UNITED STATES-HUNGARY INCOME TAX CONVENTION

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UNITED STATES-HUNGARY INCOME TAX CONVENTION [FN1]

November 28, 1979

Convention signed at Washington February 12, 1979;

Ratification advised by the Senate of the United States of America July 9, 1979;

Ratified by the President of the United States of America August 7, 1979;

Notes exchanged at Budapest September 18, 1979;

Proclaimed by the President of the United States of America November 28, 1979;

Entered into force September 18, 1979.

BY THE PRESIDENT OF THE UNITED STATES OF AMERICA

A PROCLAMATION

CONSIDERING THAT: The Convention between the Government of the United States of America and the Government of the Hungarian People's Republic for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income was signed at Washington on February 12, 1979, together with a related exchange of notes,the texts of which are hereto annexed; The Senate of the United States of America by its resolution of July 9, 1979, two-thirds of the Senators present concurring therein, gave its advice and consent to ratification of the Convention and related exchange of notes; The Convention and related exchange of notes were ratified by the President of the United States of America on August 7, 1979,in pursuance of the advice and consent of the Senate, and was approved on the part of the Hungarian People's Republic; The parties notified one another at Budapest on September 18,1979, that their respective constitutional requirements had been met, and accordingly the Convention, with related exchange of notes, entered into force on September 18, 1979, effective as specified in Article 25;

NOW, THEREFORE, I, Jimmy Carter, President of the United States of America, proclaim and make public the Convention with related exchange of notes, to the end that they be observed and fulfilled with good faith on and after September 18, 1979, by the United States of America and by the citizens of the United States of America and all other persons subject to the jurisdiction thereof.

IN TESTIMONY WHEREOF, I have signed this proclamation and caused the Seal of the United States of America to be affixed. DONE at the city of Washington this twenty-eighth day of November in the year of our Lord one thousand nine hundred seventy-nine and of the Independence of the United States of America the two hundred fourth. JIMMY CARTER By the President: CYRUS VANCE Secretary of State

CONVENTION BETWEEN THE GOVERNMENT OF THE UNITED STATED OF AMERICA AND THE GOVERNMENT OF THE HUNGARIAN PEOPLE'S REPUBLIC FOR THE AVOIDANCE OF DOUBLE TAXATION AND THE PREVENTION OF FISCAL EVASION WITH RESPECT TO TAXES ON INCOME

The Government of the United States of America and the Government of the Hungarian People's Republic, desiring to further expand and facilitate mutual economic relations, have resolved to conclude a convention for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income, and have agreed as follows:

Article 1

PERSONAL SCOPE

1. This Convention shall apply to persons who are residents of one or both of the Contracting States, except as otherwise provided in this convention.

2. Notwithstanding any provision of this Convention except paragraph 3 of this Article, a Contracting State may tax its residents (as determined under Article 4 (Fiscal Domicile)) and citizens (including, in the case of the United States, former citizens) as if this Convention had not come into effect.

3. The provisions of paragraph 2 shall not affect: (a) The benefits conferred by a Contracting State under paragraph 2 of Article 15 (Pensions), Articles 20 (Relief from Double Taxation),21 (Non- discrimination), and 22 (Mutual Agreement Procedure);and (b) The benefits conferred by a Contracting State under Articles 16 (Government Service), 17 (Teachers), 18 (Students and Trainees) and 24 (Effect of Convention on Diplomatic and Consular Officials, Domestic Laws, and Other Treaties), upon individuals who are neither citizens of, nor have immigrant status in, that State.

Article 2

TAXES COVERED

1. This Convention shall apply to taxes on income imposed on behalf of each Contracting State.

2. The existing taxes to which this Convention shall apply are: (a) In the case of the United States, the Federal income taxes imposed by the Internal Revenue Code and the excise taxes imposed on insurance premiums paid to foreign insurers and with respect to private foundations, but excluding the accumulated earnings tax and the personal holding company tax. (b) In the case of the Hungarian People's Republic: (i) The general income tax. (ii) The income tax on intellectual activities, (iii) The profit tax, (iv) The profit tax on economic associations with foreign participation, $DPA3(v) The enterprises special tax, (vi) The levy on dividends and profit distributions of commercial companies, (vii) The profit tax on state-owned enterprises, and (viii) The contribution to communal development, but only to the extent imposed in respect of income taxes covered by this Convention.

3. The Convention shall apply also to any identical or substantially similar taxes which are imposed by a Contracting State after the date of signature of this Convention in addition to, or in place of, the existing taxes. The competent authorities of the Contracting States shall notify each other of any changes which have been made in their respective taxation laws and shall notify each other of any official published material concerning the application of this Convention, including explanations, regulations, rulings, or judicial decisions.

4. For the purpose of Article 21 (Non-discrimination), this Convention shall also apply to taxes of every kind and description imposed by a Contracting State or a political subdivision or local authority thereof. For the purpose of Article 23 (Exchange of Information), this Convention shall also apply to taxes of every kind imposed by a Contracting State.

Article 3

GENERAL DEFINITIONS

1. In this Convention, unless the context otherwise requires:(a) The term 'person' includes an individual, a partnership, a company or juridical person, an estate, a trust, and any other body of persons; (b) The term 'company' means any body corporate or any entity which is treated as a body corporate for tax purposes; (c) The terms 'enterprise of a Contracting State's and 'enterprise of the other Contracting State's means respectively an enterprise carried on by a resident of a Contracting State and an enterprise carried on by a resident of the other Contracting State; (d) The term 'nationals' means: (i) All individuals possessing the citizenship of a Contracting State, and (ii) All legal persons, partnerships and associations deriving their status as such from the law in force in a Contracting State; (e) The terms 'international traffic' means any transport by a ship or aircraft, except where such transport is solely between places in the other Contracting State; (f) The term 'competent authority' means: (i) In the case of the United States, the Secretary of the Treasury or his delegate, and (ii) In the case of the Hungarian People's Republic, the Minister of Finance or his delegate; (g) (i) The term 'United States' means the United States of America, and (ii) When used in a geographical sense,the term 'United States' does not include Puerto Rico, the Virgin Islands, Guam, or any other United States possession or territory; and (h) The term 'Hungarian People's Republic', when used in a geographical sense, means the territory of the Hungarian People's Republic.

2. As regards the application of this Convention by a Contracting State any term not otherwise defined shall, unless the context otherwise requires and subject to the provisions of Article 22 (Mutual Agreement Procedure), have the meaning which it has under the laws of that Contracting State relating to the taxes which are the subject of this Convention.

Article 4

FISCAL DOMICILE

1. For purposes of this Convention, the term 'resident of a Contracting State's means any person who, under the law of that State, is liable to taxation therein by reason of his domicile, residence, citizenship, place of management, place of incorporation, or any other criterion of a similar nature, provided, however, that: (a) This term does not include any person who is liable to tax in that Contracting State in respect only of income from sources therein or capital situated in that State; and (b) In the case of income derived or paid by a partnership, estate, or trust, this term applies only to the extent that the income derived by such partnership, estate, or trust is subject to tax as the income of a resident of the Contracting State, either in its hands or in the hands of its partners or beneficiaries.

2. Where by reason of the provisions of paragraph 1 an individual is a resident of both Contracting States, then the individual's tax status shall be determined as follows: (a) The individual shall be deemed to be a resident of the Contracting State in which the individual has a permanent home available to him. If the individual has a permanent home available to him in both Contracting States or in neither Contracting State, the individual shall be deemed to be a resident of the Contracting State in which the individual's center of vital interests is located; (b) If the Contracting State in which the individual's center of vital interests is located cannot be determined, the individual shall be deemed to be resident of that Contracting State in which the individual has an habitual abode; (c) If the individual has an habitual abode in both Contracting States or in neither of them, the individual shall be deemed to be a resident of the Contracting State of which the individual is a national; and (d) If the individual is a national of both Contracting States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement.

3. Where by reason of the provisions of paragraph 1 a company is a resident of both Contracting States, then if it is created or organized under the laws of a Contracting State or a political subdivision thereof, it shall be treated as a resident of that State.

4. Where by reason of the provisions of paragraph 1 a person other than an individual or a company is a resident of both Contracting States, the competent authorities of the Contracting States shall by mutual agreement endeavor to settle the question and to determine the mode of application of the Convention to such person.

5. For purposes of this Convention, an individual who is a national of a Contracting State shall also be deemed to be a resident of that State if (a) the individual is an employee of that State or an instrumentality thereof in the other Contracting State or in a third State; (b) the individual is engaged in the performance of governmental functions for the first-mentioned State; and (c) the individual is subjected in the first-mentioned State to the same obligations in respect of taxes on income as are residents of the first mentioned State. The spouse and minor children residing with the employee and subject to the requirements of (c) above shall also be deemed to be residents of the first-mentioned State.

Article 5

PERMANENT ESTABLISHMENT

1. For the purposes of this Convention, the term 'permanent establishment' means a fixed place of business or production through which the activities of an enterprise are wholly or partially carried on.

2. The term 'permanent establishment' shall include especially: (a) A place of management; (b) A branch; (c) An office; (d) A factory; (e) A workshop; and (f) A mine, an oil or gas well, a quarry, or any other place of extraction of natural resources.

3. A building site or construction or installation project, or an installation or drilling rig or ship used for the exploration of development of natural resources, shall constitute a permanent establishment only if it lasts more than 24 months.

