subparagraph 8(g)(i)(B) of Article 17 with respect to 
any dividends received by its U.S. subsidiary from a Spanish 
company. For example, assume USCo is a wholly-owned subsidiary 
of ICo, an Italian publicly-traded company. USCo owns all of 
the shares of SCo, a Spanish company. If SCo were to pay 
dividends directly to ICo, those dividends would be exempt from 
withholding tax in Spain by reason of the Parent-Subsidiary 
Directive. If ICo meets the other conditions to be an 
equivalent beneficiary under subparagraph 8(g) of Article 17, 
it will be treated as an equivalent beneficiary.
    A company also may qualify for the elimination of 
withholding tax pursuant to subparagraph 3(c) if it is owned by 
seven or fewer U.S. or Spanish residents who qualify as an 
``equivalent beneficiary'' and meet the other requirements of 
the derivative benefits provision. This rule may apply, for 
example, to certain Spanish corporate joint venture vehicles 
that are closely-held by a few Spanish resident individuals.
    Subparagraph 8(g) of Article 17 contains a specific rule of 
application intended to ensure that for purposes of applying 
paragraph 3, certain joint ventures, not just wholly-owned 
subsidiaries, can qualify for benefits. For example, assume 
that the United States were to enter into a treaty with Country 
X, a member of the European Union, that includes a provision 
identical to paragraph 3. USCo is 100 percent owned by SCo, a 
Spanish company, which in turn is owned 49 percent by PCo, a 
Spanish publicly-traded company, and 51 percent by XCo, a 
publicly-traded company that is resident in Country X. In the 
absence of a special rule for interpreting the derivative 
benefits provision, each of PCo and XCo would be treated as 
owning only their proportionate share of the shares held by SCo 
in USCo. If that rule were applied in this situation, neither 
PCo nor XCo would be an equivalent beneficiary, because neither 
would meet the 80 percent ownership test with respect to USCo. 
However, since both PCo and XCo are residents of countries that 
have treaties with the United States that provide for 
elimination of withholding tax on inter-company dividends, it 
is appropriate to provide benefits to SCo in this case.
    Accordingly, the definition of ``equivalent beneficiary'' 
includes a rule of application that is intended to ensure that 
such joint ventures qualify for the benefits of paragraph 3. 
Under that rule, each of the shareholders is treated as owning 
shares of USCo with the same percentage of voting power as the 
shares held by SCo for purposes of determining whether it would 
be entitled to an equivalent rate of withholding tax. This rule 
is necessary because of the high ownership threshold for 
qualification for the elimination of withholding tax on inter-
company dividends.
    If a company does not qualify for the elimination of 
withholding tax under any of the foregoing objective tests, it 
may request a determination from the relevant competent 
authority pursuant to paragraph 7 of Article 17.

Paragraph 4 of New Article 10

    Paragraph 4 of new Article 10 provides that dividends 
beneficially owned by a pension fund may not be taxed in the 
Contracting State of which the company paying the tax is a 
resident, unless such dividends are derived from the carrying 
on of a business, directly or indirectly, by the pension fund 
or through an associated enterprise. For purposes of 
application of this paragraph by the United States, the term 
``trade or business'' shall be defined in accordance with Code 
section 513(c). The term ``pension fund'' is defined in 
subparagraph 1(j) of Article 3 (General Definitions) of the 
Convention, as amended by Article II of the Protocol.

Paragraph 5 of New Article 10

    Paragraph 5 of new Article 10 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 state of 
source, as well as arrangements that might be developed in the 
future.
    The term includes income from shares, ``jouissance'' shares 
or ``jouissance'' rights, mining shares, founders' shares or 
other 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 State of 
source, including amounts treated as dividend equivalents under 
Code section 871(m). Thus, 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 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, which is taxed as a corporation under U.S. law, is 
a dividend for purposes of Article 10. However, a distribution 
by a limited liability company is not taxable by the United 
States under Article 10, provided the limited liability company 
is not characterized as an association taxable as a corporation 
under U.S. law. Paragraph 5 also clarifies that the term 
``dividends'' does not include distributions that are treated 
as gain under the laws of the State of which the company making 
the distribution is a resident. In such case, the provisions of 
Article 13 (Gains) shall apply (for example, the United States 
shall apply Code Section 897(h) and the regulations 
thereunder).
    Finally, 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.

Paragraph 6 of New Article 10

    Paragraph 6 of new Article 10 provides a rule for taxing 
dividends paid with respect to holdings that form part of the 
business property of a permanent establishment or fixed base. 
In such case, the rules of Article 7 (Business Profits) shall 
apply. Accordingly, the dividends 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 or 
fixed base is located, as such rules may be modified by the 
Convention. An example of dividends paid with respect to the 
business property of a permanent establishment would be 
dividends derived by a dealer in stock or securities from stock 
or securities that the dealer held for sale to customers.

Paragraph 7 of New Article 10

    The right of a Contracting State to tax dividends paid by a 
company that is a resident of the other Contracting State is 
restricted by paragraph 7 of new Article 10 to cases in which 
the dividends are paid to a resident of that Contracting State 
or are effectively connected to a permanent establishment in 
that Contracting State. Thus, a Contracting State may not 
impose a ``secondary'' withholding tax on dividends paid by a 
nonresident company out of earnings and profits from that 
Contracting State.
    The paragraph also restricts the right of a Contracting 
State to impose corporate level taxes on undistributed profits, 
other than a branch profits tax. The paragraph does not 
restrict a State's right to tax its resident shareholders on 
undistributed earnings of a corporation resident in the other 
State. Thus, the authority of the United States to impose taxes 
on subpart F income and on earnings deemed invested in U.S. 
property, and its tax on income of a passive foreign investment 
company that is a qualified electing fund is in no way 
restricted by this provision.

Paragraph 8 of New Article 10

    Paragraph 8 of new Article 10 permits a Contracting State 
to impose a branch profits tax on a company resident in the 
other Contracting State. The tax is in addition to other taxes 
permitted by the Convention. The term ``company'' is defined in 
subparagraph 1(e) of Article 3 (General Definitions) of the 
Convention.
    A Contracting State may impose a branch profits tax on a 
company if the company has income attributable to a permanent 
establishment in that Contracting State, derives income from 
real property (immovable property) in that Contracting State 
that is taxed on a net basis under Article 6 (Income from Real 
Property (Immovable Property)), or realizes gains taxable in 
that State under paragraph 1 of Article 13 (Capital Gains). In 
the case of the United States, the imposition of such tax is 
limited, however, to the portion of the aforementioned items of 
income that represents the amount of such income that is the 
``dividend equivalent amount.'' The dividend equivalent amount 
for any year approximates the dividend that a U.S. branch 
office would have paid during the year if the branch had been 
operated as a separate U.S. subsidiary company. This is 
consistent with the relevant rules under the U.S. branch 
profits tax, and the term dividend equivalent amount is defined 
under U.S. law. Section 884 defines the dividend equivalent 
amount as an amount for a particular year that is equivalent to 
the income described above that is included in the 
corporation's effectively connected earnings and profits for 
that year, after payment of the corporate tax under Articles 6, 
7 (Business Profits) or 13, reduced for any increase in the 
branch's U.S. net equity during the year or increased for any 
reduction in its U.S. net equity during the year. U.S. net 
equity is U.S. assets less U.S. liabilities. See Treas. Reg. 
1.884-1. The amount analogous to the dividend equivalent amount 
in the case of Spain is the amount of income (Imposicion 
Complementaria) determined under the Spanish Non Residents 
Income Tax regulated by the Amended Text of Non Residents 
Income Tax Law, passed by Legislative Royal Decree 5/2004 of 
5th March, as it may be amended from time to time.
    As discussed in the Technical Explanation to paragraph 2 of 
Article 1 (General Scope), consistency principles prohibit a 
taxpayer from applying provisions of the Code and this 
Convention in an inconsistent manner in order to minimize tax. 
In the context of the branch profits tax, this consistency 
requirement means that if a company resident in Spain uses the 
principles of Article 7 to determine its U.S. taxable income, 
it must then also use those principles to determine its 
dividend equivalent amount. Similarly, if the company instead 
uses the Code to determine its U.S. taxable income it must also 
use the Code to determine its dividend equivalent amount. As in 
the case of Article 7, if a Spanish company, for example, does 
not from year to year consistently apply the Code or the 
Convention to determine its dividend equivalent amount, then 
the company must make appropriate adjustments or recapture 
amounts that would otherwise be subject to U.S. branch profits 
tax if it had consistently applied the Code or the Convention 
to determine its dividend equivalent amount from year to year.

Paragraph 9 of New Article 10

    Paragraph 9 of new Article 10 limits the rate of the branch 
profits tax that may be imposed under paragraph 8 to 5 percent, 
as provided in subparagraph 2(a) of Article 10. Paragraph 9 
also provides that the branch profits tax shall not be imposed 
on a company in any case if certain requirements are met. In 
general, these requirements provide rules for a branch that 
parallel the rules for when a dividend paid by a subsidiary 
will be subject to exclusive residence-country taxation (i.e., 
the elimination of source-country withholding tax). 
Accordingly, the branch profits tax cannot be imposed in the 
case of a company that satisfies any of the following 
requirements set forth in Article 17 (Limitation on Benefits) 
as revised by Article IX: (1) the ``publicly traded'' test of 
subparagraph 2(c); (2) both the ``ownership-base erosion'' and 
``active trade or business'' tests described in subparagraph 
2(e) and paragraph 4; (3) the ``derivative benefits'' test of 
paragraph 3; or (4) paragraph 7. If the company did not meet 
any of those tests, but otherwise qualified for benefits under 
Article 17, then the branch profits tax would apply at a rate 
of 5 percent as provided in subparagraph 2(a).
    Paragraph 9 applies equally if a taxpayer determines its 
taxable income under the laws of a Contracting State or under 
the provisions of Article 7 (Business Profits). For example, as 
discussed above, consistency principles require a company 
resident in Spain that determines its U.S. taxable income under 
the Code to also determine its dividend equivalent amount under 
the Code. In that case, the withholding rate reduction provided 
in subparagraph 2(a) would apply even though the company did 
not determine its dividend equivalent amount using the 
principles of Article 7.

                               ARTICLE V

    Article V of the Protocol replaces Article 11 (Interest) of 
the existing Convention. New Article 11 specifies the taxing 
jurisdictions over interest income of the States of source and 
residence and defines the terms necessary to apply the Article.

Paragraph 1 of New Article 11

    Paragraph 1 of new Article 11 generally grants to the State 
of residence the exclusive right to tax interest beneficially 
owned by its residents and arising in the other Contracting 
State.
    The term ``beneficial owner'' is not defined in the 
Convention, and is, therefore, defined under the domestic law 
of the State of source. The beneficial owner of the interest 
for purposes of Article 11 is the person to which the income is 
attributable under the laws of the source State. Thus, if 
interest arising in a Contracting State is received by a 
nominee or agent that is a resident of the other State on 
behalf of a person that is not a resident of that other State, 
the interest is not entitled to the benefits of Article 11. 
However, interest received by a nominee on behalf of a resident 
of that other State would be entitled to benefits. These 
limitations are confirmed by paragraph 9 of the OECD Commentary 
to Article 11.
    Special rules apply to interest derived through fiscally 
transparent entities for purposes of determining the beneficial 
owner of the interest. In such cases, residence State 
principles shall be used to determine who derives the interest, 
to assure that the interest 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.
    For example, assume that FCo, a company that is a resident 
of Spain, owns a 50 percent interest in FP, a partnership that 
is organized in Spain. FP receives interest arising in the 
United States. Spain views FP as fiscally transparent under its 
domestic law, and taxes FCo currently on its distributive share 
of the income of FP and determines the character and source of 
the income received through FP in the hands of FCo as if such 
income were realized directly by FCo. In this case, FCo is 
treated as deriving 50 percent of the interest received by FP 
that arises in the United States under paragraph 6 of Article 
1. The same result would be reached even if the tax laws of the 
United States would treat FP differently (e.g., if FP were not 
treated as fiscally transparent in the United States), or if FP 
were organized in a third state, provided such state has an 
agreement in force containing a provision for the exchange of 
information on tax matters with Spain, which in this example is 
the Contracting State from which the interest arises, and as 
long as FP were still treated as fiscally transparent under the 
laws of the United States.
    While residence State principles control who is treated as 
deriving the interest, source State principles of beneficial 
ownership apply to determine whether the person who derives the 
interest, or another resident of the other Contracting State, 
is the beneficial owner of the interest. If the person who 
derives the interest under paragraph 6 of Article 1 would not 
be treated as a nominee, agent, custodian, conduit, etc. under 
the source State's principles for determining beneficial 
ownership, that person will be treated as the beneficial owner 
of the interest for purposes of the Convention. In the example 
above, FCo is required to satisfy the beneficial ownership 
principles of the United States with respect to the interest it 
derives. If under the beneficial ownership principles of the 
United States, FCo is found not to be the beneficial owner of 
the interest, FCo will not be entitled to the benefits of 
Article 11 with respect to such interest. If FCo is found to be 
a nominee, agent, custodian, or conduit for a person who is a 
resident of the other Contracting State, that person may be 
entitled to benefits with respect to the interest.

Paragraph 2 of New Article 11

    Paragraph 2 of new Article 11 provides anti-abuse 
exceptions to the source-country exemption in paragraph 1 for 
two classes of interest payments arising in the United States.
    The first class of interest, dealt with in subparagraph 
2(a) is so-called ``contingent interest'' that does not qualify 
as portfolio interest under U.S. domestic law as defined in 
Code section 871(h)(4). The exceptions of section 871(h)(4)(c) 
will be applicable. If the beneficial owner of the contingent 
interest is a resident of Spain, subparagraph 2(a) provides 
that the gross amount of the interest may be taxed at a rate 
not exceeding 10 percent.
    The second class of interest is dealt with in subparagraph 
2(b). 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.

Paragraph 3 of New Article 11

    Paragraph 3 of new Article 11 provides a definition of the 
term ``interest'' for purposes of the Article that is 
essentially identical to that provided in paragraph 4 of 
Article 11 of the existing Convention. The term ``interest'' as 
used in Article 11 is defined in paragraph 3 to include, inter 
alia, income from debt claims of every kind, whether or not 
secured by a mortgage and whether or not carrying a right to 
participate in the debtor's profits. The term does not, 
however, include amounts that are treated as dividends under 
Article 10 (Dividends), nor does it include penalty charges for 
late payment.
    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 
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 recharacterized as loans because of a 
``substantial non-periodic payment.''

