TREASURY DEPARTMENT TECHNICAL EXPLANATION OF THE CONVENTION BETWEEN THE UNITED STATES OP AMERICA AND THE KINGDOM OF THE NETHERLANDS FOR THE AVOIDANCE OF DOUBLE TAXATION AND THE PREVENTION OF FISCAL EVASION WITH RESPECT TO TAXES ON INCOME SIGNED AT WASHINGTON ON DECEMBER 18, 1992 AND PROTOCOL SIGNED AT WASHINGTON ON OCTOBER 13, 1993 GENERAL EFFECTIVE DATE UNDER ARTICLE 37: 1 JANUARY 1994 INTRODUCTION This document is a technical explanation of the Convention between the United States and the Netherlands signed on December 18, 1992 ("the Convention") and the Protocol amending the Convention signed on October 13, 1993 ("the Protocol"). References are made to the Convention between the United States and the Netherlands with Respect to Taxes on Income and Certain other Taxes, signed on 29 April, 1948, as amended by the Supplementary Convention signed on December 30, 1965 ("the prior Convention"). The Convention replaces the prior Convention. Negotiations took as their starting point the U.S. Treasury Department's draft Model Income Tax Convention, published on June 16, 1981 ("the U.S. Model"), the Model Double Taxation Convention on Income and Capital, published by the OECD in 1977 ("the 1977 OECD Model"), and other Conventions of both States. References in this Explanation to the "OECD Model" refer to the Model Income Tax Convention on Income and on Capital, published by the OECD in 1992. The Technical Explanation is an official guide to the Convention and Protocol. It reflects the policies behind particular Convention provisions, as well as understandings reached with respect to the application and interpretation of the Convention and Protocol. The Convention was accompanied by an exchange of notes and a detailed Memorandum of Understanding indicating the views of the negotiators and of the States with respect to a number of the provisions of the Convention. The Protocol also was accompanied by an exchange of notes and Agreed Minutes indicating the views of the negotiators and of the States with respect to a number of the provisions of the Convention and Protocol. In the discussions of each Article in this explanation, the relevant portions of these documents are discussed. TABLE OF ARTICLES Article 1------------------------------General Scope Article 2------------------------------Taxes Covered Article 3------------------------------General Definitions Article 4------------------------------Resident Article 5------------------------------Permanent Establishment Article 6------------------------------Income from Real Property Article 7------------------------------Business Profits Article 8------------------------------Shipping and Air Transport Article 9------------------------------Associated Enterprises Article 10-----------------------------Dividends Article 11-----------------------------Branch Tax Article 12-----------------------------Interest Article 13-----------------------------Royalties Article 14-----------------------------Capital Gains Article 15-----------------------------Independent Personal Services Article 16-----------------------------Dependent Personal Services Article 17-----------------------------Directors’ Fees Article 18-----------------------------Artistes and Athletes Article 19-----------------------------Pensions, Annuities, Alimony Article 20-----------------------------Government Service Article 21-----------------------------Professors and Teachers Article 22-----------------------------Students and Trainees Article 23-----------------------------Other Income Article 24-----------------------------Basis of Taxation Article 25-----------------------------Methods of Elimination of Double Taxation Article 26-----------------------------Limitation on Benefits Article 27-----------------------------Offshore Activities Article 28-----------------------------Non-Discrimination Article 29-----------------------------Mutual Agreement Procedure Article 30-----------------------------Exchange of Information and Administrative Assistance Article 31-----------------------------Assistance and Support in Collection Article 32-----------------------------Limitation of Articles 30 and 31 Article 33-----------------------------Diplomatic Agents and Consular Officers Article 34-----------------------------Regulations Article 35-----------------------------Exempt Pension Trusts Article 36-----------------------------Exempt Organizations Article 37-----------------------------Entry into Force Article 38-----------------------------Termination ARTICLE 1 General Scope Article 1 provides that the Convention is applicable to residents of the United States or the Netherlands except where the terms of the Convention provide otherwise. The Convention, at the request of the Netherlands, departs from the convention adopted in the U.S. and OECD Models, and employs the term "State" instead of the term "Contracting State" to refer to the United States or to the Netherlands. In this explanation, the terms are used interchangeably. Under Article 4 (Resident) a person is treated as a resident of a Contracting State if that person is, under the laws of that State, liable to tax therein by reason of his domicile, residence or other similar criteria, subject to certain limitations described in Article 4. If, however, a person is, under those criteria, a resident of both Contracting States, a single State of residence (or no State of residence) is assigned under Article 4. This definition governs for all provisions of the Convention. Certain provisions are applicable