4. Notwithstanding the preceding provisions of this Article,the term 'permanent establishment' shall be deemed not to include: (a) The use of facilities solely for the purpose of storage, display or delivery of goods or merchandise belonging to the enterprise; (b) The maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display or delivery; (c) The maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise; (d) The maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or for collecting information, for the enterprise; (e) The maintenance of a fixed place of business solely for the purpose of carrying on for the enterprise any other activity if it has a preparatory or auxiliary character; and (f) The maintenance of a fixed place of business solely for any combination of the activities mentioned in subparagraphs a)to e) of this paragraph.

5. Notwithstanding the provisions of paragraphs 1 and 2, where a person-- other than an agent of an independent status to whom paragraph 6 applies--is acting on behalf of an enterprise and has, and habitually exercises in a Contracting State, an authority to conclude contracts in the name of such enterprise, that enterprise shall be deemed to have a permanent establishment in respect of any activities which that person undertakes for the enterprise, unless the activities of such person are limited to those mentioned in paragraph 4 which, if exercised at a fixed place of business, would not make this place of business a permanent establishment under the provisions of that paragraph.

6. An enterprise shall not be deemed to have a permanent establishment in a Contracting State merely because it carries on business in that State through a broker, general commission agent or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business.

7. The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other State (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other.

Article 6

INCOME FROM IMMOVABLE PROPERTY (REAL PROPERTY)

1. Income derived by a resident of a Contracting State from immovable property (real property) situated in the other Contracting State may be taxed in that other State.

2. The term 'immovable property' shall have the meaning which it has under the law of the Contracting State in which the property in question is situated. The term shall in any case include property accessory to immovable property, livestock and equipment used in agriculture and forestry, rights to which the provisions of general law respecting land property apply, usufruct of immovable property and rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources and other natural resources; ships, boats and aircraft shall not be regarded as immovable property.

3. The provisions of paragraph 1 shall apply to income derived from the direct use, letting, or use in any other form of immovable property.

4. The provisions of paragraphs 1 and 3 shall also apply to the income from immovable property of an enterprise and to income from immovable property used for the performance of independent personal services.

Article 7

BUSINESS PROFITS

1. The business profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the business profits of the enterprise may be taxed in that other State but only so much of them as is attributable to that permanent establishment.

2. Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the business profits which it might be expected to make if it were a distinct and independent enterprise engaged in the same or similar activities under the same or similar conditions.

3. In the determination of the business profits of a permanent establishment, there shall be allowed as deductions those expenses which are incurred for the purposes of the permanent establishment, including a reasonable allocation of executive and general administrative expenses, research and development expenses, interest, and other expenses incurred for the purposes of the enterprise as a whole (or the part thereof which includes the permanent establishment), whether incurred in the State in which the permanent establishment is situated or elsewhere.

4. No business profits shall be attributed to a permanent establishment by reason of: (a) The mere purchase by that permanent establishment of goods or merchandise for the enterprise, or (b) The mere delivery to the permanent establishment of goods or merchandise for its use.

5. Where business profits include items of income which are dealt with separately in other Articles of this Convention, then the provisions of those Articles shall not be affected by the provisions of this Article.

Article 8

SHIPPING AND AIR TRANSPORT

1. Profits of an enterprise of a Contracting State from the operation in international traffic of ships or aircraft shall be taxable only in that State.

2. For purposes of this Article, profits from the operation of ships or aircraft in international traffic include profits derived from the rental on a full or bareboat basis of ships or aircraft operated in international traffic if such rental profits are incidental to other profits described in paragraph 1.

3. Profits of an enterprise of a Contracting State from the use, maintenance or rental of containers (including trailers and related equipment for the transport of containers) used for the transport of goods or merchandise in international traffic shall be taxable only in that State.

4. The provisions of this Article shall also apply where the enterprise has an agency in the other State for the transportation of goods or persons, but only to the extent of activities directly connected with the business of shipping and aircraft transportation, including auxiliary activities connected therewith.

Article 9

DIVIDENDS

1. Dividends paid by a company which is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State.

2. However, such dividends may be taxed in the Contracting State of which the company paying the dividends is a resident,and according to the law of that State, but if the beneficial owner of the dividends is a resident of the other Contracting State, the tax so charged shall not exceed: (a) Five percent of the gross amount of the dividends if the beneficial owner is a company which owns, directly or indirectly, at least 10 percent of the voting stock of the company paying the dividends; (b) In all other cases, 15 percent of the gross amount of the dividends. This paragraph shall not affect the taxation of the company in respect of the profits out of which the dividends are paid.

3. The term 'dividends' as used in this Article means income from shares or other rights, not being debt-claims, participating in profits, as well as income from other corporate rights which is subjected to the same taxation treatment as income from shares by the taxation law of the State of which the company making the distribution is a resident.

4. The provisions of paragraphs 1 and 2 shall not apply if the recipient of the dividends, being a resident of a Contracting State, carries on business in the other Contracting State, of which the company paying the dividends is a resident, through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the holding in respect of which the dividends are paid is effectively connected with such permanent establishment or fixed base. In such case, the provisions of Article 7 (Business Profits) or Article 13 (Independent Personal Services), as the case may be, shall apply.

5. Where a company is a resident of a Contracting State, the other Contracting State may not impose any tax on the dividends paid by the company, except insofar as: (a) Such dividends are paid to a resident of that other State, (b) The holding in respect of which the dividends are paid is effectively connected with a permanent establishment or a fixed base situated in that other State, or (c) Such dividends are paid out of profits attributable to a permanent establishment which such company had in that other State, provided that at least 50 percent of such company's gross income from all sources was attributable to a permanent establishment which such company had in that other State. Where subparagraph (c) applies and subparagraphs (a) and (b) do not apply, any such tax shall be subject to the limitations of paragraph 2.

Article 10

INTEREST

1. Interest arising in a Contracting State and paid to a resident of the other Contracting State shall be taxable only in that other State.

2. The term 'interest' as used in this Convention means income from debt- claims of every kind, whether or not secured by mortgage, and whether or not carrying a right to participate in the debtor's profits, and in particular, income from government securities and income from bonds or debentures, including premiums or prizes attaching to bonds or debentures.

3. The provisions of paragraph 1 shall not apply if the person deriving the interest, being a resident of a Contracting State, carries on business in the other Contracting State through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the debt claim in respect of which the interest is paid is effectively connected with such permanent establishment or fixed base. In such a case, the provisions of Article 7 (Business Profits) or Article 13 (Independent Personal Services), as the case may be, shall apply.

Article 11

ROYALTIES

1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State shall be taxable only in that other State.

2. The term 'royalties' as used in this Article means payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work, including cinematographic films or films or tapes used for radio or television broadcasting, any patent, trade mark, design or model, plan, secret formula or process, or other like right or property, or for information concerning industrial, commercial or scientific experience.

3. The provisions of paragraph 1 shall not apply if the person deriving the royalties, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties arise through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the right or property in respect of which the royalties are paid is effectively connected with such permanent establishment or fixed base. In such a case the provisions of Article 7 (Business Profits) or Article 13 (Independent Personal Services), as the case may be, shall apply.

Article 12

CAPITAL GAINS

1. Gains derived by a resident of a Contracting State from the alienation of immovable property, as defined in paragraph 2 of Article 6 (Immovable Property), situated in the other Contracting State may be taxed in that other State.

2. Gains from the alienation of movable property forming part of the business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State or of movable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment (alone or together with the whole enterprise) or of such a fixed base, may be taxed in the other State. However, gains derived by an enterprise of a Contracting State from the alienation of ships, aircraft or containers operated by such enterprise in international traffic shall be taxable only in that State.

3. Gains from the alienation of any property other than those mentioned in paragraphs 1 and 2, shall be taxable only in the Contracting State of which the alienator is a resident.

Article 13

INDEPENDENT PERSONAL SERVICES

1. Income derived by an individual who is a resident of a Contracting State from the performance of personal services in an independent capacity shall be taxable only in that State unless such services are performed in the other Contracting State and--(a) The individual is present in that other State for a period or periods aggregating more than 183 days in the taxable year concerned, or (b) The individual has a fixed base regularly available to him in that other State for the purpose of performing his activities, but only so much of the income as is attributable to that fixed base.

2. The term 'personal services' includes, especially, independent scientific, literary, artistic, educational or teaching activities as well as the independent activities of physicians, lawyers, engineers, architects, dentists, artistes, athletes and accountants.

Article 14

DEPENDENT PERSONAL SERVICES

1. Subject to the provisions of Article 15 (Pensions) and 16 (Government Service), salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived therefrom may be taxed in that other State.

2. Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first-mentioned State if: (a) The recipient is present in the other State for a period or periods not exceeding in the aggregate 183 days in the taxable year concerned, and (b) The remuneration is paid by, or on behalf of,an employer who is not a resident of the other State, and (c) The remuneration is not borne by a permanent establishment or a fixed base which the employer has in the other State.

3. Notwithstanding the preceding provisions of this Article, remuneration in respect of an employment as a member of the regular complement of a ship or aircraft operated by an enterprise of a Contracting State in international traffic may be taxed only in that Contracting State.

Article 15

PENSIONS

Subject to the provisions of paragraph 2 of Article 16 (Government Services),

1. Pensions and other similar remuneration beneficially derived by a resident of a Contracting State in consideration of past employment shall be taxable only in that State, and

2. Social security payments and other public pensions paid by a Contracting State to an individual who is a resident of the other Contracting State or a citizen of the United States shall be taxable only in the first-mentioned Contracting State.