Paragraph 4 of New Article 11

    Paragraph 4 of new Article 11 is identical in substance to 
paragraph 5 of Article 11 of the existing Convention. Paragraph 
4 provides an exception to the exclusive residence taxation 
rule of paragraph 1 and the source State gross taxation rule of 
paragraph 2 in cases where the beneficial owner of the interest 
carries on or has carried on business through a permanent 
establishment situated in that State, or performs or has 
performed independent personal services through a fixed base 
situated in that state, and the debt-claim in respect of which 
the interest is paid is effectively connected with such 
permanent establishment or fixed base. In such cases the 
provisions of Article 7 (Business Profits) or Article 15 
(Independent Personal Servicers), as the case may be, will 
apply and the State of source will retain the right to impose 
tax on such interest income.
    In the case of a permanent establishment or fixed base that 
once existed in a Contracting State but no longer exists, the 
provisions of this paragraph shall apply to interest paid with 
respect to a debt-claim that would be effectively connected to 
such a permanent establishment or fixed base if it did exist in 
the year of payment or accrual. Accordingly, such interest 
would remain taxable under the provisions of Article 7 or 15, 
as the case may be, and not under this Article.

Paragraph 5 of New Article 11

    Paragraph 5 of new Article 11 provides a source rule for 
interest that is identical in substance to the interest source 
rule of the existing Convention. Interest is considered to 
arise in a Contracting State if paid by a resident of that 
State. However, interest that is borne by a permanent 
establishment or fixed base in one of the Contracting States is 
considered to arise in that State. For this purpose, interest 
is considered to be borne by a permanent establishment or fixed 
base if it is allocable to taxable income of that permanent 
establishment or fixed base. If the actual amount of interest 
on the books of a U.S. branch of a resident of Spain exceeds 
the amount of interest allocated to the branch under Treas. 
Reg. 1.882-5, the amount of such excess will not be considered 
U.S. source interest for purposes of this Article.

Paragraph 6 of New Article 11

    Paragraph 6 of new Article 11 is identical to paragraph 7 
of Article 11 of the existing Convention. Paragraph 5 provides 
that in cases involving special relationships between the payor 
and the beneficial owner of interest income, Article 11 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 the other Contracting State, respectively, with due regard 
to the other provisions of the Convention. Thus, if the excess 
amount would be treated under the source country's law as a 
distribution of profits by a corporation, such amount could be 
taxed as a dividend rather than as interest, but the tax would 
be subject, if appropriate, to the rate limitations of 
paragraph 2 of Article 10 (Dividends).
    The term ``special relationship'' is not defined in the 
Convention. In applying this paragraph the United States 
considers the term to include the relationships described in 
Article 9, which in turn corresponds to the definition of 
``control'' for purposes of Code section 482.
    This paragraph does not address cases where, owing to a 
special relationship between the payer and the beneficial owner 
or between both of them and some other person, the amount of 
the interest is less than an arm's-length amount. In those 
cases a transaction may be characterized to reflect its 
substance and interest may be imputed consistent with the 
definition of ``interest'' in paragraph 3. The United States 
would apply Code section 482 or 7872 to determine the amount of 
imputed interest in those cases.
            Relation to Other Articles
    Notwithstanding the foregoing limitations on source country 
taxation of interest, the saving clause of subparagraph 3 of 
Article 1 (General Scope) permits the United States to tax its 
residents and citizens, subject to the special foreign tax 
credit rules of paragraph 3 of Article 24 (Relief from Double 
Taxation), as if the Convention had not come into force.
    The benefits of this Article are also subject to the 
provisions of Article 17 (Limitation on Benefits). Thus, if a 
resident of Spain is the beneficial owner of interest paid by a 
U.S. corporation, the resident must qualify for treaty benefits 
under at least one of the tests of Article 17 in order to 
receive the benefits of this Article.

                               ARTICLE VI

    Article VI of the Protocol replaces Article 12 (Royalties) 
of the existing Convention. New Article 12 provides rules for 
the taxation of royalties arising in one Contracting State and 
paid to a beneficial owner that is a resident of the other 
Contracting State.

Paragraph 1 of New Article 12

    Paragraph 1 of new Article 12 generally grants to the State 
of residence the exclusive right to tax royalties beneficially 
owned by its residents and arising in the other Contracting 
State.
    The term ``beneficial owner'' is not defined in the 
Convention, and is, therefore, defined under the domestic law 
of the State of source. The beneficial owner of the royalties 
for purposes of Article 12 is the person to which the income is 
attributable under the laws of the source State. Thus, if 
royalties arising in a Contracting State are received by a 
nominee or agent that is a resident of the other State on 
behalf of a person that is not a resident of that other State, 
the royalties are not entitled to the benefits of Article 12. 
However, the royalties received by a nominee on behalf of a 
resident of that other State would be entitled to benefits. 
These limitations are confirmed by paragraph 4 of the OECD 
Commentary to Article 12.
    Special rules apply to royalties derived through fiscally 
transparent entities for purposes of determining the beneficial 
owner of the royalties. In such cases, residence State 
principles shall be used to determine who derives the 
royalties, to assure that the royalties 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.For example, assume that FCo, a company that is a 
resident of Spain, owns a 50 percent interest in FP, a 
partnership that is organized in Spain. FP receives royalties 
arising in the United States. Spain views FP as fiscally 
transparent under its domestic law, and taxes FCo currently on 
its distributive share of the income of FP and determines the 
character and source of the income received through FP in the 
hands of FCo as if such income were realized directly by FCo. 
In this case, FCo is treated as deriving 50 percent of the 
royalties received by FP that arise in the United States under 
paragraph 6 of Article 1. The same result would be reached even 
if the tax laws of the United States would treat FP differently 
(e.g., if FP were not treated as fiscally transparent in the 
United States), or if FP were organized in a third state, 
provided that that state has an agreement in force containing a 
provision for the exchange of information on tax matters with 
Spain, which in this example is the the Contracting State from 
which the royalty arises, and as long as FP were still treated 
as fiscally transparent under the laws of the United States.
    While residence State principles control who is treated as 
deriving the royalties, source State principles of beneficial 
ownership apply to determine whether the person who derives the 
royalties, or another resident of Spain, is the beneficial 
owner of the royalties. If the person who derives the royalties 
under paragraph 6 of Article 1 would not be treated as a 
nominee, agent, custodian, conduit, etc. under the source 
State's principles for determining beneficial ownership, that 
person will be treated as the beneficial owner of the royalties 
for purposes of the Convention. In the example above, FCo is 
required to satisfy the beneficial ownership principles of the 
United States with respect to the royalties it derives. If 
under the beneficial ownership principles of the United States, 
FCo is found not to be the beneficial owner of the royalties, 
FCo will not be entitled to the benefits of Article 12 with 
respect to such royalties. If FCo is found to be a nominee, 
agent, custodian, or conduit for a person who is a resident of 
Spain, that person may be entitled to benefits with respect to 
the royalties.

Paragraph 2 of New Article 12

    Paragraph 2 of new Article 12 defines the term 
``royalties,'' as used in Article 12, to include any 
consideration for the use of, or the right to use, any 
copyright of literary, artistic scientific or other work 
(including cinematographic films, and films and recordings for 
radio or television broadcasting), any patent, trademark, 
design or model, plan, secret formula or process, or for 
information concerning industrial, commercial, or scientific 
experience. The term ``royalties'' does not include income from 
leasing personal property.
    The term royalties is defined in the Convention and 
therefore is generally independent of domestic law. Certain 
terms used in the definition are not defined in the Convention, 
but these may be defined under domestic tax law. For example, 
the term ``secret process or formula'' is found in the Code, 
and its meaning has been elaborated in the context of sections 
351 and 367. See Rev. Rul. 55-17, 1955-1 C.B. 388; Rev. Rul. 
64-56, 1964-1 C.B. 133; Rev. Proc. 69- 19, 1969-2 C.B. 301.
    Consideration for the use or right to use cinematographic 
films, or works on film, tape, or other means of reproduction 
in radio or television broadcasting is specifically included in 
the definition of royalties. It is intended that, with respect 
to any subsequent technological advances in the field of radio 
or television broadcasting, consideration received for the use 
of such technology will also be included in the definition of 
royalties.
    If an artist who is resident in one Contracting State 
records a performance in the other Contracting State, retains a 
copyrighted interest in a recording, and receives payments for 
the right to use the recording based on the sale or public 
playing of the recording, then the right of such other 
Contracting State to tax those payments is governed by Article 
12. See Boulez v. Commissioner, 83 T.C. 584 (1984), aff'd, 810 
F.2d 209 (D.C. Cir. 1986). By contrast, if the artist earns in 
the other Contracting State income covered by Article 19 
(Artistes and Athletes), for example, endorsement income from 
the artist's attendance at a film screening, and if such income 
also is attributable to one of the rights described in Article 
12 (e.g., the use of the artist's photograph in promoting the 
screening), Article 19 and not Article 12 is applicable to such 
income.
    Computer software generally is protected by copyright laws 
around the world. Under the Convention, consideration received 
for the use, or the right to use, computer software is treated 
either as royalties or as business profits, depending on the 
facts and circumstances of the transaction giving rise to the 
payment.
    The primary factor in determining whether consideration 
received for the use, or the right to use, computer software is 
treated as royalties or as business profits is the nature of 
the rights transferred. See Treas. Reg. 1.861-18. The fact that 
the transaction is characterized as a license for copyright law 
purposes is not dispositive. For example, a typical retail sale 
of ``shrink wrap'' software generally will not be considered to 
give rise to royalty income, even though for copyright law 
purposes it may be characterized as a license.
    The means by which the computer software is transferred are 
not relevant for purposes of the analysis. Consequently, if 
software is electronically transferred but the rights obtained 
by the transferee are substantially equivalent to rights in a 
program copy, the payment will be considered business profits.
    The term ``industrial, commercial, or scientific 
experience'' (sometimes referred to as ``know-how'') has the 
meaning ascribed to it in paragraph 11 et seq. of the 
Commentary to Article 12 of the OECD Model. Consistent with 
that meaning, the term may include information that is 
ancillary to a right otherwise giving rise to royalties, such 
as a patent or secret process.
    Know-how also may include, in limited cases, technical 
information that is conveyed through technical or consultancy 
services. It does not include general educational training of 
the user's employees, nor does it include information developed 
especially for the user, such as a technical plan or design 
developed according to the user's specifications. Thus, as 
provided in paragraph 11.3 of the Commentary to Article 12 of 
the OECD Model, the term ``royalties'' does not include 
payments received as consideration for after-sales service, for 
services rendered by a seller to a purchaser under a warranty, 
or for pure technical assistance.
    The term ``royalties'' also does not include payments for 
professional services (such as architectural, engineering, 
legal, managerial, medical or software development services). 
For example, income from the design of a refinery by an 
engineer (even if the engineer employed know-how in the process 
of rendering the design) or the production of a legal brief by 
a lawyer is not income from the transfer of know-how taxable 
under Article 12, but is income from services taxable under 
either Article 15 (Independent Personal Services) or Article 16 
(Dependent Personal Services) as applicable. Professional 
services may be embodied in property that gives rise to 
royalties, however. Thus, if a professional contracts to 
develop patentable property and retains rights in the resulting 
property under the development contract, subsequent license 
payments made for those rights would be royalties.

Paragraph 3 of New Article 12

    This paragraph provides an exception to the rule of 
paragraph 1 that gives the State of residence exclusive taxing 
jurisdiction in cases where the beneficial owner of the 
royalties carries on or has carried on a business through a 
permanent establishment or performs or has performed personal 
services from a fixed base in the state of source and the right 
or property in respect of which the royalties are paid is 
effectively connected with that permanent establishment or 
fixed base. In such cases the provisions of Article 7 (Business 
Profits) or Article 15 (Independent Personal Services) will 
apply.
    In the case of a permanent establishment that once existed 
in a Contracting State but that no longer exists, the 
provisions of this paragraph also apply to royalties paid with 
respect to rights or property that would be effectively 
connected to such permanent establishment if it did exist in 
the year of payment or accrual. Accordingly, such royalties 
would remain taxable under the provisions of Article 7, and not 
under this Article.

Paragraph 4 of New Article 12

    Paragraph 4 of new Article 12 provides that in cases 
involving special relation-ships between the payor and 
beneficial owner of royalties, Article 12 applies only to the 
extent the royalties would have been paid absent such special 
relationships (i.e., an arm's-length royalty). Any excess 
amount of royalties paid remains taxable according to the laws 
of the two Contracting States, with due regard to the other 
provisions of the Convention. If, for example, the excess 
amount is treated as a distribution of corporate profits under 
domestic law, such excess amount will be taxed as a dividend 
rather than as royalties, but the tax imposed on the dividend 
payment will be subject to the rate limitations of paragraph 2 
of Article 10 (Dividends).
            Relationship to Other Articles
    Notwithstanding the foregoing limitations on source country 
taxation of royalties, the saving clause of paragraph 3 of 
Article 1 (General Scope) permits the United States to tax its 
residents and citizens, subject to the special foreign tax 
credit rules of paragraph 3 of Article 24 (Relief from Double 
Taxation), as if the Convention had not come into force.
    As with other benefits of the Convention, the benefits of 
exclusive residence State taxation of royalties under paragraph 
1 of Article 12 are available to a resident of the other State 
only if that resident is entitled to those benefits under 
Article 17 (Limitation on Benefits).

                              ARTICLE VII

    Article VII of the Protocol makes amendments to Article 13 
(Capital Gains) of the existing Convention.

Paragraph 1

    Paragraph 1 of Article VII replaces paragraph 4 of existing 
Article 13. Because of the deletion of paragraph 4 of the 
existing Article, gains from the alienation of stock, 
participations or other rights in the capital of a company 
shall be taxed in accordance with the general rules of the 
Article. Revised paragraph 4 reflects Spain's prevailing tax 
treaty policy. Under the paragraph, a Contracting State may tax 
the gain from the alienation of shares of other rights, which 
directly or indirectly entitled the owner of such shares or 
rights to the enjoyment of immovable property situated in such 
Contracting State.

Paragraph 2

    Paragraph 2 replaces paragraphs 6 and 7 of Article 13 of 
the existing Convention. New paragraph 6 of revised Article 13 
provides that gains from the alienation of any property other 
than property referred to in paragraph 1 through 5 will be 
taxable only in the state of residence of the person alienating 
the property.