to persons who may not be residents of either Contracting State. For example, Article 20 (Government Service) may apply to a citizen of a Contracting State who is resident in neither. Paragraph 1 of Article 28 (Non-Discrimination) applies to nationals of the Contracting States, irrespective of their residence. Under Article 30 (Exchange of Information and Administrative Assistance), information may be exchanged with respect to residents of third States. Paragraph 2 of Article 1, like the comparable provision of the U.S. Model, describes the relationship between the rules of the Convention, on the one hand, and the laws of the Contracting States and other agreements between the Contracting States, on the other. This paragraph makes explicit, subject to one exception in the case of the Netherlands as described below, the generally accepted principle that no provision in the Convention may restrict any exclusion, exemption, deduction, credit or other allowance accorded by the tax laws of the Contracting States. For example, if a deduction would be allowed under the Internal Revenue Code (the "Code") in computing the taxable income of a resident of the Netherlands, the deduction will be available to that person in computing income under the Convention. In no event may the Convention increase the tax burden on a resident of a Contracting State beyond that permitted under the State's internal law. Thus, a right to tax given by the Convention cannot be exercised by the United States unless that right also exists under the Code. A taxpayer may generally rely on more favorable treatment afforded under the Code. A taxpayer may not, however, pick and choose among Code and Convention provisions in an inconsistent manner in order to minimize tax. For example, assume a resident of the Netherlands has three separate businesses in the United States. One is a profitable permanent establishment and the other two are trades or businesses that do not meet the permanent establishment threshold tests of the Convention. One is profitable and the other incurs a loss. Under the Convention, the income of the permanent establishment is taxable, and both the profit and the loss of the other two businesses are ignored. Under the Code, all three would be taxable. The loss would be offset against the profits of the two profitable ventures. The taxpayer may not invoke the Convention to exclude the profits of the profitable trade or business and invoke the Code to offset the loss of the 1055 trade or business against the profit of the permanent establishment. (See Rev. Rul. 84-17 C.B. 1984-1, 10.) If the taxpayer invokes the Code to subject all three ventures to U.S. tax, he would not be precluded from invoking the Convention with respect to, for example, any dividend income he may receive from the United States that is not effectively connected with any of his business activities in the United States. Similarly, nothing in the Convention can be used to deny any benefit granted by any other agreement between the United States and the Netherlands. For example, if certain protections, not found in the Convention, are afforded under a Consular Convention or under a Treaty of Friendship, Commerce and Navigation, those protections will be available to residents of the Contracting States regardless of any provisions to the contrary (or silence) in the Convention. As noted above, there is an exception to the general rule that the Convention cannot restrict or deny any more favorable statutory benefit. This rule does not apply, as regards the Netherlands, with respect to Article 25 (Methods of Elimination of Double Taxation). Treaty relief from double taxation in the Netherlands differs from the statutory relief. Even if, in a particular circumstance, the statutory relief would provide a greater benefit, the taxpayer is precluded, under the Convention, from invoking the statutory rule. The "saving c1ause" provisions of paragraphs 3 and 4 of Article 1 of the U.S. Model, preserving certain statutory taxing rights of the Contracting States, are found in Paragraphs 1 and 2 of Article 24 (Basis of Taxation) of the Convention. ARTICLE 2 Taxes Covered This Article identifies the U.S. and Netherlands taxes to which the Convention applies. These are referred to in the Convention as "United States tax" and "Netherlands tax," respectively. Subparagraph 1(a) specifies the existing Netherlands taxes to which the Convention applies. These are the inkomstenbelasting (income tax), the loonbelasting (wages tax), the vennootschapsbelasting (company tax) and the dividendbelasting (dividend tax). The company tax includes the "profit share," which is the government share in the net profits arising from the exploitation of natural resources levied pursuant to the Mining Act of 1810 (Mijnwet 1810) with respect to concessions issued from 1967, or pursuant to the Netherlands Continental Shelf Mining Act of 1965 (Mijnwet Continentaal Flat 1965). Special rules are provided in paragraph 5 of Article 25 (Methods of Elimination of Double Taxation) for the calculation under the Convention of the U.S. foreign tax credit for the profit share. The covered taxes of the United States are specified in subparagraph 1(b). They are the Federal income taxes imposed by the Code and the excise taxes imposed on insurance premiums paid to foreign insurers (Code section 4371), and with respect to private foundations (Code sections 4940 through 4948). The Convention does not apply to social security taxes (Code sections 1401, 3101 and 