Article 16

GOVERNMENT SERVICES

1(a) Remuneration other than a pension, paid by a Contracting State or a political subdivision or a local authority thereof to any individual in respect of services rendered to that State o r subdivision or local authority thereof shall be taxable only in that State. (b) However, such remuneration shall be taxable only in the other Contracting State if the services are rendered in that State and the recipient is a resident of that other Contracting State who: (i) Is a national of that State; or (ii) Did not become a resident of that State solely for the purpose of performing the services.

2(a) Any person paid by, or out of funds created by, a Contracting State or a political subdivision or a local authority thereof to any individual in respect of services rendered to that State or subdivision or local authority thereof shall be taxable only in that State.
(b) However, such pension shall be taxable only in the other Contracting State if the recipient is a national of and a resident of that State.

3. The provisions of Article 13 (Independent Personal Services), 14 (Dependent Personal Services), and 15 (Pensions), as the case may be, shall apply to remuneration and pensions in respect of services rendered in connection with any business carried on by a Contracting State or a political subdivision or a local authority thereof.

Article 17

TEACHERS

1. Where a resident of one of the Contracting States is invited by the Government of the other Contracting State, a political subdivision or a local authority thereof, or by a university or other recognized educational institution in that other Contracting State to come to that other Contracting State for a period not expected to exceed 2 years for the purpose of teaching or engaging in research, or both, at a university or other recognized educational institution, and such resident comes to that other Contracting State primarily for such purpose, his income from personal services for teaching or research at such university or educational institution shall be exempt from tax by that other Contracting State for a period not exceeding 2 years from the date of his arrival in that other Contracting State.

2. This Article shall not apply to income from research if such research is undertaken not in the public interest but primarily for the private benefit of a specific person or persons.

Article 18

STUDENTS AND TRAINEES

1. Payments which a student, apprentice or business trainee who is, or was immediately before visiting a Contracting State, a resident of the other Contracting State and who is present in the first-mentioned Contracting State for the purpose of his full-time education or training receives for the purposes of his maintenance, education or training shall not be taxed in that State provided that such payments are made to him from sources outside that State.

2. An individual to whom paragraph 1 applies may elect to be treated for tax purposes as a resident of the first-mentioned State. The election shall apply to all periods during the taxable year of the election and subsequent taxable years during which the individual qualifies under paragraph 1, and may not be revoked except with the consent of the competent authority of that State.

Article 19

ALL OTHER INCOME

Items of income of a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention shall be taxable only in that State.

Article 20

RELIEF FROM DOUBLE TAXATION

1. In the case of the United States, double taxation shall be avoided as follows: In accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle hereof), the United States shall allow to a resident or citizen of the United States as a credit against the United States tax on income the appropriate amount of tax paid to the Hungarian People's Republic; and, in the case of a United States company owning at least 10 percent of the voting stock of a company which is a resident of the Hungarian People's Republic from which it receives dividends in any taxable year, the United States shall allow as a credit against the United States tax on income the appropriate amount of income tax paid to the Hungarian People's Republic by that company with respect to the profits out of which such dividends are paid. Such appropriate amount shall be based upon the amount of income tax paid to the Hungarian People's Republic, but the credit shall not exceed the limitations (for the purpose of limiting the credit to the United States tax on income from sources outside of the United States) provided by United States law for the taxable year. For purposes of applying the United States credit in relation to tax paid to the Hungarian People's Republic, the taxes referred to in paragraphs 2(b) and 3 of Article 2 (Taxes Covered) shall be considered to be income taxes.

2. In the case of the Hungarian People's Republic, double taxation shall be avoided as follows: (a) Where a resident of the Hungarian People's Republic: (i) Derives income which, in accordance with the provisions of this Convention other than paragraph 2 of Article 1 (Personal Scope), may be taxed in the United States, or (ii) Derives income from sources within the United States which may be taxed only by reason of paragraph 2 of Article 1 (Personal Scope), the Hungarian People's Republic shall, subject to the provisions of subparagraphs (b) and (c),exempt such income from tax. (b) Where a resident of the Hungarian People's Republic derives items of income which, in accordance with the provisions of paragraph 2 of Article 9, maybe taxed in the United States, the Hungarian People's Republic shall allow as a deduction from the tax on the income of that resident an amount equal to the tax paid in the United States. Such deduction shall not, however, exceed that part of the tax, as computed before the deduction is given, which is attributable to such items of income derived from the United States. (c) Where in accordance with any provision of the Convention income derived by a resident of the Hungarian People's Republic is exempt from tax in the Hungarian People's Republic, the Hungarian People's Republic may nevertheless, in calculating the amount of tax on the remaining income of such resident, take into account the exempted income.

Article 21

NON-DISCRIMINATION

1. The nationals of a Contracting State, whether or not they are residents of one of the Contracting States, shall not be subjected in the other State to any taxation or any requirement connected therewith, which is more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances are or may be subjected. For purposes of the preceding sentence, nationals who are subject to tax by a Contracting State on world-wide income are not in the same circumstances as nationals who are not so subject.

2. The taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favorably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities. This Article shall not be construed as obliging a Contracting State to grant to residents of the other Contracting State any personal allowances, reliefs and reductions for taxation purposes on account of civil status or family responsibilities which it grants to its own residents.

3. Interest, royalties and other disbursements paid by an enterprise of a Contracting State to a resident of the other Contracting State shall, for the purpose of determining the taxable profits of such enterprise, be deductible under the same conditions as if they had been paid to a resident of the first-mentioned State. Similarly, any debts of an enterprise of a Contracting State to a resident of the other Contracting State shall, for the purpose of determining the taxable capital of such enterprise, be deductible under the same conditions as if they had been contracted to a resident of the first-mentioned State.

4. Enterprises of a Contracting State, the capital of which is wholly or partly owned or controlled, directly or indirectly by one or more residents of the other Contracting State, shall not be subjected in the first-mentioned Contracting State to any taxation or any requirement connected there with which is more burdensome than the taxation and connected requirements to which other similar enterprises of the first-mentioned State are or may be subjected.

5. In this Article the term 'taxation' means taxes of every kind and description imposed by a Contracting State or a political subdivision or local authority thereof.

Article 22

MUTUAL AGREEMENT PROCEDURE

1. Where a resident or national of a Contracting State considers that the actions of one or both of the Contracting States result or will result for it in taxation not in accordance with this Convention, it may, notwithstanding the remedies provided by the national laws of those States, present its case to the competent authority of the Contracting State of which it is a resident or national.

2. The competent authority shall endeavor, if the objection appears to it to be justified and if it is not itself able to arrive at an appropriate solution, to resolve the case by mutual agreement with the competent authority of the other Contracting State with a view to the avoidance of taxation not in accordance with the Convention. Any agreement reached shall be implemented notwithstanding any time limits in the national laws of the Contracting States.

3. The competent authorities of the Contracting States shall endeavor to resolve by mutual agreement any difficulties or doubts arising as to the interpretation or application of the Convention. They may also consult together for the elimination of double taxation in cases not provided for in the Convention.

4. The competent authorities of the Contracting States may communicate with each other directly for the purpose of reaching an agreement in the sense of the preceding paragraphs.

5. The competent authorities of the Contracting States may prescribe regulations to carry out the purposes of this Convention.

Article 23

EXCHANGE OF INFORMATION

1. The competent authorities of the Contracting States shall exchange such information as is necessary for the carrying out of this Convention or of the domestic laws of the Contracting States concerning taxes covered by this Convention insofar as the taxation thereunder is not contrary to this Convention. The exchange of information is not restricted by Article 1 (Personal Scope). Any information received by a Contracting State shall be treated as secret in the same manner as information obtained under the domestic laws of that State and shall be disclosed only to persons or authorities (including courts and administrative bodies) involved in the assessment or collection of, the enforcement or prosecution in respect of, or the determination of appeals in relation to, the taxes which are the subject of the Convention. Such persons or authorities shall use the information only for such purposes. These persons or authorities may disclose the information in public court proceedings or in judicial decisions.

2. In no case shall the provisions of paragraph 1 be construed so as to impose on one of the Contracting States the obligation:(a) To carry out administrative measures at variance with the laws and administrative practice of that or of the other Contracting State; (b) To supply particulars which are not obtainable under the laws or in the normal course of the administration of that or of the other Contracting State; (c) To supply information which would disclose any trade, business, industrial, commercial or professional secret or trade process, or information, the disclosure of which would be contrary to public policy (order public).

3. If information is requested by a Contracting State in accordance with this Article, the other Contracting State shall obtain the information to which the request relates in the same manner and to the same extent as if the tax of the first-mentioned State were the tax of that other State and were being imposed by that other State. If specifically requested by the competent authority of a Contracting State, the competent authority of the other Contracting State shall provide information under this Article in the form of depositions of witnesses and copies of unedited original documents (including books, documents, statements, records, accounts, or writings), to the same extent such depositions and documents can be obtained under the laws and administrative practices of such other State with respect to its own taxes.

Article 24

EFFECT OF CONVENTION ON DIPLOMATIC AND CONSULAR OFFICIALS, DOMESTIC LAWS, AND OTHER TREATIES

1. Nothing in this Convention shall affect the taxation privileges of diplomatic or consular officials under the general rules of international law or under the provisions of special agreements.

2. This Convention shall not restrict in any manner any exclusion, exemption, deduction, credit, or other allowance now or hereafter accorded-- (a) By the laws of either Contracting State, or (b) By any other agreement between the Contracting States.