                              ARTICLE VIII

    In a conforming change to the restatement of Article 10 
(Dividends) of the existing Convention under Article IV of the 
Protocol, Article VIII of the Protocol deletes Article 14 
(Branch Tax) of the existing Convention.

                               ARTICLE IX

    Article IX of the Protocol replaces Article 17 (Limitation 
on Benefits) of the existing Convention. New Article 17 
contains anti-treaty-shopping provisions that are intended to 
prevent residents of third countries from benefiting from what 
is intended to be a reciprocal agreement between two countries. 
In general, the provision does not rely on a determination of 
purpose or intention but instead sets forth a series of 
objective tests. A resident of a Contracting State that 
satisfies one of the tests will receive benefits regardless of 
its motivations in choosing its particular business structure.
    The structure of the revised Article is as follows: 
Paragraph 1 states the general rule that residents are entitled 
to benefits otherwise accorded to residents only to the extent 
provided in the Article. Paragraph 2 lists a series of 
attributes of a resident of a Contracting State, the presence 
of any one of which will entitle that person to all the 
benefits of the Convention. Paragraph 3 provides a derivative 
benefits rule. Paragraph 4 provides that, regardless of whether 
a person qualifies for benefits under paragraph 2, benefits may 
be granted to that person with regard to certain income earned 
in the conduct of an active trade or business. Paragraph 5 
provides a test for headquarters companies. Paragraph 6 
provides a special rule for so-called ``triangular cases'' 
notwithstanding the other provisions of new Article 17. 
Paragraph 7 sets forth rules for the competent authorities of 
the Contracting States to apply to determine if a resident 
which cannot satisfy any of the tests in paragraphs 2, 3, 4 or 
5 should nevertheless be entitled to a benefits provided in the 
Convention. Paragraph 8 defines certain terms used in the 
Article.

Paragraph 1 of New Article 17

    Paragraph 1 of new Article 17 provides that a resident of a 
Contracting State will be entitled to the benefits otherwise 
accorded to residents of a Contracting State under the 
Convention only to the extent provided in the Article. The 
benefits otherwise accorded to residents under the Convention 
include all limitations on source-based taxation under Articles 
6 (Income from Real Property (Immovable Property) through 16 
(Dependent Personal Services) and 18 (Director's Fees) through 
23 (Other Income), the treaty-based relief from double taxation 
provided by Article 24 (Relief from Double Taxation), and the 
protection afforded to residents of a Contracting State under 
Article 25 (Non-Discrimination). Some provisions do not require 
that a person be a resident in order to enjoy the benefits of 
those provisions. For example, Article 26 (Mutual Agreement 
Procedure) is not limited to residents of the Contracting 
States, and Article 28 (Diplomatic Agents and Consular 
Officers) applies to diplomatic agents or consular officials 
regardless of residence. Article 17 accordingly does not limit 
the availability of treaty benefits under these provisions.
    Article 17 and the anti-abuse provisions of domestic law 
complement each other, as Article 17 effectively determines 
whether an entity has a sufficient nexus to the Contracting 
State to be treated as a resident for treaty purposes, while 
domestic anti-abuse provisions (e.g., business purpose, 
substance-over-form, step transaction or conduit principles) 
determine whether a particular transaction should be recast in 
accordance with its substance. Thus, domestic law principles of 
the source Contracting State may be applied to identify the 
beneficial owner of an item of income, and Article 17 then will 
be applied to the beneficial owner to determine if that person 
is entitled to the benefits of the Convention with respect to 
such income.

Paragraph 2 of New Article 17

    Paragraph 2 of new Article 17 has five subparagraphs, each 
of which describes a category of residents that will be 
considered qualified persons.
    It is intended that the provisions of paragraph 2 will be 
self-executing. Unlike the provisions of paragraph 7 of the new 
Article, discussed below, claiming benefits under paragraph 2 
does not require advance competent authority ruling or 
approval. 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.
            Individuals--Subparagraph 2(a)
    Subparagraph 2(a) provides that individual residents of a 
Contracting State will be considered qualified persons. If such 
an individual receives income as a nominee on behalf of a third 
country resident, benefits may be denied under the applicable 
Articles of the Convention by the requirement that the 
beneficial owner of the income be a resident of a Contracting 
State.
            Governments--Subparagraph 2(b)
    Subparagraph 2(b) provides that the Contracting States and 
any political subdivision or local authority or wholly-owned 
instrumentality thereof will be considered qualified persons.
            Publicly-Traded Corporations--Subparagraph 2(c)(i)
    Subparagraph 2(c) applies to two categories of companies: 
publicly traded companies and subsidiaries of publicly traded 
companies. A company resident in a Contracting State will be 
considered a qualified person under clause (i) of subparagraph 
(c) if the principal class of its shares, and any 
disproportionate class of shares, is regularly traded on one or 
more recognized stock exchanges and the company satisfies at 
least one of the following additional requirements. First, 
under clause A) in the case of a company resident in Spain, the 
company's principal class of shares must be primarily traded on 
one or more recognized stock exchanges located either in Spain 
or within the European Union, and in the case of a company 
resident in the United States, the company's principal class or 
shares must be primarily traded on a recognized stock exchange 
located either in the United States or in another state that is 
a party to the North American Free Trade Agreement. If the 
company's principal class of shares does not satisfy the 
trading requirement set forth in clause A), clause B) provides 
that the regularly-traded company can nevertheless satisfy the 
requirements of clause (i) if the company's primary place of 
management and control is in its State of residence.
    The term ``recognized stock exchange'' is defined in 
subparagraph 8(a) of revised Article 17. It includes (i) any 
stock exchange registered with the Securities and Exchange 
Commission as a national securities exchange for purposes of 
the Securities Exchange Act of 1934; (ii) any Spanish stock 
exchange controlled by the Comision Nacional del Mercado de 
Valores; (iii) the principal stock exchanges of Stuttgart, 
Hamburg, Dusseldorf, Frankfurt, Berlin, Hannover, Munich, 
London, Amsterdam, Milan, Budapest, Lisbon, Toronto, Mexico 
City and Buenos Aires, and (iv) any other stock exchange agreed 
upon by the competent authorities of the Contracting States.
    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''. Subparagraph 8(e) clarifies that the term 
``shares'' includes depository receipts thereof. The term 
``principal class of shares'' is defined in subparagraph 8(b) 
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 
shares, 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 be 
considered a qualified person 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 8(c). 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 
resident in Spain the other Contracting State 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.
    The following example illustrates this result.
    Example. OCo is a corporation resident in Spain. OCo has 
two classes of shares: Common and Preferred. The Common shares 
are listed and regularly traded on a Spanish stock exchange 
controlled by the Comision Nacional del Mercado de Valores. 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 regularly traded on a recognized stock exchange, OCo 
will not qualify for benefits under subparagraph (c) of 
paragraph 2.
    The term ``regularly traded'' is not defined in the 
Convention. In accordance with paragraph 2 of Article 3 
(General Definitions), this term will be defined by reference 
to the domestic tax laws of the State from which treaty 
benefits 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. 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 regular trading requirement can be met by trading on 
any recognized exchange or exchanges located in either State. 
Trading on one or more recognized stock exchanges 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 any recognized stock exchange. 
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 3 
(General Definitions), 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. 1.884-5(d)(3), 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 in the 
Contracting State of which the company is a resident exceeds 
the number of shares in the company's principal class of shares 
that are traded during that year on established securities 
markets in any other single foreign country.
    A company whose principal class of shares is regularly 
traded on a recognized exchange but cannot meet the primarily 
traded test may claim treaty benefits if its primary place of 
management and control is in its country of residence. This 
test is distinct from the ``place of effective management'' 
test which is used in the OECD Model and by many other 
countries to establish residence. In some cases, the place of 
effective management test has been interpreted to mean the 
place where the board of directors meets. By contrast, the 
primary place of management and control test looks to where 
day-to-day responsibility for the management of the company 
(and its subsidiaries) is exercised. The company's primary 
place of management and control will be located in the State in 
which the company is a resident only if the executive officers 
and senior management employees exercise day-to-day 
responsibility for more of the strategic, financial and 
operational policy decision making for the company (including 
direct and indirect subsidiaries) in that State than in the 
other State or any third state, and the staff that support the 
management in making those decisions are also based in that 
State. Thus, the test looks to the overall activities of the 
relevant persons to see where those activities are conducted. 
In most cases, it will be a necessary, but not a sufficient, 
condition that the headquarters of the company (that is, the 
place at which the CEO and other top executives normally are 
based) be located in the Contracting State of which the company 
is a resident.
    To apply the test, it will be necessary to determine which 
persons are to be considered ``executive officers and senior 
management employees''. In most cases, it will not be necessary 
to look beyond the executives who are members of the Board of 
Directors (the ``inside directors'') in the case of a U.S. 
company. That will not always be the case, however; in fact, 
the relevant persons may be employees of subsidiaries if those 
persons make the strategic, financial and operational policy 
decisions. Moreover, it would be necessary to take into account 
any special voting arrangements that result in certain board 
members making certain decisions without the participation of 
other board members.
            Subsidiaries of Publicly-Traded Corporations--Subparagraph 
                    2(c)(ii)
    A company resident in a Contracting State is entitled to 
all the benefits of the Convention under clause (ii) of 
subparagraph (c) of paragraph 2 if five or fewer publicly 
traded companies described in clause (i) are the direct or 
indirect owners of at least 50 percent of the aggregate vote 
and value of the company's shares (and at least 50 percent of 
any disproportionate class of shares). If the publicly-traded 
companies are indirect owners, however, each of the 
intermediate companies must be a resident of one of the 
Contracting States.
    Thus, for example, a company that is a resident of Spain, 
all the shares of which are owned by another company that is a 
resident of Spain, would qualify for benefits under 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 
in Spain (or within the European Union). However, such a 
subsidiary would not qualify for benefits under clause (ii) if 
the publicly traded parent company were a resident of a third 
state, for example, and not a resident of the United States or 
Spain. Furthermore, if a parent company in Spain indirectly 
owned the bottom-tier company through a chain of subsidiaries, 
each such subsidiary in the chain, as an intermediate owner, 
must be a resident of the United States or Spain in order for 
the subsidiary to meet the test in clause (ii).
            Tax Exempt Organizations--Subparagraph 2(d)
    Subparagraph 2(d) set forth a limitation on benefits rule 
for persons referred to in paragraph 4 of the Memorandum of 
Understanding, which provides that the United States and Spain 
follow the positions described in paragraph 8.6 of the 
Commentary to Article 4 (Resident) of the OECD Model. Under 
clause (i) of subparagraph 2(d), a tax-exempt organization 
other than a pension fund automatically shall be considered a 
qualified person without regard to the residence of its 
beneficiaries or members. Entities qualifying under this rule 
generally are those that are exempt from tax in their State of 
residence and that are organized and operated exclusively to 
fulfill religious, charitable, scientific, artistic, cultural, 
or educational purposes.
    Clause (ii) of paragraph 2(d), sets forth a rule to 
determine when pension funds described in subparagraph 1(j) of 
Article 3 (General Definitions) will be considered qualified 
persons. Clause (A) provides that pension funds described in 
clauses (i) and (ii)(A) of subparagraph 1(j) of Article 3 will 
be considered qualified persons if more than fifty percent of 
the beneficiaries, members or participants of the organization 
are individuals resident in either Contracting State. For 
purposes of this provision, the term ``beneficiaries'' should 
be understood to refer to the persons receiving benefits from 
the organization. Pension funds described in clause (ii)(B) of 
subparagraph 1(j) will be qualified persons if all of the 
persons for which such pension fund earns income satisfy the 
requirements of clause (A) of subparagraph 2(d).
            Ownership/Base Erosion--Subparagraph 2(e)
    Subparagraph 2(e) provides an additional method to qualify 
for treaty benefits that applies to any form of legal entity 
that is a resident of a Contracting State. The test provided in 
subparagraph (e), the so-called ownership and base erosion 
test, is a two-part test. Both prongs of the test must be 
satisfied for the resident to be entitled to treaty benefits 
under subparagraph 2(e).
    The ownership prong of the test, under clause (i), requires 
that 50 percent or more of each class of shares or other 
beneficial interests in the person is owned, directly or 
indirectly, on at least half the days of the person's taxable 
year by persons who are residents of the Contracting State of 
which that person is a resident and that are themselves 
entitled to treaty benefits under subparagraphs (a), (b), (d) 
or clause (i) of subparagraph (c) of paragraph 2. In the case 
of indirect owners, however, each of the intermediate owners 
must be a resident of that Contracting State.
    Trusts may be entitled to benefits under this provision if 
they are treated as residents under Article 4 (Residence) and 
they otherwise satisfy the requirements of this subparagraph. 
For purposes of this subparagraph, the beneficial interests in 
a trust will be considered to be owned by its beneficiaries in 
proportion to each beneficiary's actuarial interest in the 
trust. The interest of a remainder beneficiary will be equal to 
100 percent less the aggregate percentages held by income 
beneficiaries. A beneficiary's interest in a trust will not be 
considered to be owned by a person entitled to benefits under 
the other provisions of paragraph 2 if it is not possible to 
determine the beneficiary's actuarial interest. Consequently, 
if it is not possible to determine the actuarial interest of 
the beneficiaries in a trust, the ownership test under clause 
i) cannot be satisfied, unless all possible beneficiaries are 
persons entitled to benefits under the other subparagraphs of 
paragraph 2.
    The base erosion prong of clause (ii) of subparagraph (e) 
is satisfied with respect to a person if less than 50 percent 
of the person's gross income for the taxable year, as 
determined under the tax law in the person's State of 
residence, is paid or accrued to persons who are not residents 
of either Contracting State entitled to benefits under 
subparagraphs (a), (b), (d) or clause (i) of subparagraph (c) 
of paragraph 2, in the form of payments deductible for tax 
purposes in the payer's State of residence. These amounts do 
not include arm's-length payments in the ordinary course of 
business for services or tangible property or payments in 
respect of financial obligations to a bank that is not related 
to the payer. To the extent they are deductible from the 
taxable base, trust distributions are deductible payments. 
However, depreciation and amortization deductions, which do not 
represent payments or accruals to other persons, are 
disregarded for this purpose.