3111). U.S. and Netherlands social security taxes are dealt within the bilateral Social Security Totalization Agreement, which entered into force on November 1, 1990. The Convention applies to the federal excise tax on insurance premiums only to the extent that the risks covered by such premiums are not reinsured, directly or indirectly, with a person not entitled, under this or any other Convention, to exception from the tax. Under the Code, the tax applies to a Netherlands company only if it earns premiums that are not attributable to an active trade or business in the United States or are exempt by treaty from U.S. net basis income tax. Providing Convention coverage for the U.S. insurance excise tax effectively exempts from the tax certain premiums received by Netherlands companies from the insurance of U.S. risks, subject to the anti-conduit rule for reinsurance, described above. This result is confirmed in paragraph 7 of Article 7 (Business Profits). Under Article 7 (Business Profits), the United States does not subject the business profits of a Netherlands enterprise to tax (i.e., a covered tax) if the income of the enterprise is not attributable to a permanent establishment that the enterprise has in the United States. In contrast with this Convention, the prior Convention did not cover the insurance excise tax, allowing it to be imposed on premiums paid to Netherlands insurers if such premiums were not attributable to a permanent establishment of the insurer in the United States. As Treasury has discussed in prior consultations with the staffs of the Foreign Relations Committee and the tax-writing committees of Congress, Treasury's review of the Netherlands' taxation of the income of Dutch insurance companies indicated that it results in a burden that is substantial in relation to the U.S. tax on U.S. insurance companies. Treasury accordingly believed that it was appropriate to waive the tax with the Netherlands, as was done in the case of the recent conventions with Germany, Spain, Finland and India. Unlike the U.S. Model, the Convention applies to the accumulated earnings tax (Code section 531) and the personal holding company tax (Code section 541). Paragraph 6 of Article 10 (Dividends) prohibits the imposition of these taxes on Netherlands companies. Except with respect to Article 28 (Non-Discrimination), state and local taxes in the United States are not covered by the Convention. Article 28 prohibits discriminatory taxation with respect to all taxes, whether or not they are covered taxes under Article 2, and whether they are imposed by the Contracting States, their political subdivisions or local authorities. In an exchange of notes signed at the time of the signing of the Convention, the United States agreed that, although state and local taxes are not covered under the Convention, if a state or local government seeks to impose an income tax on a Netherlands shipping or airline company in circumstances in which the Convention prohibits the imposition of a Federal income tax, the U.S. Government will seek to persuade that state or local government to refrain from imposing the tax. Under paragraph 2, the Convention will apply to any taxes that are identical, or substantially similar, to those enumerated in paragraph 1, and that are imposed in addition to, or in place of, the existing taxes after December 18, 1992 (the date of signature of the Convention). The paragraph also provides that the U.S. and Netherlands competent authorities will notify each other of significant changes in their taxation laws. This requirement refers to changes that are of significance to the operation of the Convention. ARTICLE 3 General Definitions Paragraph 1 of Article 3 defines a number of basic terms used in the Convention. Terms that are not defined in the Convention are dealt within paragraph 2. Certain others are defined in other articles of the Convention. For example, the term "resident of one of the States" is defined in Article 4 (Resident). The term "permanent establishment" is defined in Article 5 (Permanent Establishment). The terms "dividends," "interest" and "royalties" are defined in Articles 10, 12 and 13, respectively, which deal with the taxation of those classes of income. The term "State" is defined in subparagraph 1(a) to mean the United States or the Netherlands, depending on the context in which the term is used. The term "States" is defined as the United States and the Netherlands. The terms "the Netherlands" and "United States" are defined in subparagraphs 1(b) and (c), respectively. The term "the Netherlands" means that part of the Kingdom of the Netherlands that is situated in Europe (i.e., excluding the Netherlands Antilles and Aruba). The term includes the Dutch continental shelf (with respect to the exploration or exploitation of natural resources). The term "United States" is defined to mean the United States of America, not including Puerto Rico, the virgin Islands, Guam or any other U.S. possession or territory. When used geographically, the term means the 50 states and the District of Columbia. The U.S. continental shelf (with respect to the exploration or exploitation of natural resources) is also specifically included within the definition of the United States. Subparagraph 1(d) defines the term "person" to include an individual, an estate, a trust, a company and any other body of persona. The term "company" is defined in subparagraph 1(e) as a body corporate or an entity treated as a body corporate for tax purposes. Since the