Article 25

ENTRY INTO FORCE

1. This Convention shall be subject to ratification or approval in accordance with the applicable procedures of the Governments of the Contracting States and it shall enter into force as soon as the parties have notified one another that their respective constitutional requirements have been met.

2. The provisions of this Convention shall have effect: (a) In respect of tax withheld at the source, to amounts paid o r credited on or after the first day of the second month next following the date on which this Convention enters into force,(b) In respect of other taxes, to taxable periods beginning on or after the first day of January next following the date on which this Convention enters into force.

Article 26

TERMINATION

This Convention shall remain in force until terminated by the Government of one of the Contracting States. The Government of either Contracting State may terminate the Convention at any time after 5 years from the date on which this Convention enters into force provided that at least 6 months' prior notice of termination has been given through diplomatic channels. In such event, the Convention shall cease to have effect:

1. In respect of tax withheld at the source, to amounts paid or credited on or after the first day of January next following the expiration of the 6 months' period;

2. In respect of other taxes, to taxable periods beginning on or after the first day of January next following the expiration of the 6 months' period.

Done at Washington in duplicate, both in the English and Hungarian languages, the two texts having equal authenticity, this 12th day of February 1979. W. MICHAEL BLUMENTHAL, Secretary of the Treasury. For the Government of the Hungarian People's Republic: LAJOS FALUVEGI, Minister of Finance.

FEBRUARY 12, 1979.

His Excellency W. MICHAEL BLUMENTHAL,

Secretary of the Treasury, United States of America.

EXCELLENCY: In connection with the Income Tax Convention signed today, I should like to state our understanding of the agreement reached by the delegations of the United States of America and of the Hungarian People's Republic concerning the application of certain provisions of the Convention:

1. In connection with Article 9, subparagraph 5(c), it is understood that Hungary will not impose a tax in such cases.

2. Income (other than income from immovable property) will be taxed in accordance with the provisions of Article 7 and Article 13, rather than in accordance with the provisions of Article 19, if the person deriving the income, being a resident of one Contracting State, carries on business in the other Contracting State through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the right or property in respect of which the income is paid is effectively connected with such permanent establishment or fixed base.

3. In the case of dealings between an enterprise of one Contracting State and a related enterprise of the other Contracting State that involve conditions that differ from those that would have been made between independent enterprises, each Contracting State may apply its internal law to distribute, apportion or allocate income, deductions, credits and allowances between the related enterprises, to reflect any profits which would, but for those conditions, have accrued to one of the enterprises. The internal law of each Contracting State may also be applied to restrict the exemption of interest provided in paragraph 1 of Article 10 and of royalties provided in paragraph 1 of Article 11 to the amount of interest and royalties that would have been agreed upon between unrelated parties in cases where interest and royalties are paid by an enterprise of one Contracting State to a related enterprise in the other Contracting State.

4. It is agreed that each of the Contracting States shall endeavor to collect on behalf of the other Contracting State such amounts as may be necessary to ensure that relief granted by the present Convention from taxation imposed by such other Contracting State does not enure to the benefit of persons not entitled thereto. This agreement shall not impose upon either of the Contracting States the obligation to carry out administrative measures which are of a different nature from those used in the collection of its own tax, or which would be contrary to its sovereignty, security, or public policy. I have the honor to propose to you that the present note and Your Excellency's reply thereto constitute the agreement of our two Governments on these points. Accept, Excellency, the assurances of my highest consideration. Sincerely yours, LAJOS FALUVEGI, Minister of Finance, Hungarian People's Republic.

FEBRUARY 12, 1979.

His Excellency LAJOS FALUVEGI,

Minister of Finance, Hungarian People's Republic.

EXCELLENCY: I have the honor to refer to your letter of today's date concerning the Income Tax Convention signed today reading as follows: In connection with the Income Tax Convention signed today, I should like to state our understanding of the agreement reached by the delegations of the United States of America and of the Hungarian People's Republic concerning the application of certain provisions of the Convention:

1. In connection with Article 9, subparagraph 5(c), it is understood that Hungary will not impose a tax in such cases.

4. It is agreed that each of the Contracting States shall endeavor to collect on behalf of the other Contracting State such amounts as may be necessary to ensure that relief granted by the present Convention from taxation imposed by such other Contracting State does not enure to the benefit of persons not entitled thereto. This agreement shall not impose upon either of the Contracting States the obligation to carry out administrative measures which are of a different nature from those used in the collection of its own tax, or which would be contrary to its sovereignty, security or public policy. I wish to inform you that I agree with the contents of your letter. Accept, Excellency, the assurance of my highest consideration. Sincerely yours, W. MICHAEL BLUMENTHAL.

Senate Executive Report No. 96-8 [Bracketed numerals indicate official report page numbers]

TAX CONVENTION WITH THE HUNGARIAN PEOPLE'S REPUBLIC

JUNE 15, 1979

Mr. CHURCH, from the Committee on Foreign Relations, submitted the following report to accompany Ex. X, 96th Cong., 1st sess. The Committee on Foreign Relations, to which was referred the Tax Treaty with the Hungarian People's Republic ('Hungary') [FN2] for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income (Executive X), as amplified by a concurrent Exchange of Notes (collectively referred to as the proposed treaty), having considered the same, reports favorably thereon without reservation and recommends that the Senate give its advice and consent to ratification thereof.

I. PURPOSE

There is presently no income tax treaty in force between the United States and Hungary. The proposed treaty is intended to reduce or eliminate double taxation of income earned in one country by residents of the other country and deals with administrative matters between the United States and Hungary, and to promote closer economic cooperation and more active trade between the two countries. The proposed treaty with Hungary was signed on February 12, 1979, and was amplified by an Exchange of Notes signed the same day. The Tax Treaty and the Exchange of Notes were transmitted to the Senate on May 9, 1979.

[2] III. SUMMARY OF TREATY

The proposed treaty is similar to other recent U.S. income tax treaties and to the model income tax treaty of the Organization of Economic Cooperation and Development (OECD) in virtually all respects. As in other U.S. tax treaties, the objectives of the treaty are principally achieved by each country's agreeing to limit, in certain specified situations, its right to tax income derived from its territory by residents of the other. For example, the treaty contains the standard tax treaty provision that neither country will tax the business income derived from sources within that country by residents of the other unless the business activities in the taxing country are substantial enough to constitute a branch or other permanent establishment or fixed base (Article 7). Similarly, the treaty contains standard 'commercial visitor' exemptions under which residents of one country performing personal services will not be required to file tax returns and pay tax in the other unless their contacts with the other exceed certain specified minimums (Articles 13 through 18). Also, the proposed treaty provides that interest, royalties, capital gains and certain other income derived by residents of either country from sources within the other are generally to be taxed only by the country of residence and not by the country of source (Articles 10, 11, 12 and 19), and that dividends received by residents of one country from sources within the other are to be taxed at reduced rates by the country of source (Article 9). In situations where the country of source retains the right under the proposed treaty to tax income derived by residents of the other country, the treaty generally provides for the relief by the country of residence of the potential double taxation (Article 20) through a foreign tax credit (in the case of the United States) or an exemption (in the case of Hungary). The treaty contains the standard provision (the 'saving clause') contained in U.S. tax treaties that each country retains the right to tax its citizens and residents as if the treaty had not come into effect (Article 1). In addition, it contains the standard provision that the treaty will not be applied to deny any taxpayer any benefits he would be entitled to under the domestic law of either country or under any other agreement between the two countries (Article 24); that is, the treaty generally will be applied only to the benefit of taxpayers. The treaty also contains standard nondiscrimination provisions and provides for exchanges of information and administrative cooperation between the tax authorities of the two countries to avoid double taxation and prevent fiscal evasion with respect to income taxes.

[3] IV. DATE OF ENTRY INTO FORCE AND TERMINATION

Entry into force

The proposed treaty will enter into force as soon as the United States and Hungary notify each other that their constitutional requirements for ratification have been met (in the case of the United States, upon its presentation of an instrument o f ratification). With respect to taxes withheld at source, it will apply to income paid or credited on or after the first day of the second month following the date on which it enters into force. This would apply to dividends (Article 9), interest (Article 10), royalties (Article 11), and annuities and other fixed and determinable annual or periodic income which is not specifically covered by any article (Article 19). With respect to all other taxes, it will become effective for taxable years beginning on or after January 1 of the year following the date on which the proposed treaty comes into force.

Termination

The proposed treaty will continue in force indefinitely, but either country may terminate it at any time after 5 years from its entry into force by giving at least 6 months' prior notice through diplomatic channels. If terminated, the termination will be effective with respect to income of taxable years beginning (or, in the case of withholding taxes, payments of income made) on or after January 1 next following the expiration of the 6-month period.

V. COMMITTEE ACTION

The Committee on Foreign Relations held a public hearing on the proposed treaty and other tax treaties on June 6, 1979. The Committee considered the proposed treaty on June 12, 1979 and ordered it favorably reported by a vote of 13 yeas, no nays, with the recommendation that the Senate give its advice and consent to ratification of the treaty.

VI. BUDGET IMPACT

The Committee estimates that the effect of the proposed treaty on budget receipts will be negligible. In accordance with the objectives of section 403 of the Budget Act, the Committee advises that the Director of the Congressional Budget Office has examined the Committee's budget estimate and agrees that the effect on budget receipts will be negligible. In keeping with section 308(a) of the Budget Act, and after consultation with the Director of the Congressional Budget Office, the Committee states that the treaty does not provide any new budget authority or any new or increased tax expenditures.