Paragraph 3 of New Article 17

    Paragraph 3 of new Article 17 sets forth a ``derivative 
benefits'' test that is potentially applicable to all treaty 
benefits, although the test is applied to individual items of 
income. In general, a derivative benefits test entitles certain 
companies that are residents of a Contracting State to treaty 
benefits if the owner of the company would have been entitled 
to the same benefit had the income in question flowed directly 
to that owner. To qualify under this paragraph, the company 
must meet an ownership test and a base erosion test.
    Subparagraph 3(a) sets forth the ownership test. Under this 
test, seven or fewer equivalent beneficiaries must own shares 
representing at least 95 percent of the aggregate voting power 
and value of the company and at least 50 percent of any 
disproportionate class of shares. Ownership may be direct or 
indirect, although in the case of indirect ownership, each 
intermediate owner must be a resident of a member state of the 
European Union or any party to the North American Free Trade 
Agreement.
    The term ``equivalent beneficiary'' is defined in 
subparagraph 8(g). This definition may be met in two 
alternative ways.
    Under the first alternative, a person may be an equivalent 
beneficiary because it is entitled to equivalent benefits under 
a tax treaty between the country of source and the country in 
which the person is a resident. This alternative has two 
requirements.
    The first requirement as set forth in clause (i) of 
subparagraph 8(g) is that the person must be a resident of a 
member state of the European Union or of a party to the North 
American Free Trade Agreement (collectively, ``qualifying 
States''). In addition, the person must be entitled to all the 
benefits of a comprehensive tax treaty between the Contracting 
State from which benefits of the Convention are claimed and a 
qualifying state under provisions that are analogous to the 
rules in subparagraphs 2(a), 2(b), 2(c)(i), or 2(d) of this 
Article. If the treaty in question does not have a 
comprehensive limitation on benefits article, this requirement 
is met only if the person would be entitled to treaty benefits 
under the tests in subparagraphs 2(a), 2(b), 2(c)(i), or 2(d) 
of this Article if the person were a resident of one of the 
Contracting States.
    Clause (i)(B) of subparagraph 8(g) requires that with 
respect to insurance premiums, dividends (including branch 
profits), interest, and royalties, the person must be entitled 
to a rate of tax that is at least as low as the tax rate that 
would apply under the Convention to such income. Thus, the 
rates to be compared are: (1) the rate of tax that the source 
State would have imposed if a qualified resident of the other 
Contracting State was the beneficial owner of the income; and 
(2) the rate of tax that the source State would have imposed if 
the third state resident had received the income directly from 
the source State.
    Subparagraph 8(g) provides a special rule to take account 
of the fact that withholding taxes on many inter-company 
dividends, interest and royalties are exempt within the 
European Union by reason of various EU directives, rather than 
by tax treaty. If a U.S. company is owned by a company resident 
in a member state of the European Union that would have 
qualified for an exemption from withholding tax if it had 
received the income directly and receives such payments from a 
Spanish company, the parent company will be treated as an 
equivalent beneficiary. This rule is necessary because many 
European Union member countries have not re-negotiated their 
tax treaties to reflect the exemptions available under the 
directives.
    The requirement that a person be entitled to ``all the 
benefits'' of a comprehensive tax treaty eliminates those 
persons that qualify for benefits with respect to only certain 
types of income. Accordingly, the fact that a French parent of 
a Spanish company is engaged in the active conduct of a trade 
or business in France and therefore would be entitled to the 
benefits of the U.S.-France treaty if it received dividends 
directly from a U.S. subsidiary of the Spanish company will not 
qualify such French company as an equivalent beneficiary. 
Further, the French company cannot be an equivalent beneficiary 
if it qualifies for benefits only with respect to certain 
income as a result of a ``derivative benefits'' provision in 
the U.S.-France treaty. However, because such French company is 
a resident of a qualifying state, it would be possible to look 
through the French company to its parent company to determine 
whether the parent company is an equivalent beneficiary.
    The second alternative for satisfying the ``equivalent 
beneficiary'' test is available only to residents of one of the 
two Contracting States. U.S. or Spanish residents who are 
eligible for treaty benefits by reason of subparagraphs 2(a), 
2(b), 2(c)(i), or 2(d) are equivalent beneficiaries for 
purposes of the relevant tests in this Article. Thus, a Spanish 
individual will be an equivalent beneficiary without regard to 
whether the individual would have been entitled to receive the 
same benefits if it received the income directly. A resident of 
a third country cannot qualify for treaty benefits under these 
provisions by reason of those paragraphs or any other rule of 
the treaty, and therefore does not qualify as an equivalent 
beneficiary under this alternative. Thus, a resident of a third 
country can be an equivalent beneficiary only if it would have 
been entitled to equivalent benefits had it received the income 
directly.
    The second alternative was included in order to clarify 
that ownership by certain residents of a Contracting State 
would not disqualify a U.S. or Spanish company under this 
paragraph. Thus, for example, if 90 percent of a Spanish 
company is owned by five companies that are resident in member 
states of the European Union who satisfy the requirements of 
subparagraph 8(g)(i), and 10 percent of the Spanish company is 
owned by a U.S. or Spanish individual, then the Spanish company 
still can satisfy the requirements of subparagraph 3(a).
    Subparagraph 3(b) sets forth the base erosion test. A 
company meets this base erosion test if less than 50 percent of 
its gross income (as determined in the company's State of 
residence) for the taxable period is paid or accrued, directly 
or indirectly, to a person or persons who are not equivalent 
beneficiaries in the form of payments deductible for tax 
purposes in company's State of residence. These deductible 
payments do not include arm's-length payments in the ordinary 
course of business for services or tangible property or 
payments in respect of financial obligations to a bank that is 
not related to the payor. This test is qualitatively the same 
as the base erosion test in subparagraph 2(e)(ii), except that 
the test in paragraph 3(b) focuses on base-eroding payments to 
persons who are not equivalent beneficiaries.

Paragraph 4 of New Article 17

    Paragraph 4 of new Article 17 sets forth an alternative 
test under which a resident of a Contracting State may receive 
treaty benefits with respect to certain items of income that 
are connected to an active trade or business conducted in its 
State of residence. A resident of a Contracting State may 
qualify for benefits under paragraph 4 whether or not it also 
qualifies under paragraph 2.
    Subparagraph 4(a) sets forth the general rule that a 
resident of a Contracting State engaged in the active conduct 
of a trade or business in that State may obtain the benefits of 
the Convention with respect to an item of income derived in the 
other Contracting State. The item of income, however, must be 
derived in connection with or incidental to that trade or 
business.
    The term ``trade or business'' is not defined in the 
Convention. Pursuant to paragraph 2 of Article 3 (General 
Definitions), when determining whether a resident of Spain is 
entitled to the benefits of the Convention under paragraph 3 of 
this Article with respect to an item of income derived from 
sources within the United States, the United States will 
ascribe to this term the meaning that it has under the law of 
the United States. Accordingly, the U.S. competent authority 
will refer to the regulations issued under Code section 367(a) 
for the definition of the term ``trade or business.'' In 
general, therefore, a trade or business will be considered to 
be a specific unified group of activities that constitutes or 
could constitute an independent economic enterprise carried on 
for profit. Furthermore, a corporation generally will be 
considered to carry on a trade or business only if the officers 
and employees of the corporation conduct substantial managerial 
and operational activities.
    The business of making or managing investments for the 
resident's own account will be considered to be a trade or 
business only when part of banking, insurance or securities 
activities conducted by a bank, an insurance company, or a 
registered securities dealer respectively. Such activities 
conducted by a person other than a bank, insurance company or 
registered securities dealer will not be considered to be the 
conduct of an active trade or business, nor would they be 
considered to be the conduct of an active trade or business if 
conducted by a bank, insurance company or registered securities 
dealer but not as part of the company's banking, insurance or 
dealer business. Because a headquarters operation is in the 
business of managing investments, a company that functions 
solely as a headquarters company will not be considered to be 
engaged in an active trade or business for purposes of 
paragraph 4.
    An item of income is derived in connection with a trade or 
business if the income-producing activity in the State of 
source is a line of business that ``forms a part of'' or is 
``complementary'' to the trade or business conducted in the 
State of residence by the income recipient.
    A business activity generally will be considered to form 
part of a business activity conducted in the State of source if 
the two activities involve the design, manufacture or sale of 
the same products or type of products, or the provision of 
similar services. The line of business in the State of 
residence may be upstream, downstream, or parallel to the 
activity conducted in the State of source. Thus, the line of 
business may provide inputs for a manufacturing process that 
occurs in the State of source, may sell the output of that 
manufacturing process, or simply may sell the same sorts of 
products that are being sold by the trade or business carried 
on in the State of source.
    Example 1. USCo is a corporation resident in the United 
States. USCo is engaged in an active manufacturing business in 
the United States. USCo owns 100 percent of the shares of FCo, 
a corporation resident in Spain. FCo distributes USCo products 
in Spain. Since the business activities conducted by the two 
corporations involve the same products, FCo's distribution 
business is considered to form a part of USCo's manufacturing 
business.
    Example 2. The facts are the same as in Example 1, except 
that USCo does not manufacture. Rather, USCo operates a large 
research and development facility in the United States that 
licenses intellectual property to affiliates worldwide, 
including FCo. FCo and other USCo affiliates then manufacture 
and market the USCo-designed products in their respective 
markets. Since the activities conducted by FCo and USCo involve 
the same product lines, these activities are considered to form 
a part of the same trade or business.
    For two activities to be considered to be 
``complementary,'' the activities need not relate to the same 
types of products or services, but they should be part of the 
same overall industry and be related in the sense that the 
success or failure of one activity will tend to result in 
success or failure for the other. Where more than one trade or 
business is conducted in the State of source and only one of 
the trades or businesses forms a part of or is complementary to 
a trade or business conducted in the State of residence, it is 
necessary to identify the trade or business to which an item of 
income is attributable. Royalties generally will be considered 
to be derived in connection with the trade or business to which 
the underlying intangible property is attributable. Dividends 
will be deemed to be derived first out of earnings and profits 
of the treaty-benefited trade or business, and then out of 
other earnings and profits. Interest income may be allocated 
under any reasonable method consistently applied. A method that 
conforms to U.S. principles for expense allocation will be 
considered a reasonable method.
    Example 3. Americair is a corporation resident in the 
United States that operates an international airline. FSub is a 
wholly-owned subsidiary of Americair resident in Spain. FSub 
operates a chain of hotels in Spain that are located near 
airports served by Americair flights. Americair frequently 
sells tour packages that include air travel to Spain and 
lodging at FSub hotels. Although both companies are engaged in 
the active conduct of a trade or business, the businesses of 
operating a chain of hotels and operating an airline are 
distinct trades or businesses. Therefore FSub's business does 
not form a part of Americair's business. However, FSub's 
business is considered to be complementary to Americair's 
business because they are part of the same overall industry 
(travel) and the links between their operations tend to make 
them interdependent.
    Example 4. The facts are the same as in Example 3, except 
that FSub owns an office building in Spain instead of a hotel 
chain. No part of Americair's business is conducted through the 
office building. FSub's business is not considered to form a 
part of or to be complementary to Americair's business. They 
are engaged in distinct trades or businesses in separate 
industries, and there is no economic dependence between the two 
operations.
    Example 5. USFlower is a corporation resident in the United 
States. USFlower produces and sells flowers in the United 
States and other countries. USFlower owns all the shares of 
ForHolding, a corporation resident in Spain. ForHolding is a 
holding company that is not engaged in a trade or business. 
ForHolding owns all the shares of three corporations that are 
resident in Spain: ForFlower, ForLawn, and ForFish. ForFlower 
distributes USFlower flowers under the USFlower trademark in 
Spain. ForLawn markets a line of lawn care products in Spain 
under the USFlower trademark. In addition to being sold under 
the same trademark, ForLawn and ForFlower products are sold in 
the same stores and sales of each company's products tend to 
generate increased sales of the other's products. ForFish 
imports fish from the United States and distributes it to fish 
wholesalers in Spain. For purposes of paragraph 3, the business 
of ForFlower forms a part of the business of USFlower, the 
business of ForLawn is complementary to the business of 
USFlower, and the business of ForFish is neither part of nor 
complementary to that of USFlower.
    An item of income derived from the State of source is 
``incidental to'' the trade or business carried on in the State 
of residence if production of the item facilitates the conduct 
of the trade or business in the State of residence. An example 
of incidental income is the temporary investment of working 
capital of a person in the State of residence in securities 
issued by persons in the State of source.
    Subparagraph (b) of paragraph 4 states a further condition 
to the general rule in subparagraph (a) in cases where the 
trade or business generating the item of income in question is 
carried on either by the person deriving the income or by any 
associated enterprises. Subparagraph (b) states that the trade 
or business carried on in the State of residence, under these 
circumstances, must be substantial in relation to the activity 
in the State of source. The substantiality requirement is 
intended to prevent a narrow case of treaty-shopping abuses in 
which a company attempts to qualify for benefits by engaging in 
de minimis connected business activities in the treaty country 
in which it is resident (i.e., activities that have little 
economic cost or effect with respect to the company business as 
a whole). Paragraph 5 of the Memorandum of Understanding sets 
forth the understanding of the Contracting States that a person 
shall be deemed to be related to another person if either 
person participates directly or indirectly in the management, 
control or capital of the other, or the same persons 
participate directly or indirectly in the management, control 
or capital of both.
    The determination of substantiality is made based upon all 
the facts and circumstances and takes into account the 
comparative sizes of the trades or businesses in each 
Contracting State the nature of the activities performed in 
each Contracting State, and the relative contributions made to 
that trade or business in each Contracting State. In any case, 
in making each determination or comparison, due regard will be 
given to the relative sizes of the economies in the two 
Contracting States.
    The determination in subparagraph (b) also is made 
separately for each item of income derived from the State of 
source. It therefore is possible that a person would be 
entitled to the benefits of the Convention with respect to one 
item of income but not with respect to another. If a resident 
of a Contracting State is entitled to treaty benefits with 
respect to a particular item of income under paragraph 4, the 
resident is entitled to all benefits of the Convention insofar 
as they affect the taxation of that item of income in the State 
of source.
    The application of the substantiality requirement only to 
income from related parties focuses only on potential abuse 
cases, and does not hamper certain other kinds of non-abusive 
activities, even though the income recipient resident in a 
Contracting State may be very small in relation to the entity 
generating income in the other Contracting State. For example, 
if a small U.S. research firm develops a process that it 
licenses to a very large, unrelated, pharmaceutical 
manufacturer in Spain, the size of the U.S. research firm would 
not have to be tested against the size of the manufacturer. 
Similarly, a small U.S. bank that makes a loan to a very large 
unrelated company operating a business in Spain would not have 
to pass a substantiality test to receive treaty benefits under 
paragraph 4.
    Subparagraph (c) of paragraph 3 provides special 
attribution rules for purposes of applying the substantive 
rules of subparagraphs (a) and (b). Thus, these rules apply for 
purposes of determining whether a person meets the requirement 
in subparagraph (a) that it be engaged in the active conduct of 
a trade or business and that the item of income is derived in 
connection with that active trade or business, and for making 
the comparison required by the ``substantiality'' requirement 
in subparagraph (b). Subparagraph (c) attributes to a person 
activities conducted by persons ``connected'' to such person. A 
person (``X'') is connected to another person (``Y'') if X 
possesses 50 percent or more of the beneficial interest in Y 
(or if Y possesses 50 percent or more of the beneficial 
interest in X). For this purpose, X is connected to a company 
if X owns shares representing fifty percent or more of the 
aggregate voting power and value of the company or fifty 
percent or more of the beneficial equity interest in the 
company. X also is connected to Y if a third person possesses 
fifty percent or more of the beneficial interest in both X and 
Y. For this purpose, if X or Y is a company, the threshold 
relationship with respect to such company or companies is fifty 
percent or more of the aggregate voting power and value or 
fifty percent or more of the beneficial equity interest. 
Finally, X is connected to Y if, based upon all the facts and 
circumstances, X controls Y, Y controls X, or X and Y are 
controlled by the same person or persons.