term "body corporate" is not defined in the Convention, in accordance with paragraph 2 of this Article, it has the meaning that it has under the law of the Contracting State whose tax is being applied. Thus, for U.S. tax purposes, the principles of Code section 7701 will be applied to determine whether an entity is a body corporate. The definition of "person" in the U.S. Model includes partnerships. The Convention, however, follows the OECD Model by not making specific reference to partnership. It was agreed during the negotiations, however, that the term "person" would be understood to include partnerships. The terms "enterprise of one of the States" and "enterprise of the other State" are defined in subparagraph 1(f) as an enterprise carried on by a resident of one of the States and an enterprise carried on by a resident of the other State, respectively. The term "enterprise" is not defined in the Convention. The term "nationals," as it relates to both the United States and the Netherlands, is defined in subparagraphs 1(g)(i) and (ii). A national of the United States is (1) a U.S. citizen, and (2) any legal person, partnership or association deriving its status as such from the law in force in the United States. A national of the Netherlands is correspondingly defined as (1) an individual possessing the nationality of the Netherlands, and (2) any legal person, partnership or association deriving its status as such from the law in force in the Netherlands. This definition is comparable to that found in the OECD Model. A U.S. national is defined in the U.S. Model as a citizen of the United States, and does not include juridical persons. The addition in the convention of juridical persons to the definition may have significance in relation to paragraph 1 of Article 28 (Non-Discrimination), which provides that nationals of one of the States may not be subject in the other State to any taxes or connected requirements that are other or more burdensome than those applicable to nationals of that other State who are in the same circumstances. Subparagraph 1(h) defines the term "international traffic." This definition is significant principally in relation to Article 8 (Shipping and Air Transport), but also is relevant to Article 16 (Dependent Personal Services) and Article 27 (Offshore Activities). The term means any transport by a ship or aircraft operated by an enterprise of one of the States, except when the vessel is operating solely between places within the other State. The exclusion from international traffic of transport solely between places within one of the States means, for example, that carriage of goods or passengers between New York and Chicago by either a U.S. or a Netherlands carrier would not be treated as international traffic. The substantive taxing rules of the Convention relating to the taxation of income from transport, principally Article 8 (Shipping and Air Transport), therefore, would not apply to income from such carriage. If the carrier is a Netherlands resident (if that were possible under U.S. law) the United States would not be required to exempt the income under Article 8. The income would, however, be treated as business profits under Article 7 (Business Profits), and, therefore, would be taxable in the United States only if attributable to a U.S. permanent establishment, and then only on a net basis. The gross basis U.S. tax would never apply under the circumstances described. If, however, goods or passengers are carried from Rotterdam to New York, and some of the goods or passengers are carried only to New York, while the rest are taken to Philadelphia, the entire transport, including the New York to Philadelphia portion, would be international traffic. Subparagraphs l(i)(i) and (ii) define the term "competent authority" for the Netherlands and the United States, respectively. The competent authority of the Netherlands is the Minister of Finance or his duly authorized representative. The U.S. competent authority is the Secretary of the Treasury or his delegate. The Secretary of the Treasury has delegated the competent authority function to the Commissioner of Internal Revenue, who has, in turn, redelegated the authority to the Assistant Commissioner (International). With respect to interpretative issues, the Assistant Commissioner acts with the concurrence of the Associate Chief Counsel (International) of the Internal Revenue Service. Paragraph 2 establishes a procedure for determining a definition for a term, for purposes of the Convention, that is not otherwise defined in the Convention. The paragraph provides the general rule that any such term will have the meaning that it has under the law of the Contracting State whose tax is being applied. A meaning other than this statutory meaning may be used, however, if the context so requires, or if the competent authorities, pursuant to the authority granted to them in paragraph 3 of Article 29 (Mutual Agreement Procedure), so agree. If, for example, the meaning of a term cannot be readily determined under the law of a Contracting State, or if there is a conflict in meaning under the laws of the two States which creates problems in the application of the Convention, the competent authorities may establish a common meaning in order to prevent double taxation or further any other purpose of the Convention. This common meaning need not conform to the meaning of the term under the laws of either Contracting State. ARTICLE 4 Resident This Article sets forth rules for determining whether