[4] VII. EXPLANATION OF TREATY PROVISIONS

Set forth below is a comprehensive article-by-article explanation of the proposed income tax treaty between the United States and Hungary.

Article 1. Personal scope

The proposed treaty applies generally to residents of the United States and to residents of Hungary, with specific exceptions designated in other articles. This follows other U.S. income tax treaties and the OECD model income tax treaty. The proposed treaty contains the 'saving clause' contained in all U.S. income tax treaties which provides, with specified exceptions, that the treaty is not to affect the taxation by the United States of its citizens and residents or the taxation by Hungary of its citizens and residents. Residents for purposes of the treaty (and thus for purposes of the saving clause) include corporations and other entities as well as individuals (Article 4. Fiscal domicile). In the case of the United States, the saving clause also extends to former citizens. (Under section 877 of the Internal Revenue Code, an individual who gives up U.S. citizenship is subject to U.S. tax on his U.S.-source income as if he were still a U.S. citizen if one of his principal purposes in giving up U.S. citizenship was to avoid U.S. tax.) Exceptions to the saving clause are provided for the benefits conferred by the articles dealing with pensions (Article 15), relief from double taxation (Article 20), nondiscrimination (Article 21), and mutual agreement procedures (Article 22); thus, the benefits of those articles will be conferred by each country on its own citizens and residents as well as the citizens and residents of the other. In addition, the benefits conferred by the articles dealing with the taxation of income received by government employees (Article 16), teachers (Article 17), students and trainees (Article 18), and diplomatic and consular officials (Article 24) are to be provided for each country to its residents provided those residents are neither citizens of, nor have immigrant status in, that country. Consequently, except for the exceptions to the saving clause set forth above, U.S. citizens and residents generally benefit under the treaty as the result of the agreement by Hungary to reduce its rate of tax on their income or exempt their income from tax rather than as the result of reductions in tax or exemptions by the United States. Even in this situation, if the tax which is foregone by Hungary could have otherwise been claimed in full by the U.S. taxpayers as a foreign tax credit, the real beneficiary of the reduction or elimination of the Hungarian tax would, as a practical matter, be the U.S. Treasury rather than the U.S. taxpayer. Similarly, except as noted above, Hungarian citizens and residents benefit under the treaty only to the extent that the United States agrees to reduce its tax on their income or to exempt their income from tax.

[5] Article 2. Taxes covered

In the case of the United States, the proposed treaty applies to the Federal income taxes imposed under the Internal Revenue Code and to the excise taxes imposed on insurance premiums paid to foreign insurers and with respect to private foundations. However, it does not apply to the accumulated earnings tax or the personal holding company tax. In the case of Hungary, the treaty applies to the general income tax, the income tax on intellectual activities, the profit tax, the profit tax on economic associations with foreign participation, the enterprises special tax, the levy on dividends and profit distributions of commercial companies, the profit tax on state-owned enterprises, and the contribution to communal development (but only to the extent that the contribution is required in respect of income taxes covered by the treaty). The proposed treaty also contains a provision generally found in U.S. income tax treaties to the effect that it will apply to substantially similar taxes which either country may subsequently impose. Each country is obligated under the treaty to notify the other of any changes it makes in its tax laws and of any official published material concerning the treaty, including explanations, regulations, rulings, and judicial determinations. Additionally, the nondiscrimination provisions (Article 21) of the treaty apply to all taxes of every kind imposed at the national, state, or local level by the United States or Hungary. The exchange of information provisions (Article 23) of the proposed treaty will also apply to all taxes of every kind imposed by the two countries at the national level.

Article 3. General definitions

Certain of the standard definitions found in most U.S. income tax treaties are contained in the proposed treaty. Under the proposed treaty, the term 'United States' when used in a geographical sense does not apply to Puerto Rico, the Virgin Islands, Guam or any other possession or territory of the United States. A 'national' of either country is defined to include both a citizen of that country and also any legal entity such as a corporation, trust, estate, partnership, or association which is established under the laws of that country. A 'company' is defined as a corporation or other entity treated as a corporation for tax purposes. An enterprise of a country is defined as an enterprise carried on by a resident of that country. Although the treaty does not define the term 'enterprise,' it would have the same meaning that it has in other U.S. tax treaties--the trade or business activities undertaken by an individual, partnership, corporation, or other entity. The proposed treaty also contains the standard provision that, unless the context otherwise requires or the competent authorities of the two countries establish a common meaning, any terms are to have the meaning which they have under the applicable tax laws of the country applying the treaty.

Article 4. Fiscal domicile

The benefits of the proposed treaty generally are available only to residents of the two countries. Under the treaty, a person (either an [6] individual or an entity such as a corporation or partnership) is considered to be a resident of either country if, under the laws of that country, the person is subject to taxation by that country because it is the country of domicile, residence, citizenship, place of management, place of incorporation, or other criterion of similar nature. A person will not be considered to be a resident of a country if he is only taxable on his income from sources within that country or on his assets located in that country. A partnership, estate, or trust will be considered to be a resident of either country only to the extent that the income it derives is subject to tax, either in its hands or in the hands of its partners or beneficiaries, as the income of a resident of the country. This provision of the proposed treaty is generally based on the fiscal domicile article of the OECD model tax treaty and is similar to the provisions found in other U.S. tax treaties. However, a significant difference between the definition of resident in this treaty and the definition in other recent U.S. income tax treaties, and consequently a significant difference in the coverage of the treaty, is that the term resident includes an individual who is subject to worldwide taxation on the basis of citizenship. As a result, U.S. citizens residing overseas (in countries other than Hungary) are entitled to the benefits of the treaty as U.S. residents. (Moreover, if they reside in Hungary, they are still allowed the benefits afforded U.S. residents which are unaffected by the saving clause.) Since Hungary generally taxes on a residency basis rather than on a citizenship basis, this broadened definition of resident does not benefit citizens of Hungary who are not Hungarian residents. However, Hungary does tax certain of its nationals who work overseas for the Hungarian Government (or its instrumentalities), and a special rule is provided under which these individuals and their families are treated as residents of Hungary entitled to the benefits of the treaty. A set of rules is provided to determine residence in the case of a person who, under the basic treaty definition, would be considered to be a resident of both countries (e.g., a U.S. citizen and resident in Hungary). In the case of a dual resident individual, the individual will be deemed for all purposes of the treaty to be a resident only of the country in which he has his permanent home (where an individual dwells with his family), his center of vital interests (his closest economic and personal relations), his habitual abode, or his citizenship. If the residence of an individual cannot be determined by these tests, applied in the order stated, the competent authorities of the countries will settle the question by mutual agreement. In the case of a dual resident corporation which is created or organized under the laws of either country (or a political subdivision), the corporation will be treated as a resident only of that country. In the case of a dual resident person, other than an individual or a corporation (e.g., a dual resident partnership ,trust, or estate), the residence of the person and the mode of application of the treaty will be determined by the competent authorities.

Article 5. Definition of permanent establishment

The proposed treaty contains a definition of permanent establishment which follows the pattern of other recent U.S. income tax treaties and the OECD model tax treaty. The permanent establish-[7]ment concept is one of the basic devices used in income tax treaties to avoid double taxation. Generally, a resident of one country is not taxable on its business profits by the other country unless those profits are attributable to a permanent establishment of the resident in the other country. In addition, the permanent establishment concept is used to determine whether the reduced rates of, or exemptions from, tax provided for dividends, interest, and royalties are applicable. In general, a fixed place of business through which a resident of one country engages in business in the other country is considered a permanent establishment. This includes a place of management; a branch; an office; a factory; a workshop; or a mine, an oil or gas well, a quarry, or other place of extraction of natural resources. It also includes any building site, construction or installation project, or an installation or drilling rig or ship used for the exploration or development of natural resources, but only if the site, project, etc., lasts for more than 24 months. This general rule is modified to provide that a fixed place of business which is only used for any or all of a number of specified activities will not constitute a permanent establishment. These activities include the use of facilities for storing, displaying, or delivering merchandise belonging to the resident; the maintenance of a stock of goods belonging to the resident for purposes of storage, display, delivery, or processing by another person, or the purchase of goods or merchandise, collection of information, or any other preparatory or auxiliary activities for the resident. If a resident of one country maintains an agent in the other country who has, and regularly exercises, the authority to enter into contracts in that other country in the name of the resident, then the resident will be deemed to have a permanent establishment in the other country with respect to the activities which the agent undertakes on its behalf. This rule does not apply where the contracting authority is limited to those activities (described above) such as storage, display, or delivery of merchandise which are excepted from the definition of permanent establishment. The proposed treaty contains the usual provision that the agency rule will not apply if the agent is a broker, general commission agent, or other agent of independent status acting in the ordinary course of its business. The fact that a company which is a resident of one country controls or is controlled by a company which is a resident of the other country or which carries on business in that other country (whether through a permanent establishment or otherwise), will not of itself constitute either company a permanent establishment of the other.

Article 6. Income from immovable property (real property)

The proposed treaty provides that income from real property may be taxed in the country where the real property or natural resources are located. For purposes of the treaty, real property will generally have the meaning provided under the laws of the country where the property is located, but will in any case include property which is accessory to real property, livestock and equipment used in agriculture and forestry, and rights to real property. Ships, boats, and aircraft will not be considered real property. [8] Income from real property includes income from the direct use or renting of the property. It also includes royalties and other payments in respect of the exploitation of natural resources (e.g., oil wells) and gains on the sale, exchange, or other disposition of the royalty rights or the underlying natural resources. It does not include interest on loans secured by real property. Under Article 12 (Capital gains), gains on the sale, exchange, or other disposition of the property may also be taxed by the country where the property is located.