Paragraph 5 of Article 17

    Paragraph 5 of new Article 17 provides that a resident of 
one of the Contracting States is entitled to all the benefits 
of the Convention if that person functions as a recognized 
headquarters company for a multinational corporate group. The 
provisions of this paragraph are consistent with the other U.S. 
tax treaties where this provision has been adopted. For this 
purpose, the multinational corporate group includes all 
corporations that the headquarters company supervises, and 
excludes affiliated corporations not supervised by the 
headquarters company. The headquarters company does not have to 
own shares in the companies that it supervises. In order to be 
considered a headquarters company, the person must meet several 
requirements that are enumerated in paragraph 5. These 
requirements are discussed below.
            Overall Supervision and Administration
    Subparagraph 5(a) provides that the person must provide a 
substantial portion of the overall supervision and 
administration of the group. This activity may include group 
financing, but group financing may not be the principal 
activity of the person functioning as the headquarters company. 
A person only will be considered to engage in supervision and 
administration if it engages in a number of the following 
activities: group financing, pricing, marketing, internal 
auditing, internal communications, and management. Other 
activities also could be part of the function of supervision 
and administration.
    In determining whether a ``substantial portion'' of the 
overall supervision and administration of the group is provided 
by the headquarters company, its headquarters-related 
activities must be substantial in relation to the same 
activities for the same group performed by other entities. 
Subparagraph 5(a) does not require that the group that is 
supervised include persons in the other State. However, it is 
anticipated that in most cases the group will include such 
persons, due to the requirement in subparagraph 5(g), discussed 
below, that the income derived in the other Contracting State 
by the headquarters company be derived in connection with or be 
incidental to an active trade or business supervised by the 
headquarters company.
            Active Trade or Business
    Subparagraph 5(b) is the first of several requirements 
intended to ensure that the relevant group is truly 
``multinational.'' This subparagraph provides that the 
corporate group supervised by the headquarters company must 
consist of corporations resident in, and engaged in active 
trades or businesses in, at least five countries. Furthermore, 
at least five countries must each contribute substantially to 
the income generated by the group, as the rule requires that 
the business activities carried on in each of the five 
countries (or groupings of countries) generate at least 10 
percent of the gross income of the group. For purposes of the 
10 percent gross income requirement, the income from multiple 
countries may be aggregated into non-overlapping groupings, as 
long as there are at least five individual countries or 
groupings that each satisfies the 10 percent requirement. If 
the gross income requirement under this subparagraph is not met 
for a taxable year, the taxpayer may satisfy this requirement 
by applying the 10 percent gross income test to the average of 
the gross incomes for the four years preceding the taxable 
year.
    Example. SHQ is a corporation resident in Spain. SHQ 
functions as a headquarters company for a group of companies. 
These companies are resident in the United States, Canada, New 
Zealand, the United Kingdom, Malaysia, the Philippines, 
Singapore, and Indonesia. The gross income generated by each of 
these companies for 2012 and 2013 is as follows:

------------------------------------------------------------------------
             Country                     2012                2013
------------------------------------------------------------------------
United States                                   $40                 $45
Canada                                           25                  15
New Zealand                                      10                  20
United Kingdom                                   30                  35
Malaysia                                         10                  12
Philippines                                       7                  10
Singapore                                        10                   8
Indonesia                                         5                  10
------------------------------------------------------------------------
  Total                                        $137                $155
------------------------------------------------------------------------

    For 2012, 10 percent of the gross income of this group is 
equal to $13.70. Only the United States, Canada, and the United 
Kingdom satisfy this requirement for that year. The other 
countries may be aggregated to meet this requirement. Because 
New Zealand and Malaysia have a total gross income of $20, and 
the Philippines, Singapore, and Indonesia have a total gross 
income of $22, these two groupings of countries may be treated 
as the fourth and fifth members of the group for purposes of 
subparagraph 5(b).
    In the following year, 10 percent of the gross income is 
$15.50. Only the United States, New Zealand, and the United 
Kingdom satisfy this requirement. Because Canada and Malaysia 
have a total gross income of $27, and the Philippines, 
Singapore, and Indonesia have a total gross income of $28, 
these two groupings of countries may be treated as the fourth 
and fifth members of the group for purposes of subparagraph 
5(b). The fact that Canada replaced New Zealand in a group is 
not relevant for this purpose. The composition of the grouping 
may change from year to year.
            Single Country Limitation
    Subparagraph 5(c) provides that the business activities 
carried on in any one country other than the headquarters 
company's State of residence must generate less than 50 percent 
of the gross income of the group. If the gross income 
requirement under this subparagraph is not met for a taxable 
year, the taxpayer may satisfy this requirement by applying the 
50 percent gross income test to the average of the gross 
incomes for the four years preceding the taxable year. The 
following example illustrates the application of this clause.
    Example. SHQ is a corporation resident in Spain. SHQ 
functions as a headquarters company for a group of companies. 
SHQ derives dividend income from a United States subsidiary in 
the 2008 taxable year. The state of residence of each of these 
companies, the situs of their activities and the amounts of 
gross income attributable to each for the years 2008 through 
2012 are set forth below.

----------------------------------------------------------------------------------------------------------------
                    Country                               Situs            2012    2011    2010    2009    2008
----------------------------------------------------------------------------------------------------------------
United States                                    U.S.                       $100    $100     $95     $90     $85
Mexico                                           U.S.                         10       8       5       0       0
Canada                                           U.S.                         20      18      16      15      12
United Kingdom                                   U.K                          30      32      30      28      27
New Zealand                                      N.Z.                         35      42      38      36      35
Japan                                            Japan                        35      32      30      30      28
Singapore                                        Singapore                    30      25      24      22      20
----------------------------------------------------------------------------------------------------------------
  Total                                                                     $260    $257    $238    $221    $207
----------------------------------------------------------------------------------------------------------------

    Because the United States' total gross income of $130 in 
2012 is not less than 50 percent of the gross income of the 
group, subparagraph 5(c) is not satisfied with respect to 
dividends derived in 2012. However, the United States' average 
gross income for the preceding four years may be used in lieu 
of the preceding year's average. The United States' average 
gross income for the years 2008-11 is $111.00 ($444/4). The 
group's total average gross income for these years is $230.75 
($923/4). Because $111 represents 48.1 percent of the group's 
average gross income for the years 2008 through 2011, the 
requirement under subparagraph 5(c) is satisfied.
            Other State Gross Income Limitation
    Subparagraph 5(d) provides that no more than 25 percent of 
the headquarters company's gross income may be derived from the 
other Contracting State. Thus, if the headquarters company's 
gross income for the taxable year is $200, no more than $50 of 
this amount may be derived from the other Contracting State. If 
the gross income requirement under this subparagraph is not met 
for a taxable year, the taxpayer may satisfy this requirement 
by applying the 25 percent gross income test to the average of 
the gross incomes for the four years preceding the taxable 
year.
            Independent Discretionary Authority
    Subparagraph 5(e) requires that the headquarters company 
have and exercise independent discretionary authority to carry 
out the functions referred to in subparagraph 5(a). Thus, if 
the headquarters company was nominally responsible for group 
financing, pricing, marketing and other management functions, 
but merely implemented instructions received from another 
entity, the headquarters company would not be considered to 
have and exercise independent discretionary authority with 
respect to these functions. This determination is made 
individually for each function. For instance, a headquarters 
company could be nominally responsible for group financing, 
pricing, marketing and internal auditing functions, but another 
entity could be actually directing the headquarters company as 
to the group financing function. In such a case, the 
headquarters company would not be deemed to have independent 
discretionary authority for group financing, but it might have 
such authority for the other functions. Functions for which the 
headquarters company does not have and exercise independent 
discretionary authority are considered to be conducted by an 
entity other than the headquarters company for purposes of 
subparagraph 5(a).
            Income Taxation Rules
    Subparagraph 2(f) requires that the headquarters company be 
subject to the generally applicable income taxation rules in 
its country of residence. This reference should be understood 
to mean that the company must be subject to the income taxation 
rules to which a company engaged in the active conduct of a 
trade or business would be subject. Thus, if one of the 
Contracting States has or introduces special taxation 
legislation that imposes a lower rate of income tax on 
headquarters companies than is imposed on companies engaged in 
the active conduct of a trade or business, or provides for an 
artificially low taxable base for such companies, a 
headquarters company subject to these rules is not entitled to 
the benefits of the Convention under paragraph 5.
            In Connection With or Incidental to Trade or Business
    Subparagraph 5(g) requires that the income derived in the 
other Contracting State be derived in connection with or be 
incidental to the active business activities referred to 
subparagraph 5(b). This determination is made under the 
principles set forth in paragraph 3. For instance, assume that 
a Spanish company satisfies the other requirements in paragraph 
5 and acts as a headquarters company for a group that includes 
a U.S. corporation. If the group is engaged in the design and 
manufacture of computer software, but the U.S. corporation is 
also engaged in the design and manufacture of photocopying 
machines, the income that the Spanish company derives from the 
United States would have to be derived in connection with or be 
incidental to the income generated by the computer business in 
order to be entitled to the benefits of the Convention under 
paragraph 5. Interest income received from the U.S. corporation 
also would be entitled to the benefits of the Convention under 
this subparagraph as long as the interest was attributable to 
the computer business supervised by the headquarters company. 
Interest income derived from an unrelated party would normally 
not, however, satisfy the requirements of this clause.

Paragraph 6 of Article 17

    Paragraph 6 of new Article 17 deals with the treatment of 
income in the context of a so-called ``triangular case.'' The 
term ``triangular case'' refers to the use of a structure like 
the one described in the following paragraph by a resident of 
the other Contracting State to earn income from the United 
States:
    A resident of Spain, who would, absent paragraph 6, qualify 
for benefits under one or more of the provisions of this 
Article, sets up a permanent establishment in a third state 
that imposes a low or zero rate of tax on the income of the 
permanent establishment. The resident of Spain lends funds into 
the United States through the permanent establishment. The 
permanent establishment, despite its third-jurisdiction 
location, is an integral part of the resident of Spain. 
Therefore, the income that it earns on those loans, absent the 
provisions of paragraph 6, is entitled to exemption from U.S. 
withholding tax under the Convention. Under a current income 
tax treaty between Spain and the host jurisdiction of the 
permanent establishment, the income of the permanent 
establishment is exempt from tax by Spain (alternatively, Spain 
may choose to exempt the income of the permanent establishment 
from income tax). Thus, the interest income, absent paragraph 
6, would be exempt from U.S. tax, subject to little or no tax 
in the host jurisdiction of the permanent establishment, and 
exempt from tax in Spain.
    Paragraph 6 provides that the tax benefits that would 
otherwise apply under the Convention will not apply to any item 
of income if the combined aggregate effective tax rate in the 
residence State and the third state is less than 60 percent of 
the general rate of company tax applicable in the residence 
State. In the case of dividends, interest and royalties to 
which this paragraph applies, the withholding tax rates under 
the Convention are replaced with a 15 percent withholding tax. 
Any other income to which the provisions of paragraph 6 apply 
is subject to tax under the domestic law of the source State, 
notwithstanding any other provisions of the Convention.
    In general, the principles employed under Code section 
954(b)(4) will be employed to determine whether the profits are 
subject to an effective rate of taxation that is above the 
specified threshold.
    Notwithstanding the level of tax on interest and royalty 
income of the permanent establishment, paragraph 6 will not 
apply under certain circumstances. In the case of royalties, 
paragraph 6 will not apply if the royalties are received as 
compensation for the use of, or the right to use, intangible 
property produced or developed by the permanent establishment 
itself. In the case of any other income, paragraph 6 will not 
apply if that income is derived in connection with, or is 
incidental to, the active conduct of a trade or business 
carried on by the permanent establishment in the third state. 
The business of making, managing or simply holding investments 
is not considered to be an active trade or business, unless 
these are securities activities carried on by a registered 
securities dealer.
    Paragraph 6 applies reciprocally. However, the United 
States does not exempt the profits of a third-jurisdiction 
permanent establishment of a U.S. resident from U.S. tax, 
either by statute or by treaty.

Paragraph 7 of New Article 17

    Paragraph 7 of new Article 17 provides that a resident of 
one of the States that is not entitled to the benefits of the 
Convention as a result of paragraphs 1 through 5 may be granted 
benefits under the Convention at the discretion of the 
competent authority of the State from which benefits in certain 
circumstances. Such competent authority shall make the 
determination of whether the granting of benefits would be 
justified based on an evaluation of the extent to which such 
resident satisfies the requirements of paragraphs 2, 3, 4 or 5. 
Such competent authority shall also consider the opinion, if 
any of the competent authority of the other Contracting State 
as to whether under the circumstances it would be appropriate 
to grant such benefits.
    A competent authority may grant all of the benefits of the 
Convention to the taxpayer making the request, or it may grant 
only certain benefits. For instance, it may grant benefits only 
with respect to a particular item of income in a manner similar 
to paragraph 3. Further, the competent authority may establish 
conditions, such as setting time limits on the duration of any 
relief granted.
    For purposes of implementing paragraph 7, a taxpayer will 
be permitted to present his case to the relevant competent 
authority for an advance determination based on the facts. In 
these circumstances, it is also expected that, if 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 treaty provision or the establishment of the structure 
in question, whichever is later.
    Finally, there may be cases in which a resident of a 
Contracting State may apply for discretionary relief to the 
competent authority of his State of residence. This would 
arise, for example, if the benefit it is claiming is provided 
by the residence country, and not by the source country. So, 
for example, if a company that is a resident of the United 
States would like to claim the benefit of treaty-based relief 
from double taxation under Article 24 (Relief from Double 
Taxation), but it does not meet any of the objective tests of 
paragraphs 2 through 5, it may apply to the U.S. competent 
authority for discretionary relief.

Paragraph 8 of New Article 17

    Paragraph 8 of new Article 17 defines several key terms for 
purposes of Article 17. Each of the defined terms is discussed 
above in the context in which it is used.

                               ARTICLE X

    Article X of the Protocol amends Article 20 (Pensions, 
Annuities, Alimony and Child Support) of the existing 
Convention by adding a new paragraph 5.

New Paragraph 5 of Article 20

    New paragraph 5 provides that, if a resident of a 
Contracting State participates in a pension fund established in 
the other Contracting State, the State of residence will not 
tax the income of the pension fund with respect to that 
resident until a distribution is made from the pension fund. 
Thus, for example, if a U.S. citizen contributes to a U.S. 
qualified plan while working in the United States and then 
establishes residence in Spain, paragraph 5 prevents Spain from 
taxing currently the plan's earnings and accretions with 
respect to that individual. When the resident receives a 
distribution from the pension fund, that distribution may be 
subject to tax in the State of residence, subject to paragraph 
1 of Article 20.

                               ARTICLE XI

    Article XI of the Protocol replaces paragraph 3 of Article 
25 (Non-Discrimination) of the existing Convention in order to 
conform to changes made by the deletion of Article 14 and the 
changes made to Article 10 dealing with the taxation of branch 
profits tax. It clarifies that nothing in Article 25 should be 
construed as preventing either Contracting State from imposing 
a tax described in paragraph 8 of Article 10 (Dividends) as 
revised by Article IV.

                              ARTICLE XII

    Article XII of the Protocol makes amendments to Article 26 
(Mutual Agreement Procedure) of the existing Convention, which 
deals with the mutual agreement procedure. In particular, 
Article XII of the Protocol incorporates into Article 26 rules 
that provide for mandatory binding arbitration to resolve 
certain cases that the competent authorities of the Contracting 
States have been unable to resolve after a reasonable amount of 
time.

New Paragraph 5 of Article 26

    New paragraph 5 provides that a case shall be resolved 
through mandatory binding arbitration when a ``concerned 
person'' as defined in subparagraph 6(a) has presented a case 
to the competent authority of either Contracting State on the 
basis that the actions of one or both of the Contracting States 
have resulted for that person in taxation not in accordance 
with the provisions of the Convention, and the competent 
authorities of the Contracting States have not been able to 
reach an agreement to resolve the case, and if the conditions 
specified in this paragraph and in paragraph 6 are satisfied. 
The mandatory binding arbitration provision is an extension of 
(as opposed to an alternative to) the interaction between the 
competent authorities as provided in the mutual agreement 
procedure. Accordingly, only cases that have first been 
negotiated by the competent authorities pursuant to Article 26 
shall be eligible for arbitration.
    An initial condition set forth in paragraph 5 is that a 
concerned person has presented a case to the competent 
authority of either Contracting State on the basis that the 
actions of one or both of the Contracting States have resulted 
for that person in taxation not in accordance with the 
provisions of the Convention. Such taxation should be 
considered to have resulted from the actions of one or both of 
the Contracting States as soon as, for example, tax has been 
paid, assessed, or otherwise determined, or even in cases where 
the taxpayer is officially notified by the tax authorities that 
they intend to tax him on a certain element of income. As 
provided in paragraph 18 of the Protocol of 1990 as revised by 
Article XIV of the Protocol, in the case of the United States, 
such notification would take the form of a notice of proposed 
adjustment, and in Spain, such notification would include a 
notification of the Administrative Act of Assessment.
    The additional conditions that must be satisfied before a 
case may be resolved through arbitration are set forth in 
subparagraphs 5(a) through 5(e). Subparagraph 5(a) provides 
that tax returns must be filed with at least one of the 
Contracting States with respect to the taxable years at issue 
in the case. Subparagraph 5(b) provides that the case may not 
be a case that the competent authorities have mutually agreed 
before the date on which arbitration proceedings would 
otherwise have begun, is not suitable for determination by 
arbitration. Subparagraph 5(c) provides that an unresolved case 
shall not be submitted to arbitration if a decision on such 
case has already been rendered by a court or administrative 
tribunal of either Contracting State. Subparagraph 5(d) 
provides that the case must not involve a determination under 
paragraph 3 of Article 4 (Residence) dealing with dual resident 
entities. Finally, subparagraph 5(e) provides that the 
provisions of subparagraph 6(c), described below, which sets 
forth the rule governing the date on which an arbitration 
proceeding shall commence, must be satisfied.

New paragraph 6 of Article 26

    New paragraph 6 sets forth additional rules and definitions 
to be used in applying the arbitration provisions. Subparagraph 
6(a) defines the term ``concerned person'' as the person that 
brought the case to competent authority for consideration under 
Article 26 and 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 would include a U.S. corporation that brings 
a transfer pricing case with respect to a transaction entered 
into with its subsidiary in Spain for resolution to the U.S. 
competent authority, as well as the subsidiary, which may seek 
a correlative adjustment as a result of the resolution of the 
case.
    Subparagraph 6(b) defines the term ``commencement date'' as 
the earliest date on which the information necessary to 
undertake substantive consideration for a mutual agreement has 
been received by the competent authorities of both Contracting 
States. The competent authority of the United States will be 
considered to have received the information necessary to 
undertake substantive consideration for a mutual agreement on 
the date that it has received the information that must be 
submitted pursuant to Rev Proc. 2006-54, 2006-2 C.B. 1035,' 
4.05 (or any similarly applicable or successor procedures). The 
competent authority of Spain will be considered to have 
received the information necessary to undertake substantive 
consideration for a mutual agreement on the date it has 
received the information that must be submitted pursuant to 
Article 6 of Royal Decree 1794/2008 of November 3 (or any 
similarly applicable or successor procedures). 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.
    Subparagraph 6(c) provides that an arbitration proceeding 
shall begin on the latest of four dates: (i) two years from the 
commencement date of that case (unless both competent 
authorities have previously agreed to a different date), (ii) 
the date upon which the present of the case has submitted a 
written request to a competent authority for a resolution of 
the case through arbitration, (iii) the earliest date upon 
which all concerned persons have entered into a confidentiality 
agreement and the agreements have been received by both 
competent authorities, or (iv) the date on which all legal 
actions or suits pending before the courts of either 
Contracting State concerning any issue involved in the care are 
suspended or withdrawn (as applicable) under the laws of the 
Contracting State in which the legal actions or suits are 
pending.
    Clause (i) of this subparagraph permits the competent 
authorities of the Contracting States to mutually agree to 
initiate arbitration proceedings on a date other than two years 
after the commencement date. This could be the case, for 
instance, if the negotiation of a case between the competent 
authorities was nearing completion and could be expected to be 
resolved in an additional short period of time, thus avoiding 
the need for an arbitration proceeding. As another example, if 
under paragraphs 5 and 6 arbitration proceedings would be 
initiated on the same date for a large number of cases, clause 
(i) would allow the competent authorities of the Contracting 
States to agree to establish different dates (including 
accelerated dates) to initiate arbitration proceedings for such 
cases in order to avoid having multiple arbitration proceedings 
take place at the same time. Clause (i) requires that the 
competent authorities of the Contracting States notify the 
presenter of the case of any such agreements.
    Clause (ii) of this subparagraph provides that the 
presenter of the case must submit a written request to the 
competent authority for a resolution of the case through 
arbitration. However, the presenter of the case may not submit 
such written request prior to the completion of the two year 
period after the commencement date described in clause (i).
    Clause (iii) of this subparagraph requires that all 
concerned persons and their authorized representatives or 
agents agree in writing prior to the beginning of an 
arbitration proceeding not to disclose to any other person any 
information received during the course of the arbitration 
proceeding from either Contracting State or the arbitration 
panel, other than the determination of the panel. A 
confidentiality agreement may 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.
    Clause (iv) of this subparagraph requires that in the event 
that any issue involved in the case that is potentially subject 
to arbitration is the subject of any legal actions or suits 
pending before the courts of either Contracting States, such 
legal action must be either suspended or withdrawn as 
applicable under the laws of the Contracting State in which 
such legal actions or suits are pending.
    Subparagraph 6(d) provides that the determination of the 
arbitration panel shall constitute a resolution by mutual 
agreement under Article 26 and thus shall be binding on the 
Contracting States. As is the case with any negotiated 
resolution between the competent authorities pursuant to the 
mutual agreement procedure, the presenter of the case preserves 
the right not to accept the determination of the arbitration 
panel.
    Subparagraph 6(e) provides that for purposes of an 
arbitration proceeding under paragraphs 5 and 6 of Article 26, 
the members of the arbitration panel and their staff shall be 
considered ``persons or authorities'' to whom information may 
be disclosed under Article 27 (Exchange of Information and 
Administrative Assistance) of the Convention as revised by 
Article XIII.
    Subparagraph 6(f) sets forth the confidentiality 
obligations of the competent authorities of the Contracting 
States as well as the members of the arbitration panel and 
their staffs regarding an arbitration proceeding. Subparagraph 
6(g) provides that no information relating to an arbitration 
proceeding (including the arbitration panel's determination) 
may be disclosed by the competent authorities of the 
Contracting States, except as permitted by this Convention and 
the domestic laws of the Contracting States. In addition, all 
material prepared in the course of, or relating to, an 
arbitration proceeding shall be considered to be information 
exchanged between the Contracting States. Subparagraph 6(f) 
requires that all members of the arbitration panel and their 
staff make statements in writing not to disclose any 
information relating to an arbitration proceeding (including 
the arbitration panel's determination), and to abide by and be 
subject to the confidentiality and nondisclosure provisions of 
Article 27 of this Convention and the applicable domestic laws 
of the Contracting States. In the event those provisions 
conflict, the most restrictive condition shall apply. These 
statements from the members of the arbitration panel shall also 
include confirmation of their appointment to the arbitration 
panel.
    Subparagraph 6(g) sets forth a non-exhaustive list of items 
related to the time periods and procedures related to 
conducting an arbitration proceeding that the competent 
authorities of the Contracting States must agree to in order to 
ensure the effective and timely implementation of the 
provisions of paragraph 5 and 6 of Article 26. Such agreement 
must be consistent with the provisions of paragraphs 5 and 6 of 
Article 25 and paragraph 21 of the Protocol of 1990 as amended 
by Article XIV, and shall take the form of published guidance 
before the date that the first arbitration proceeding 
commences. Subparagraph 6(g) lists the following items for 
which the competent authorities of the Contracting States shall 
agree on time frames and procedures for:

          i) notifying the presenter of the case of any 
        agreements pursuant to either subparagraph 5(b) that 
        the case is not suitable for resolution through 
        arbitration, or clause i) of subparagraph 5(c) to 
        change the date on which an arbitration proceeding 
        could begin;
          ii) obtaining the statements of each concerned 
        person, authorized representative or agent, and member 
        of the arbitration panel (including their staff), in 
        which each such person agrees not to disclose to any 
        other person any information received during the course 
        of the arbitration proceeding from the competent 
        authority of either Contracting State or the 
        arbitration panel, other than the determination of such 
        panel;
          iii) the appointment of the members of the 
        arbitration panel;
          iv) the submission of proposed resolutions, position 
        papers, and reply submissions by the competent 
        authorities of the Contracting States to the 
        arbitration panel;
          v) the submission by the presenter of the case of a 
        paper setting forth the presenter's views and analysis 
        of the case for consideration by the arbitration panel;
          vi) the delivery by the arbitration panel of its 
        determination to the competent authorities of the 
        Contracting States;
          vii) the acceptance or rejection by the presenter of 
        the case of the determination of the arbitration panel; 
        and
          vii) the adoption by the arbitration panel of any 
        additional procedures necessary for the conduct of its 
        business.

    Paragraph 6 also provides that the competent authorities of 
the Contracting States may agree in writing on such other 
rules, time periods or procedures as may be necessary for the 
effective and timely implementation of the provisions of 
paragraphs 5 and 6 of Article 26.

                              ARTICLE XIII

    Article XIII of the Protocol replaces Article 27 (Exchange 
of Information and Administrative Assistance) of the existing 
Convention. This Article provides for the exchange of 
information between the competent authorities of the 
Contracting States. While mutual agreement procedures are 
addressed in Article 26, exchanges of information for purposes 
of the mutual agreement procedures are governed by this 
Article.