Article 7. Business profits

Under the proposed treaty, business profits of an enterprise of one country are taxable in the other country only to the extent they are attributable to a permanent establishment in the other country through which the enterprise carries on business. The business profits of a permanent establishment are determined on an arm's-length basis. Thus, there is to be attributed to it the business profits which would reasonably be expected to have been derived by it if it were an independent entity engaged in the same or similar activities under the same or similar conditions and dealing at arm's-length with the resident of which it is a permanent establishment. In computing taxable business profits, deductions are allowed for all expenses, wherever incurred, which are incurred for purposes of the permanent establishment. These deductions include a reasonable allocation of executive and general administrative expenses, interest, and other expenses which are incurred for purposes of the enterprise as a whole (or for purposes of that part of the enterprise which includes the permanent establishment). Thus, for example, a U.S. company which has a branch office in Hungary but which has its head office in the United States will, in computing the Hungarian tax liability of the branch, be entitled to deduct a portion of the executive and general administrative expenses incurred in the United States by the head office for purposes of administering the Hungarian branch. Business profits will not be attributed to a permanent establishment merely by reason of the purchase of merchandise by the permanent establishment for the account of the enterprise, or by reason of the delivery to the permanent establishment of goods or merchandise for its use. Thus, where a permanent establishment purchases goods for its head office, the business profits attributed to the permanent establishment with respect to its other activities will not be increased by a profit element on its purchasing activities. Where business profits include items of income which are dealt with separately in other articles of the treaty, those other articles, and not this business profits article, will govern the treatment of those items of income.

Article 8. Shipping and air transport

The proposed treaty provides that income which is derived by an enterprise of either country from the operation of ships and aircraft in international traffic shall be exempt from tax by the other country. International traffic means any transportation by ship or aircraft, except where the transportation is solely between places in the other country (Article 3(1)(e). Definitions). The exemption applies whether or not the ships or aircraft are registered in the first country. [9] The exemption for shipping and air transport profits applies to profits from the rental on a full or bareboat basis of ships or aircraft operated in international traffic if such rental profits are incidental to the actual operation of ships and aircraft in international traffic. (Rental on a full or bareboat basis refers to whether the ships or aircraft are leased fully equipped, manned and supplied or not.) Income from the operation in international traffic of ships or aircraft also includes income derived from the use, maintenance, or rental of containers, trailers for the inland transportation of containers,and other related equipment where the equipment is used to transport goods and merchandise. The shipping and air transport exemption also applies where an enterprise has an agency in the other country for the transportation of goods or persons (e.g., an airline office), but the exemption only applies to the extent of activities directly connected with the business of shipping and aircraft transportation (including auxiliary activities).

Article 9. Dividends

Each country may tax dividends paid by its companies to shareholders resident in the other (i.e., they may impose a dividend withholding tax on shareholders resident in the other country), but the rate of tax may not exceed 15 percent if the beneficial owner is a resident of the other country. (In the absence of a treaty limitation, the statutory U.S. withholding tax rate on dividends paid by U.S. corporations to foreign shareholders is generally 30 percent.) The withholding tax rate is limited to 5 percent in the case of dividends paid to a company which directly or indirectly owns at least 10 percent of the voting stock of the company making the dividend distribution. Neither country can tax dividends paid by companies of the other except insofar as (a) the dividends are paid to residents of the country imposing the tax, (b) the dividends are effectively connected with a permanent establishment or a fixed base in the taxing country, or (c) at least 50 percent of the company's gross income was attributable to a permanent establishment in the taxing country. In this last situation, however, the tax can be imposed only to the extent the dividends are paid out of the profits derived from the permanent establishment and, in addition, the rate of tax on the taxable portion is limited to 15 percent or 5 percent under the rules (described above) applicable to dividends paid by companies of the taxing country. As set forth in the Exchange of Notes, this last exception does not apply to Hungary because Hungary does not tax dividends paid for by foreign corporations regardless of the extent to which the dividends were derived from Hungarian source profits of the distributing foreign corporation. The United States, however, does impose its withholding tax on the U.S. source portion of dividends distributed to foreign shareholders by foreign corporations which derive more than 50 percent of their gross income for the preceding 3-year period from U.S. sources. This last exception permits the United States to continue to do so. The reduced rates of tax on dividends will apply unless the recipient has a permanent establishment (or fixed base in the case of an individual performing independent personal services)in the source country [10] and the dividends are effectively connected with the permanent establishment (or fixed base). Dividends effectively connected with a permanent establishment are to be taxed as business profits (Article 8). Dividends effectively connected with a fixed base are to be taxed as income from the performance of independent personal services (Article 13).

Article 10. Interest

Interest derived by a resident of one country from sources within the other country is generally exempt from tax by the source country. (In the absence of a treaty limitation, the United States generally imposes a 30-percent withholding tax on interest paid by U.S. debtors--other than banks--to foreign lenders.) The exemption from tax on interest will apply unless the recipient has a permanent establishment or fixed base in the source country and the interest is effectively connected with the permanent establishment or fixed base. In that event, the interest will be taxed as business profits (Article 7) or income from the performance of independent personal services (Article 13). The proposed treaty defines interest as income from debt claims of every kind, whether or not secured and whether or not carrying a right to participate in profits. In particular, it includes income from government securities and from bonds or debentures, including premiums or prizes attaching to bonds or debentures.

Article 11. Royalties

Under the proposed treaty, royalties derived by a resident of one country from sources within the other are exempt from tax by the source country. (In the absence of a treaty limitation, the United States generally imposes a 30- percent withholding tax on royalties paid to foreigners not engaged in a U.S. business.) Royalties are defined for this purpose as payments of any kind received as consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work, including films, radio or television tapes, any patents, trade marks, designs or models, plans, secret formulas or processes, or any other similar rights or property. Royalties also include payments for information concerning industrial, commercial, or scientific experience (e.g., 'know-how'). However, this article does not apply to mineral royalties (which are covered by Article 6). The exemption does not apply where the recipient is an enterprise with a permanent establishment in the source country or an individual performing personal services in an independent capacity through a fixed base in the source country, and the royalties are effectively connected with the permanent establishment or fixed base. In that event the royalties will be taxed as business profits (Article 7) or income from the performance of independent personal services (Article 13).

Article 12. Capital gains

The proposed treaty generally provides that capital gains derived by a resident of one country will be exempt from tax by the source country. Under the Code, capital gains derived from U.S. sources by foreign investors are generally exempt from U.S. tax The exemption does not apply in two situations, and in those situations the gains may be taxed by both countries (with relief from double [11] taxation provided pursuant to Article 20). First, gains from the sale or exchange of real property may be taxed in the country where the property is located. Second, gains on the sale or exchange of property which forms a part of the business property of a permanent establishment or a fixed base (including gains on the disposition of the permanent establishment or the fixed base itself) may be taxed in the country where the permanent establishment or fixed base is located. This second exception does not apply to gains from the sale or exchange of ships, aircraft or containers operated by an enterprise of the other country in international traffic; such gains are only taxable by the country of residence.

Article 13. Independent personal services

Under the proposed treaty, income from the performance of independent personal services (i.e., services performed as an independent contractor, not as an employee) in one country by a resident of the other country is exempt from tax in the country where the services are performed, unless (1) the person performing the personal service is present in the country where the services are performed for more than 183 days during the taxable year or (2) the individual has a fixed base regularly available to him in that country for the purpose of performing the services. If the second requirement (but not the first) is met, the source country can only tax that portion of the individual's income which is attributable to the fixed base. Independent services include independent scientific, literary, artistic, educational or teaching activities as well as the independent activities of physicians, lawyers, engineers, architects, dentists, artistes, athletes and accountants.

Article 14. Dependent personal services

Under the proposed treaty, income from services performed as an employee in one country (the source country) by a resident of the other country will not be taxable in the source country if three requirements are met: (1) the individual is present in the source country for not more than 183 days during the taxable year; (2) his employer is not a resident of the source country; and (3) the compensation is not borne by a permanent establishment or fixed base of the employer in the source country. Compensation derived by an employee aboard a ship or aircraft operated by a resident of one country in international traffic is exempt from tax by the other country, provided that the compensation is in respect of employment as a member of the regular complement of the ship or aircraft. This article does not apply to pensions and social security payments (Article 16).

Article 15. Pensions

Under the proposed treaty, private pensions (and other similar compensation for past services) beneficially derived by residents of either country are exempt from tax in the other country, regardless of the source of pensions. Social security payments and other public pensions paid by either country to a resident of the other (or to U.S. citizens) are only taxable by the country making payments. This rule does not apply in the case [12] of pensions which are paid to resident nationals of one country attributable to service performed by that individual to government entities of the other. (Article 16(2)(b). Government service).

Article 16. Governmental service

Under the proposed treaty, compensation paid by one country, its political subdivisions or local authorities, to an individual for labor or personal services performed for the payment governmental entity is exempt from tax by the other country. However, this exemption does not apply if the services are performed in the other country and the individual is a national of that country or did not become a resident of that country solely for the purpose of performing the service. In that situation, the compensation is only taxable by the country where the services are performed. Thus, an individual performing services for a Hungarian governmental entity ordinarily will only be taxable by Hungary. However, if he performs the services in the United States and is a U.S. citizen, or is a U.S. resident whose reasons for becoming a U.S. resident were not solely to work for that Hungarian governmental agency, he will be taxable by the United States. Pensions paid for services to a governmental entity of either country will generally only be taxable by that country. However, if the recipient is a resident national of the other country, the pension will only be taxable by that other country. The governmental service rules do not apply in situations where the compensation or pensions are paid in connection with any business carried on by any governmental entity of either country. In such situations, the provisions applicable to the private sector apply: Article 13 (Independent personal services), 14 (Dependent personal services), and 15 (Pensions).

Article 17. Teachers

The proposed treaty provides that if a teacher or researcher who is a resident of one country is invited to teach or engage in research in the other, he will be exempt from tax by the host country on income from teaching or engaging in research if he is present in that country for a period not expected to exceed 2 years. The exemption only applies if the individual comes to the other country primarily for the purpose of teaching or engaging in research pursuant to an invitation of the host country (or political subdivision or local authority) or a recognized educational institution in the host country. It is not to apply with respect to income from research which is undertaken primarily for the private benefit of a specific person or persons. If the teacher or researcher remains in the other country for a period exceeding 2 years, the exemption only applies to income earned during the 2- year period. The exemption does not apply if the individual is a citizen of, or acquires immigrant status in, the host country (Article 1(3)). Income may be exempt under this Article even though it would be taxable under Article 13 (Independent Personal Services).

Article 18. Students and trainees

Under the proposed treaty, a resident of one country who becomes a full-time student, apprentice, or business trainee in the other country will generally be exempt from tax in the host country on payments from abroad used for maintenance, education, or training. [13] A full-time student, apprentice or business trainee who qualifies for the exemption from tax by the host country may instead elect under the treaty to be treated for tax purposes as a resident of the host country. The election applies for the entire period that the individual is a full-time student, apprentice, or business trainee, and it may not be revoked except with the consent of the competent authority of the host country. The purpose of the election is to permit foreign students, apprentices, and business trainees present in the United States to qualify for benefits such as the standard deduction (the zero bracket amount), and for the dependency deductions (if applicable). For example, For U.S. tax purposes nonresidential aliens are limited to one personal deduction and they are not permitted to claim the standard deduction or the dependency deduction. By electing to be taxed as U.S. residents, they may claim these deductions but, as a consequence, they are subject to U.S. tax on their worldwide income. This election would generally be advantageous for those foreign students, apprentices, and business trainees who do not have any substantial income from sources without the United States.

Article 19. All other income

Any item of income, regardless of its source, which is derived by a resident of either country and which is not dealt with in one of the other articles of the treaty will be taxable only by the country of residence. However, such an item of income which is received by a resident of one country who is a citizen of the other may be taxed by both countries (Article 1. Personal scope), subject to a foreign tax credit for taxes paid to the other if the other country is the country of source (Article 20. Relief from double taxation). Items covered by this article would include, for example, annuities, alimony, child support, and certain income from the rental of personal property.

Article 20. Relief from double taxation

United States

Under the proposed treaty, the United States agrees to provide its citizens and residents with a foreign tax credit against their U.S. income tax for the appropriate amount of taxes paid to Hungary. The credit allowed for U.S. tax purposes is in accordance with the provisions and subject to the limitations of U.S. law applicable to the year in question. Under present law, the United States only allows a credit for foreign income taxes (sec. 901 of the Internal Revenue Code), or foreign taxes imposed in lieu of income taxes (Code sec. 903), and the credit is limited to the amount of the pre-credit U.S. tax which is attributable to foreign source income (Code secs. 904 and 907). The proposed treaty also provides that a deemed-paid foreign tax credit will be made available to a U.S. corporation with respect to dividends from a Hungarian corporation in which it owns, directly or indirectly, at least 10 percent of the voting stock. In this case, a credit will be allowed for the Hungarian tax paid by the Hungarian corporation on the earnings out of which the dividend is paid. A deemed-paid foreign tax credit satisfying the treaty requirements is presently provided under the Internal Revenue Code (sec. 902). [14] This article provides that all the Hungarian taxes covered by the treaty (Article 2. Taxes covered) are to be considered to be income taxes for purposes of the U.S. foreign tax credit. Accordingly, all the Hungarian taxes covered by the treaty will be eligible for the U.S. foreign tax credit. These taxes would probably be creditable for U.S. tax purposes in the absence of the proposed treaty.

Hungary

The treaty generally provides for the relief by Hungary of double taxation of income received by its residents which is taxable under the treaty by the United States through the use of an exemption with progression. Hungary, like the United States and most other countries, has a progressive rate structure for its income tax (i.e., the tax rate becomes higher as taxable income increases). Under the exemption with progression, the exempt income is not subject to Hungarian tax, but it is taken into account in determining the effective rate on the resident's other income which is subject to tax. (By increasing the income taken into account, the effective rate becomes higher because of the progressive rate structure.) With the exception of dividend income for which a foreign tax credit is allowed (described below), the exemption is available with respect to income derived by the Hungarian residents which under the treaty may be taxed by the United States (other than income which under the treaty may be taxed by the United States solely because the Hungarian resident receiving the income is also a citizen of the United States). Income eligible for the exclusion would include, for example, income from U.S. real property, business profits attributable to a U.S. permanent establishment, or compensation for personal services performed in an independent capacity through a U.S. fixed base. The treaty exemption is also available with respect to income from sources within the United States which would not be taxable by the United States under the treaty but for the fact the recipient is a U.S. citizen. This would include U.S.-source interest and royalties received by U.S. citizens resident in Hungary. A Hungarian foreign tax credit rather than the exemption with progression will be provided under the treaty with respect to dividends received by Hungarian residents from U.S. companies where the dividends qualify for the reduced 15-percent or 5-percent treaty rate for the U.S. withholding tax (Article 9). Although Hungary does not have a statutory foreign tax credit, the treaty provides that such dividends from U.S. companies will be taxable by Hungary and that the Hungarian residents will be entitled to reduce their Hungarian tax by the 5-percent or 15-percent U.S. withholding tax imposed on the dividends. It was necessary to provide a credit in this situation rather than an exemption because the U.S. withholding tax rate under the treaty is substantially lower than the regular income tax rates of both countries. Therefore, an exemption would have more than offset any potential double taxation of the dividends. Consequently, the only income received by a U.S. citizen resident in Hungary which would not qualify for either the exemptions from, or the credit against, the Hungarian tax pursuant to this provision would be non-U.S.-source income. There would not be double taxation in this situation, however, because the Hungarian tax could be claimed [15] as a foreign tax credit against the U.S. tax on that foreign source income.

Article 21. Nondiscrimination

The proposed treaty contains a comprehensive nondiscrimination provision relating to all taxes of every kind imposed at the national, state, or local level. It is similar to provisions which have been embodied in other recent U.S. income tax treaties. Under this provision, neither country can discriminate by imposing more burdensome taxes (or other requirements connected with taxes) on citizens of the other country than it imposes on its own citizens who are in the same circumstances. For this purpose, citizens taxable on their worldwide income are not to be considered to be in the same circumstances as citizens who are not. Thus, for example, the United States would not be required to tax in the same way a U.S. citizen and a Hungarian citizen, neither of whom are residents of the United States, because the U.S. citizen is taxed by the United States on his worldwide income while the Hungary citizen is not. This provision does not, however, require either country to grant to residents of the other country the personal allowances, reliefs, or deductions for taxation purposes on account of personal status or family responsibilities which it grants to its own residents. Similarly, neither country may tax a permanent establishment of an enterprise of the other country less favorably than it taxes its own enterprises carrying on the same activities. In determining the taxable income of an enterprise of either country, both countries are required to allow the enterprise to deduct interest, royalties, and other disbursements paid by the enterprise to residents of the other country under the same conditions that they allow deductions for such amounts paid to residents of the same country as the enterprise. Similarly, for purposes of determining the taxable capital of an enterprise of one country, debts owed to residents of the other country are to be deductible under the same conditions as if they were owed to residents of the same country as the enterprise. The nondiscrimination provision also applies to corporations of one country which are owned by residents of the other country.

Articles 22 and 23. Administrative provisions

The proposed treaty contains various administrative provisions generally along the lines of the provisions contained in other U.S. tax treaties. In general, the proposed treaty provides--(1) for consultation and negotiation between the tax authorities of the two countries to resolve differences arising in the application of the proposed treaty and also to resolve claims by taxpayers that they are being subjected to taxation contrary to the terms of the proposed treaty; and (2) for the exchange between the countries of information pertinent to carrying out the provisions of the proposed treaty and of the domestic laws of the countries concerning taxes covered by the proposed treaty.

Article 24. Diplomatic and consular officials; Domestic laws and other treaties

The proposed treaty contains the rule found in other U.S. tax treaties that its provisions are not to affect the taxation privileges of [16] diplomatic and consular officials under the general rules of international law or the provisions of special agreements. The proposed treaty also contains the rules found in other U.S. tax treaties that its provisions will not restrict in any manner any exclusion, exemption, deduction, credit or other allowance otherwise accorded by the domestic laws of either country or any other agreement between the two countries. In other words, the treaty (other than the exchange of information provisions) can only be applied to the benefit of taxpayers of the two countries, and the taxing authorities cannot apply it to increase a taxpayer's tax liability.

Article 25. Entry into force

The proposed treaty will enter into force as soon as the United States and Hungary notify each other that their constitutional requirements for ratification have been met (in the case of the United States, upon its presentation of an instrument of ratification). With respect to taxes withheld at source, it will apply to income paid or credited on or after the first day of the second month following the date on which it enters into force. This would apply to dividends (Article 9), interest (Article 10), royalties (Article 11), and annuities and other fixed and determinable annual or periodic income which is not specifically covered by any article (Article 19). With respect to all other taxes, it will become effective for taxable years beginning on or after January 1 of the year following the date on which the proposed treaty comes into force.