Paragraph 1 of New Article 27

    The obligation to obtain and provide information to the 
other Contracting State is set out in paragraph 1 of new 
Article 27. The information to be exchanged is that which may 
be is foreseeably relevant for carrying out the provisions of 
the Convention or the domestic laws of the United States or of 
the other Contracting State concerning taxes of every kind 
applied at the national level. This language incorporates the 
standard of the OECD Model. The Contracting States intend for 
the phrase ``is foreseeably relevant'' to be interpreted to 
permit the exchange of information that ``may be relevant'' for 
purposes of 26 U.S.C. Section 7602 of the Code, which 
authorizes the IRS 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 IRS 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. Thus, the language of paragraph 1 
is intended to provide for exchange of information in tax 
matters to the widest extent possible, while clarifying that 
Contracting States are not at liberty to engage in ``fishing 
expeditions'' or otherwise to request information that is 
unlikely to be relevant to the tax affairs of a given taxpayer.
    Consistent with the OECD Model, a request for information 
does not constitute a ``fishing expedition'' solely because it 
does not provide the name or address (or both) of the taxpayer 
under examination or investigation. In cases where the 
requesting State does not provide the name or address (or both) 
of the taxpayer under examination or investigation, the 
requesting State must provide other information sufficient to 
identify the taxpayer. Similarly, paragraph 1 does not 
necessarily require the request to include the name and/or 
address of the person believed to be in possession of the 
information.
    The standard of ``foreseeable relevance'' can be met in 
cases dealing with both one taxpayer (whether identified by 
name or otherwise) or several taxpayers (whether identified by 
name or otherwise). Where a Contracting State undertakes an 
investigation into an ascertainable group or category of 
persons in accordance with its laws, any request related to the 
investigation will typically serve the objective of carrying 
out the domestic tax laws of the requesting State 
administration or enforcement of its domestic laws and thus 
will comply with the requirements of paragraph 1, provided it 
meets the standard of ``foreseeable relevance.'' In such cases, 
the requesting State should provide, supported by a clear 
factual basis, a detailed description of the group or category 
of persons and of the specific facts and circumstances that 
have led to the request, as well as an explanation of the 
applicable law and why there is reason to believe that the 
taxpayers in the group or category of persons for whom 
information is requested have been non-compliant with that law 
supported by a clear factual basis. The requesting State should 
further show that the requested information would assist in 
determining compliance by the taxpayers in the group or 
category of persons.
    Exchange of information with respect to each State's 
domestic law is authorized to the extent that taxation under 
domestic law is not contrary to the Convention. Thus, for 
example, information may be exchanged under this Article, even 
if the transaction to which the information relates is a purely 
domestic transaction in the requesting State and, therefore, 
the exchange is not made to carry out the Convention. An 
example of such a case is provided in subparagraph 8(b) of the 
OECD Commentary: a company resident in one Contracting State 
and a company resident in the other Contracting State transact 
business between themselves through a third-country resident 
company. Neither Contracting State has a treaty with the third 
state. To enforce their internal laws with respect to 
transactions of their residents with the third-country company 
(since there is no relevant treaty in force), the Contracting 
States may exchange information regarding the prices that their 
residents paid in their transactions with the third-country 
resident.
    Paragraph 1 clarifies that information may be exchanged 
that relates to the assessment or collection of, the 
enforcement or prosecution in respect of, or the determination 
of appeals in relation to, taxes of every kind imposed by a 
Contracting State at the national level. Accordingly, the 
competent authorities may request and provide information for 
cases under examination or criminal investigation, in 
collection, on appeals, or under prosecution, and information 
may be exchanged with respect to U.S. estate and gift taxes. In 
contrast, paragraph 7, which relates to collection assistance, 
applies only to those taxes covered for general purposes of the 
Convention as defined in Article 2 (Taxes Covered).
    Information exchange is not restricted by paragraph 1 of 
Article 1. Accordingly, information may be requested and 
provided under this Article with respect to persons who are not 
residents of either Contracting State. For example, if a third-
country resident has a permanent establishment in the other 
Contracting State, and that permanent establishment engages in 
transactions with a U.S. enterprise, the United States could 
request information with respect to that permanent 
establishment, even though the third-country resident is not a 
resident of either Contracting State. Similarly, if a third-
country resident maintains a bank account in the other 
Contracting State, and the Internal Revenue Service has reason 
to believe that funds in that account should have been reported 
for U.S. tax purposes but have not been so reported, 
information can be requested from the other Contracting State 
with respect to that person's account, even though that person 
is not the taxpayer under examination.
    Although the term ``United States'' does not encompass U.S. 
possessions or territories for most purposes of the Convention, 
section 7651 of the Code authorizes the Internal Revenue 
Service to utilize the administrative and enforcement 
provisions of the Code in the U.S. possessions or territories, 
including to obtain information pursuant to a proper request 
made under Article 26. If necessary to obtain requested 
information, the Internal Revenue Service could issue and 
enforce an administrative summons to the taxpayer, a tax 
authority (or other U.S. possession or territory government 
agency), or a third party located in a U.S. possession or 
territory.
    The final sentence of paragraph 1 provides that the 
requesting Contracting State may specify the form in which 
information is to be provided (e.g., authenticated copies of 
original documents (including books, papers, statements, 
records, accounts, and writings)). 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 2 of New Article 27

    Paragraph 2 provides assurances that any information 
exchanged will be treated as secret, subject to the same 
disclosure constraints as information obtained under the laws 
of the requesting State. The confidentiality rules cover 
communications between the competent authorities (including the 
letter requesting information) as well as references to 
exchanged information that may occur in other documents, such 
as advice by government attorneys to their respective competent 
authorities. At the same time, it is understood that the 
requested State can disclose the minimum information contained 
in a competent authority letter (but not the letter itself) 
necessary for the requested State to be able to obtain or 
provide the requested information to the requesting State, 
without frustrating the efforts of the requesting State. If, 
however, court proceedings or the like under the domestic laws 
of the requested State necessitate the disclosure of the 
competent authority letter itself, the competent authority of 
the requested State may disclose such a letter unless the 
requesting State otherwise specifies.
    Information received may be disclosed only to persons or 
authorities, including courts and administrative bodies, 
involved in the assessment, collection, or administration of, 
the enforcement or prosecution in respect of, or the 
determination of appeals in relation to, the taxes referred to 
in paragraph 1. Under this standard, information may be 
communicated to the taxpayer or his proxy. The information must 
be used by these persons only for the purposes mentioned in 
paragraph 2. Information may also be disclosed to legislative 
bodies, such as the tax-writing committees of the U.S. Congress 
and the U.S. Government Accountability Office, engaged in the 
oversight of the preceding activities. Information received by 
these bodies must be for use in the performance of their role 
in overseeing the administration of U.S. tax laws. Information 
received may be disclosed in public court proceedings or in 
judicial decisions.
    In situations in which the requested State determines that 
the requesting State does not comply with its duties regarding 
the confidentiality of the information exchanged under this 
Article, the requested State may suspend assistance under this 
Article until such time as proper assurance is given by the 
requesting State that those duties will indeed be respected. If 
necessary, the competent authorities may enter into specific 
arrangements or memoranda of understanding regarding the 
confidentiality of the information exchanged under this 
Article.
    Paragraph 2 also provides that the competent authority of 
the Contracting State that receives information under this 
Article may, with the written consent of the other Contracting 
State, make that information available to be used for other 
purposes allowed under the provisions of a mutual legal 
assistance treaty in force between the Contracting States that 
allows for the exchange of tax information.

Paragraph 3 of New Article 27

    Paragraph 3 of new Article 27 provides that the obligations 
undertaken in paragraphs 1 and 2 to exchange information do not 
require a Contracting State to carry out administrative 
measures that are at variance with the laws or administrative 
practice of either State. Nor is a Contracting State required 
to supply information not obtainable under the laws or 
administrative practice of either State, or to disclose trade 
secrets or other 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.

Paragraph 4 of New Article 27

    Paragraph 4 of new Article 27 provides that when 
information is requested by a Contracting State in accordance 
with this Article, the other Contracting State is obligated to 
obtain the requested information as if the tax in question were 
the tax of the requested State, even if that State has no 
direct tax interest in the case to which the request relates. 
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 5 of New Article 27

    Paragraph 5 of new Article 27 provides that a Contracting 
State may not decline to provide information because that 
information is held by banks, other financial institutions, 
nominees or persons acting in an agency or fiduciary capacity 
or because it relates to ownership interests in a person. 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, such as the identity of a beneficial owner of bearer 
shares.
    Subparagraphs 3 (a) and (b) do not permit the requested 
State to decline a request where paragraph 4 or 5 applies. 
Paragraph 5 would apply, for instance, in situations in which 
the requested State's inability to obtain the information was 
specifically related to the fact that the requested information 
was believed to be held by a bank or other financial 
institution. Thus, the application of paragraph 5 includes 
situations in which the tax authorities' information gathering 
powers with respect to information held by banks and other 
financial institutions are subject to different requirements 
than those that are generally applicable with respect to 
information held by persons other than banks or other financial 
institutions. This would, for example, be the case where the 
tax authorities can only exercise their information gathering 
powers with respect to information held by banks and other 
financial institutions in instances where specific information 
on the taxpayer under examination or investigation is 
available. This would also be the case where, for example, the 
use of information gathering measures with respect to 
information held by banks and other financial institutions 
requires a higher probability that the information requested is 
held by the person believed to be in possession of the 
requested information than the degree of probability required 
for the use of information gathering measures with respect to 
information believed to be held by persons other than banks or 
financial institutions.

Paragraph 6 of New Article 27

    Paragraph 6 of new Article 27 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 New Article 27

    Paragraph 7 provides for assistance in collection of taxes 
to the extent necessary to ensure that treaty benefits are 
enjoyed only by persons entitled to those benefits under the 
terms of the Convention. Under paragraph 7, a Contracting State 
will endeavor to collect on behalf of the other State only 
those amounts necessary to ensure that any exemption or reduced 
rate of tax granted under the Convention by that other State is 
not enjoyed by persons not entitled to those benefits. For 
example, if the payer of a U.S.-source portfolio dividend 
receives a Form W-8BEN or other appropriate documentation from 
the payee, the withholding agent is permitted to withhold at 
the portfolio dividend rate of 15 percent. If, however, the 
addressee is merely acting as a nominee on behalf of a third-
country resident, paragraph 7 would obligate Spain to withhold 
and remit to the United States the additional tax that should 
have been collected by the U.S. withholding agent.
    This paragraph also makes clear that the Contracting State 
asked to collect the tax is not obligated, in the process of 
providing collection assistance, to carry out administrative 
measures that are different from the laws or administrative 
practice of either Contracting State from those used in the 
collection of its own taxes, or that would be contrary to its 
sovereignty, security, or public policy.

Paragraph 8 of New Article 27

    Paragraph 8 of new Article 27 states that the competent 
authorities of the Contracting States may develop an agreement 
concerning the mode of application of the Article. The Article 
authorizes the competent authorities to exchange information on 
an automatic basis, on request in relation to a specific case, 
or spontaneously. It is contemplated that the Contracting 
States will utilize this authority to engage in all of these 
forms of information exchange, as appropriate.
    The competent authorities may also agree on specific 
procedures and timetables for the exchange of information. In 
particular, the competent authorities may agree on minimum 
thresholds regarding tax at stake or take other measures aimed 
at ensuring some measure of reciprocity with respect to the 
overall exchange of information between the Contracting States.
            Effective dates and termination in relation to exchange of 
                    information
    Once the Protocol is in force, the competent authority may 
seek information under the Protocol with respect to a year 
prior to the entry into force of the Protocol. In that case, 
the competent authorities have available to them the full range 
of information exchange provisions afforded under this Article.
    In contrast, if the provisions of new Article 27 were to 
terminate in accordance with the provisions of Article 30 
(Termination) of the existing Convention, it would cease to 
authorize, as of the date of termination, any exchange of 
information, even with respect to a year for which the Protocol 
was in force. In such case, the tax administrations of the two 
countries would only be able to exchange information to the 
extent allowed under either domestic law or another 
international agreement or arrangement.

                              ARTICLE XIV

    This Article makes a number of amendments to the Protocol 
of 1990.

Paragraph 1

    Paragraph 1 amends paragraph 5 of the Protocol of 1990 by 
deleting subparagraph 5(b) and renaming subparagraph 5(c) as 
subparagraph 5(b). Existing subparagraph 5(b) was deleted 
because it is no longer necessary, given the inclusion into 
Article 1 (General Scope) of the Convention of new paragraph 6, 
pursuant to Article 1 of this Protocol.

Paragraph 2

    Paragraph 2 replaces paragraph 7 of the Protocol of 1990. 
In the case of Spain, new subparagraph 7(a) provides special 
rules regarding dividend withholding on dividends paid by 
certain Spanish entities. Clause (i) provides that the 5 
percent withholding limitation provided in subparagraph 2(a) of 
Article 10 (Dividends) shall not apply in the case of dividends 
paid by an entity regulated under the law 11/2009 of 26th 
October on Sociedades Anonimas Cotizadas de Inversion en el 
Mercado Inmobiliario (SOCIMI) or successor statutes. Instead, 
the 15 percent withholding limitation provided in subparagraph 
2(b) of Article 10, or the exemption from withholding provided 
in paragraph 4 of Article 10 for dividends paid to pension 
funds, as the case may be, shall apply with respect to such 
dividends, but only if the beneficial owner of the dividends 
holds, directly or indirectly, capital that represents no more 
than 10 percent of all of the capital in the SOCIMI. Clause 
(ii) provides that the 5 percent withholding limitation shall 
also not apply in the case of dividends paid by a Spanish 
investment institution regulated under the law 35/2003 of 4th 
November on Instituciones de Inversion Colectiva or successor 
statutes. Instead, the 15 percent withholding limitation 
provided in subparagraph 2(b) of Article 10, or the exemption 
from withholding provided in paragraph 4 of Article 10 for 
dividends paid to pension funds, as the case may be, shall 
apply with respect to such dividends.
    In the case of the United States, new subparagraph 7(b) 
imposes limitations on the rate reductions provided by 
subparagraph 2(a) of revised Article 10 in the case of 
dividends paid by a regulated investment company (RIC) or a 
real estate investment trust (REIT). The first sentence of new 
subparagraph 7(b) provides that dividends paid by a RIC or REIT 
are not eligible for the 5 percent rate of withholding tax of 
subparagraph 2(a) of revised Article 10. The second sentence of 
new subparagraph 7(b) provides that the 15 percent maximum rate 
of withholding tax of subparagraph 2(b) of revised Article 10 
applies to dividends paid by RICs and that the elimination of 
source-country withholding tax of paragraph 4 of revised 
Article 10 applies to dividends paid by RICs and beneficially 
owned by a pension fund.
    The third sentence of new subparagraph 7(b) provides that 
the 15 percent rate of withholding tax also applies to 
dividends paid by a REIT and that the elimination of source-
country withholding tax of paragraph 4 of revised Article 10 
applies to dividends paid by REITs and beneficially owned by a 
pension fund, provided that one of the three following 
conditions is met. First, the beneficial owner of the dividend 
is an individual or a pension fund, in either case holding an 
interest of not more than 10 percent in the REIT. Second, the 
dividend 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 shares. Third, the beneficial owner of the 
dividend holds an interest in the REIT of not more than 10 
percent and the REIT is ``diversified.''
    New subparagraph 7(b) provides a definition of the term 
``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. Section 856(e) 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.

Paragraph 3

    Paragraph 3 replaces paragraph 8 of the Protocol of 1990. 
New paragraph 8 provides a definition of the term ``real estate 
mortgage investment conduit (REMIC)'' for purposes of revised 
Article 11 (Interest) of the Convention as amended by Article 
V. The term means an entity that has in effect an election to 
be treated as a REMIC under Code Section 860D.

Paragraph 4

    Paragraph 4 deletes subparagraph 10(c) of the Protocol of 
1990 as a conforming change to the amendments made to Article 
13 (Capital Gains) of the Convention by Article VII.

Paragraph 5

    Paragraph 5 deletes paragraph 11 of the Protocol of 1990 as 
a conforming change to the deletion of Article 14 (Branch Tax) 
of the Convention by Article VIII.

Paragraph 6

    Paragraph 6 deletes paragraph 12 of the Protocol of 1990. 
Prior paragraph 12 referred to Commentary on Article 14 
(Independent Personal Services) of the 1977 Model Convention 
for the Avoidance of Double Taxation with Respect to Taxes on 
Income and on Capital of the Organisation for Economic 
Cooperation and Development, and of any guidelines which, for 
the application of such Article, may be developed in the 
future. The deletion of prior paragraph 12 ensures that the 
Contracting States can interpret Article 14 (Independent 
Personal Services) of the Convention in an ambulatory manner 
and consistently with the prevailing Commentaries of the OECD 
Model.

Paragraph 7

    Paragraph 7 amends paragraph 13 of the Protocol of 1990. 
Revised paragraph 13 describes in a non-exhaustive fashion 
those entities to which clause (ii) of subparagraph 2(d) of 
revised Article 17 (Limitation on Benefits) as restated by 
Article IX applies. Because under Spain's current domestic law, 
a number of the entities described, including pension funds 
established in Spain, are not exempt from tax, the words ``tax 
exempt'' have been deleted from paragraph 13.

Paragraph 8

    Paragraph 8 replaces paragraph 18 of the Protocol of 1990. 
New paragraph 8 defines the term ``first notification'' for the 
purposes of applying paragraph 1 of Article 26 (Mutual 
Agreement Procedure) of the Convention. The term means, in the 
case of the United States, the Notice of Proposed Adjustment, 
and in the case of Spain, the Notification of the 
Administrative Act of Assessment.
    With respect to paragraph 5 of Article 26 as amended by 
Article XII, paragraph 8 clarifies when taxation not in 
accordance with the Convention shall be considered to have 
resulted from the actions of one or both of the Contracting 
States. The Contracting States understand that an action of 
either Contracting State that has resulted in taxation not in 
accordance with the provisions of the Convention shall include 
a Notice of Proposed Adjustment, a Notification of the 
Administrative Act of Assessment or in the case of taxes at 
source, a payment or withholding of tax.

Paragraph 9

    Paragraph 9 deletes paragraph 19 of the Protocol of 1990. 
The deletion of prior paragraph 19 permits the Contracting 
States to interpret Article 27 (Exchange of Information and 
Administrative Assistance) of the Convention as amended by 
Article XIII, in an ambulatory manner and consistently with the 
prevailing Commentaries of the OECD Model.

Paragraph 10

    Paragraph 10 adds a new paragraph 21 to the Protocol of 
1990. New paragraph 21 sets forth a number of principles 
related to the implementation of the mandatory binding 
arbitration rules provided in new paragraphs 5 and 6 of Article 
26 (Mutual Agreement Procedure).
    New subparagraph 21(a) of the Protocol to 1990 sets forth 
rules that the competent authorities of the Contracting States 
shall follow for selecting the members of the arbitration 
panel. The arbitration panel shall consist of three individual 
members. The members appointed shall not be employees nor have 
been employees within the twelve-month period prior to the date 
on which the arbitration proceeding begins, of the tax 
administration, the Treasury Department or the Ministry of 
Finance of the Contracting State which identifies them. Each 
competent authority of the Contracting States shall select one 
member of the arbitration panel. The two members of the 
arbitration panel who have been selected shall select the third 
member, who shall serve as Chair of the arbitration panel. If 
the two initial members of the arbitration panel fail to select 
the third member in the manner and within the time periods 
prescribed by the competent authorities of the Contracting 
States pursuant to subparagraph 6(g)(iii) of Article 26 of the 
Convention, these members shall be dismissed, and each 
competent authority of the Contracting States shall select a 
new member of the arbitration panel. The Chair shall not be a 
national or lawful permanent resident of either Contracting 
State.
    New subparagraph 21(b) of the Protocol of 1990 provides 
that if at any time before the arbitration panel delivers a 
determination to the competent authorities certain events 
occur, notwithstanding the initiation of an arbitration 
proceeding, the arbitration proceeding and the mutual agreement 
procedure with respect to a case shall terminate.
    Clause (i) provides that the arbitration proceeding and the 
mutual agreement procedure with respect to a case shall 
terminate if the competent authorities of the Contracting 
States reach a mutual agreement to resolve the case. Clause 
(ii) provides that the arbitration proceeding and the mutual 
agreement procedure with respect to a case shall terminate if 
the presenter of the case withdraws the request for 
arbitration, as is the case for the mutual agreement procedure 
as a general matter. Clause (iii) provides that the arbitration 
proceeding and the mutual agreement procedure with respect to a 
case shall terminate if any concerned person, or any of their 
representatives or agents, willfully violates the written 
statement of nondisclosure referred to in clause (iii) of 
subparagraph (c) of paragraph 6, and the competent authorities 
of both Contracting States agree that such violation should 
result in the termination of the arbitration proceeding. 
Finally, clause (iv) provides that the arbitration proceeding 
and the mutual agreement procedure with respect to a case shall 
terminate if any concerned person initiates a legal action or 
suit before the courts of either Contracting State concerning 
any issue involved in the case, unless such legal action or 
suit is suspended according to the applicable laws of the 
Contracting State.
    New subparagraph 21(c) of the Protocol to 1990 sets forth 
the rule governing the submission of proposed resolutions for 
consideration by the arbitration panel. The competent authority 
of each of the Contracting States shall be permitted to submit 
a proposed resolution addressing each adjustment or similar 
issue raised in the case. Such proposed resolution shall be a 
resolution of the entire case and shall reflect without 
modification all matters in the case previously agreed between 
the competent authorities of both of the Contracting States. 
Such proposed resolution shall be limited to a disposition of 
specific monetary amounts (for example, of income, profit, gain 
or expense) or, where specified, the maximum rate of tax 
charged pursuant to the Convention for each adjustment or 
similar issue in the case. The competent authority of each of 
the Contracting States shall also be permitted to submit a 
supporting position paper for consideration by the arbitration 
panel.
    New subparagraph 21(d) of the Protocol of 1990 provides a 
special rule for proposed resolutions involving an initial 
determination of a threshold question (such as the existence of 
a permanent establishment). Subparagraph 21(d) provides that 
notwithstanding the provisions of subparagraph 21(c), it is 
understood that, in the case of an arbitration proceeding 
concerning: i) the tax liability of an individual with respect 
to whose State of residence the competent authorities have been 
unable to reach agreement; ii) the taxation of the business 
profits of an enterprise with respect to which the competent 
authorities have been unable to reach an agreement on whether a 
permanent establishment exists; or iii) such other issues the 
determination of which are contingent on resolution of similar 
threshold questions, the proposed resolutions and position 
papers may include positions regarding the relevant threshold 
questions in clause i), ii) or iii) above (for example, the 
question of whether a permanent establishment exists), in 
addition to proposed resolutions to the contingent 
determinations (for example, the determination of the amount of 
profit attributable to such permanent establishment). The 
determination of the arbitration panel regarding the initial 
threshold question may preclude the need for a further 
determination regarding contingent determinations.
    New subparagraph 21(e) of the Protocol of 1990 provides 
that where an arbitration proceeding concerns a case comprising 
multiple adjustments or issues each requiring a disposition of 
specific monetary amounts of income, profit, gain or expense 
or, where specified, the maximum rate of tax charged pursuant 
to the Convention, the proposed resolution may propose a 
separate disposition for each adjustment or similar issue. This 
flexibility permits each adjustment or issue to be resolved 
independently through the arbitration proceeding, such that the 
determination of the arbitration panel will constitute a mutual 
agreement of the entirety of the issues in the case.
    New subparagraph 21(f) of the Protocol of 1990 provides 
that each of the competent authorities of the Contracting 
States shall receive the proposed resolution and position paper 
submitted by the other competent authority, and shall be 
permitted to submit a reply submission to the arbitration 
panel. Each of the competent authorities of the Contracting 
States shall also receive the reply submission of the other 
competent authority.
    New subparagraph 21(g) of the Protocol of 1990 provides 
that the presenter of the case shall be permitted to submit for 
consideration by the arbitration panel a paper setting forth 
the presenter's analysis and views of the case. The submission 
by the presenter of the case is not a proposed resolution that 
the arbitration panel could select in making its determination. 
The submission by the presenter may not include any information 
not previously provided to the competent authorities prior to 
the initiation of an arbitration proceeding. The competent 
authorities should determine an appropriate time frame for 
submission of such paper by the presenter in order to ensure 
that the competent authorities have sufficient time to consider 
the information.
    New subparagraph 21(h) of the Protocol of 1990 provides 
that the arbitration panel shall deliver a determination in 
writing to the competent authorities of the Contracting States. 
The determination reached by the arbitration panel in the 
arbitration proceeding shall be limited to one of the proposed 
resolutions for the case submitted by one of the competent 
authorities of the Contracting States for each adjustment or 
similar issue and any threshold questions, and shall not 
include a rationale or any other explanation of the 
determination. The determination of the arbitration panel shall 
have no precedential value with respect to the application of 
the Convention in any other case.
    New subparagraph 21(i) of the Protocol of 1990 provides 
that unless the competent authorities of both Contracting 
States agree to a longer time period, the presenter of the case 
shall have 45 days from receiving the determination of the 
arbitration panel to notify, in writing, the competent 
authority of the Contracting State to whom the case was 
presented, his acceptance of the determination. In the event 
the case is pending in litigation, each concerned person who is 
a party to the litigation must also advise, within the same 
time frame, the relevant court of its acceptance of the 
determination of the arbitration panel as the resolution by 
mutual agreement and its intention to withdraw from the 
consideration of the court the issues resolved through the 
proceeding. If any concerned person fails to so advise the 
relevant competent authority and relevant court within this 
time frame, the determination of the arbitration panel shall be 
considered not to have been accepted by the presenter of the 
case. Where the determination of the arbitration panel is not 
accepted, the case will not be eligible for any subsequent 
further consideration by the competent authorities.
    New subparagraph 21(j) of the Protocol of 1990 provides 
that the fees and expenses of the members of the arbitration 
panel, as well as any costs incurred in connection with the 
proceeding by the Contracting States, shall be borne equitably 
by the competent authorities of Contracting States.

                               ARTICLE XV

    This Article contains rules for bringing the Protocol into 
force and giving effect to its provisions.

Paragraph 1

    Paragraph 1 obligates the governments of the Contracting 
States to notify each other through diplomatic channels when 
the internal procedures required by each Contracting State for 
the entry into force of the Protocol have been complied with. 
In the United States, the process leading to ratification and 
entry into force is as follows: Once a treaty has been signed 
by authorized representatives of the two Contracting States, 
the Department of State sends the treaty to the President who 
formally transmits it to the Senate for its advice and consent 
to ratification, which requires approval by two-thirds of the 
Senators present and voting. Prior to this vote, however, it 
generally has been the practice for the Senate Committee on 
Foreign Relations to hold hearings on the treaty and make a 
recommendation regarding its approval to the full Senate. Both 
Government and private sector witnesses may testify at these 
hearings. After the Senate gives its advice and consent to 
ratification of the protocol or treaty, an instrument of 
ratification is drafted for the President's signature. The 
President's signature completes the process in the United 
States.

Paragraph 2

    Paragraph 2 provides that the Protocol will enter into 
force three months following the date of the later of the Notes 
referred to in paragraph 1. The date on which a treaty enters 
into force is not necessarily the date on which its provisions 
take effect. Paragraph 2, therefore, also contains rules that 
determine when the provisions of the treaty will have effect.
    Under subparagraph 2(a), the Protocol will have effect with 
respect to taxes withheld at source (principally dividends, 
interest and royalties) for amounts paid or credited on or 
after the date on which the Protocol enters into force. For 
example, if the later of the Notes referred to in paragraph 1 
is dated April 25 of a given year, the withholding rates 
specified in new Article 11 of the Convention as amended by 
Article V of the Protocol would be applicable to any interest 
paid or credited on or after July 25 of that year. This rule 
allows the benefits of the withholding reductions to be put 
into effect without waiting until the following year. The delay 
of three months is required to allow sufficient time for 
withholding agents to be informed about the change in 
withholding rates. If for some reason a withholding agent 
withholds at a higher rate than that provided by the Convention 
(perhaps because it was not able to re-program its computers 
before the payment is made), a beneficial owner of the income 
that is a resident of the other Contracting State may make a 
claim for refund pursuant to section 1464 of the Code.
    Under subparagraph 2(b), the Protocol will have effect with 
respect to taxes determined with reference to a taxable period 
beginning on or after the date on which the Protocol enters 
into force.
    For all other taxes, subparagraph 2(c) specifies that the 
Protocol will have effect on or after the date on which the 
Protocol enters into force.

Paragraph 3

    Paragraph 3 sets forth additional rules regarding the 
applicability of the mandatory binding arbitration rules 
provided in paragraphs 5, 6 of revised Article 26 of the 
Convention as amended by Article XII of the Protocol.
    Under paragraph 3, paragraphs 5 and 6 of revised Article 26 
of the Convention are not effective for cases that are under 
consideration by the competent authorities as of the date on 
which the Protocol enters into force. For cases that come under 
such consideration after the Protocol enters into force, the 
provision of paragraphs 5 and 6 of revised Article 26 of the 
Convention shall have effect on the date on which the competent 
authorities agree in writing on a mode of application pursuant 
to subparagraph (g) of paragraph 6 of Article 26. In addition, 
the commencement date for cases that are under consideration by 
the competent authorities as of the date on or after which the 
Convention enters into force, but before such provisions have 
effect, is the date on which the competent authorities have 
agreed in writing on the mode of application.

                                 OTHER

    The various provisions in the Memorandum of Understanding 
are explained above in the relevant portions of the Technical 
Explanation with the exception of paragraph 2. Paragraph 2 
provides that with reference to paragraph 3 of the Protocol of 
1990, the Contracting States commit to initiate discussions as 
soon as possible, but no later than six months after entry into 
force of the Protocol, regarding the conclusion of an 
appropriate agreement to avoid double taxation on investments 
between Puerto Rico and Spain.

                                  [all]