Article 26. Termination

The proposed treaty will continue in force indefinitely, but either country may terminate it at any time after 5 years from its entry into force by giving at least 6 months' prior notice through diplomatic channels. Such a termination will be effective with respect to income of taxable years beginning (or, in the case of withholding taxes, payments of income made) on or after January 1 next following the expiration of the 6-month period.

EXCHANGE OF NOTES

In an exchange of identical letters signed together with the treaty, the two countries set forth certain agreements concerning the application of certain provisions of the treaty. The interpretations and understanding set forth in the Notes have the same force and effect as if they were contained in articles of the treaty. First, although the dividend article (Article 9(5)(c)) would permit it, Hungary will not impose a tax on dividends paid to U.S. shareholders by corporations deriving more than 50 percent of their profits from Hungary in situations where the distributing corporation is not resident in Hungary. The United States imposes its withholding tax on dividends paid by foreign corporations to foreign investors where the distributing corporation derives 50 percent or more of its income from United States sources during the 3-year period preceding the distribution. Under the treaty, the United States may continue to tax dividends paid by Hungarian corporations in such situations. Second, where a resident of one country carries on business through a permanent establishment in the other, income (other than income [17] from real property) will be taxed as business profits (Article 7) rather than other income (Article 19) if the right or property in respect of which the income is paid is effectively connected with the permanent establishment. Similarly, where a resident of one country performs independent personal services through a fixed base in the other, income (other than income from real property) will be taxed as independent personal services income (Article 13) rather than other income if the right or property in respect of which the income is paid is effectively connected with the fixed base. The consequences of this understanding is that the income in these situations will be taxed by the country of the permanent establishment or fixed based rather than only by the country of residence. Third, the Notes recognize the right of each country to apply the provisions of its internal law to distribute, apportion, or allocate income, deductions, credits, and allowances between related enterprises in order to reflect property their arm's-length profit in situations where the dealings between the related enterprises involve conditions different from those that would have been made between independent enterprises. In addition, the Notes also provide that the internal law of each country may be applied to limit the exemption provided in the treaty for interest (Article 10) and royalties (Article 11) so that it only applies to the extent that the interest or royalty does not exceed the arm's-length amount that would have been paid between unrelated parties. Thus, the treaty does not in any way limit the authority of the Internal Revenue Service to allocate or apportion income, deductions, credits, or allowances between related parties under section 482 of the Internal Revenue Code in situations where it determines that the allocation is necessary in order to prevent the evasion of taxes or clearly to reflect the income of the related parties. This authority is not limited by the treaty even where the allocation is between related parties which are not enterprises or where the related parties have not had dealings with each other. Finally, the Notes set forth an agreement, similar to provisions in other recent U.S. income tax treaties, that each country will assist the other in collecting taxes imposed by the other country to the extent necessary to insure that the treaty benefits are only enjoyed by persons entitled to them. This agreement does not obligate either country to carry out administrative measures which are of a different nature from those used in the collection of its own tax or measures which would be contrary to its sovereignty, security, or public policy.

[18] VIII. TEXT OF RESOLUTION OF RATIFICATION

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RESOLUTION OF RATIFICATION

Resolved (two-thirds of the Senators present concurring therein), That the Senate advise and consent to the ratification of the Convention Between the Government of the United States of America and the Government of the Hungarian People's Republic for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, together with an exchange of notes relating thereto, done at Washington on February 12, 1979 (Ex. X, Ninety- sixth Congress, first session).

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[75] APPENDIX C

WRITTEN RESPONSES BY TREASURY TO QUESTIONS BY THE COMMITTEE STAFF

DEPARTMENT OF THE TREASURY,

Washington, D.C., June 8, 1979.

Hon. FRANK CHURCH,

Chairman, Committee on Foreign Relations,

U.S. Senate, Washington, D.C. DEAR MR. CHAIRMAN: To follow up my testimony at the June 6 hearings concerning the six tax conventions or protocols involving the United Kingdom, France, Hungary and Korea, I want to assure you that Article I of the Third Protocol of the proposed US-UK Income Tax Treaty gives full effect to the Senate's reservation on Article 9(4) of that treaty. Let me also assure you that there is no similar state tax issue in any of the other five treaties which were considered by the Committee yesterday. Again let me emphasize our view that each of these treaties is important to the United States and that their prompt approval is desirable. I am also enclosing answers to the written questions submitted to me by your staff at the hearings as well as copies of my answers to questions from Senator Helms and Senator Javits. Sincerely, DONALD C. LUBICK, Assistant Secretary (Tax Policy). Enclosures.

QUESTIONS FOR ASSISTANT SECRETARY FOR TAX POLICY

DONALD C. LUBICK

GENERAL QUESTIONS [FN3]

Question 1.

On page three of your testimony, you mentioned that the public was able to make presentations to the Treasury concerning particular private sector concerns in the area of international taxation, could you explain how the notice of such public meetings is made, what the participation level has been and any changes in tax treaties or negotiations that have been affected by this public participation?

Answer.

The public meetings, referred to in the testimony, are announced by Treasury Press Releases and notices in the Federal Register. These announcements are reported in publications which are widely read in the international tax community. Publicparticipa-[76]tion in these meetings varies, depending on the degree of interest in the particular country being discussed. The meeting to discuss the Canadian treaty was attended by well in excess of 100 individuals; a recent meeting to discuss a proposed treaty with Norway was attended by about 20 people. All of the reports we have received from the public regarding these meetings have been favorable. It is difficult to point to particular changes in treaties under negotiations as a result of these meetings. In most cases,there has not yet been a further round of negotiations following the meeting. The meetings have clearly served to sharpen the negotiations' awareness and understanding of some of the complex issues involved.

Questions 2 and 3.

The group of six treaties or protocols the Committee is conducting hearings on today, will they result in a net loss or gain for the U.S. from tax revenues? If a loss, how much and why; if again, how much and why?

Answer.

In general, these treaties and protocols tend to balance out revenue losses and gains, leaving the overall revenue effect roughly neutral. For example, where the treaty partner is required to reduce or eliminate its tax on U.S. taxpayers, this results in a reduction in the U.S. foreign tax credit and an increase in U.S. revenue. These increases are roughly offset by reductions in U.S. revenues resulting from reductions in U.S. tax on taxpayers resident in the other country. In most cases, data on international flows and transactions are not available in sufficient detail to permit precise estimation of the revenue effects of particular treaty provisions.

Question 4.

Please describe the personnel from the Department of the Treasury and other agencies of the U.S. Government involved in negotiating tax treaties or protocols. Please detail the prospective relationships between the IRS, Department of the Treasury and the Department of State.

Answer.

The Office of the Assistant Secretary for Tax Policy in the Treasury has the principal responsibility for the negotiations of tax treaties. The actual negotiations are normally conducted by members of the Office of International Tax Affairs, which combines the Office of International Tax Counsel (Attorneys) and the International Tax Staff of Tax Analysis (Economists). The delegations are headed either by the Assistant Secretary for Tax Policy or by a senior member of the Office of International Tax Affairs. The Internal Revenue Service is often represented on delegations. The nature and extent of this representation depends on the specific issues that are likely to arise. For example, if there are problems regarding the exchange of information, representatives of the IRS Office of International Operations, which is responsible for these exchanges, will participate in the discussions. In many cases, when negotiations are held abroad, the Revenue Service Representative assigned to that country will participate. The State Department is invited to participate in all discussions. Country desk officers will sometimes attend a part or all of the discussions held in Washington. When negotiations are held abroad, the economic or commercial officers in the U.S. Embassy frequently participate. The State Department generally handles correspondence be-[77]tween the U.S. and foreign negotiators and is often called upon to follow up with representatives of the other country on issues which arise in the negotiations. There is close coordination between Treasury, IRS and the State Department throughout the negotiating process. The State Department advises the Treasury on political issues and IRS advises on administrative matters. The State Department is responsible for the arrangements for signing treaties and their transmittal to the Senate.

Question 5.

The U.S. Treasury, in 1977, finalized a 'model convention' for international tax treaties, could you please explain the status of this model and in particular, any changes that have been made to it?

Answer.

For many years, the Treasury had used an informal 'model' as a basis for negotiations. This model evolved and changed as the negotiators gained experience with it. In 1976 a decision was made to publish the U.S. model. Following the 1977 publication of the revised OECD Model Convention, the Treasury revised its model to conform it to the OECD Model, where possible, and the revised model was published in May of 1977. The model is sent to potential treaty partners prior to the commencement of negotiations, and it normally serves as the discussion draft during the first round of negotiations. Many changes are made in the model during negotiations to reflect particular problems which arise in attempting to mesh two tax systems. Changes may be made to reflect the needs of the other country. For example, where negotiations are with a developing country, many of the model provisions (designed for treaties between two developed countries) are inappropriate. The U.S. negotiators are generally quite flexible in modifying the model for treaties with developing countries. These changes occur most frequently in the provisions dealing with permanent establishments or the taxation of personal service income, in which cases a somewhat lesser degree of economic contact or penetration is required for the host country to be able to tax the income of a resident of the other country. Similarly, with the taxation of dividends, interest, and royalties, less of a reduction in withholding tax rates is generally required of developing countries. The U.S. interest in these cases is to avoid rates which are so high as to generate excess foreign tax credits for