a person is a resident of the United States or the Netherlands for purposes of the Convention. As noted in the explanation to Article 1 (General Scope), as a general matter only residents of the Contracting States may claim the benefits of the Convention. The definition of resident in the Convention is to be used only for purposes of the Convention. The prior Convention contains no comprehensive definition of a resident. In general, a person will be considered a resident of a Contracting State if he is subject to tax in that State under its internal law by reason of his residence, domicile, or other similar criterion. A person who, under this rule, is a resident of one State and not of the other will generally (subject to an exception described below) be treated for purposes of the Convention as a resident of the State in which he is resident under internal law. If, however, a person is resident in both Contracting States under their respective taxation laws, the Article proceeds, where possible, to assign a single State of residence to such a person for purposes of the Convention through the use of tie-breaker rules or competent authority agreement. Paragraph 1 defines the term "resident of one of the States." In general, this definition incorporates the definitions of residence in U.S. and Netherlands law. A resident of a State is a person who, under the laws of that State, is subject to tax there by reason of his domicile, place of management, place of incorporation or any other criterion of a similar nature. Residents of the United States include aliens who are considered U.S. residents under Code section 7701(b). Unlike the U.S. Model, "citizenship" is not included among the explicit criteria of residence in the Convention. However, it is understood to be a "criterion of a similar nature" under paragraph 1. An exception to this general rule for certain individuals is described below. Paragraph 1 clarifies that certain non-taxable entities, even though not liable to tax in a State, are nevertheless to be treated as residents of a State if so treated under the laws of that State. The entities referred to are exempt pension trusts dealt within Article 35 (Exempt Pension Trusts), and exempt organizations dealt within Article 36 (Exempt Organizations). Even in the absence of this explicit reference, such organizations should be considered residents of their State of organization under the general rule because they are subject to the taxation laws of that State. It was deemed useful, however, to include this clarification due to the fact that these entities generally do not incur liability to pay taxes. This list is not exhaustive: additional entities that qualify as residents of a State under the tax laws of that State and that are exempt from tax in that State (e.g., by virtue of being government-owned or operated for public purposes) also may be considered residents under Article 4 despite the fact that they are not described in Articles 35 or 36. Paragraph I. of the Memorandum of Understanding notes that the Government of a State, as well as its political subdivisions and local authorities, are to be considered as residents of that State. Subparagraph 1(a) specifies that a person liable to tax in a State only in respect of income from sources within that State will not be treated as a resident of that State for purposes of the Convention. For example, a Dutch consular official stationed in the United States, who may be subject to U.S. tax on his U.S. source investment income, but is not taxable in the United States on his salary and non-U.S. source income, by operation both of Article 20 (Government Service) and Code section 893, would not be considered a resident of the United States for purposes of' the Convention. Similarly, a Netherlands enterprise with a permanent establishment in the United States is not, by virtue of that permanent establishment, a resident of the United States. The enterprise is subject to U.S. tax only with respect to its income attributable to the U.S. permanent establishment, not with respect to its worldwide income, as is a U.S. resident. Subparagraph 1(b) makes clear that an estate or trust will be treated as a resident of' a Contracting State for purposes of the Convention only to the extent that the income derived by such person is subject to tax in that State as the income of a resident, either in the hands of the person deriving the income or in the hands of its beneficiaries. Under U.S. law, an estate or trust is often not itself a taxable entity. Thus, for U.S. tax purposes, the question of whether income received by such an entity is received by a resident will be determined by the residence for taxation purposes of the person subject to tax on such income, which may be the grantor, the beneficiaries or the estate or trust itself, depending on the circumstances. This rule regarding the residence of estates or trusts is applied to determine the extent to which that person is entitled to treaty benefits with respect to income that it receives from the other Contracting State. In the U.S. Model, the provision corresponding to subparagraph 1(b) includes partnerships as well as estates and trusts. Subparagraph 1(b) does not refer to partnerships because both the United States and the Netherlands treat partnerships as pure conduits. Thus, by operation of internal law, both States look to the residence of the partners of a partnership for purposes of determining the availability of the benefits of the Convention to the partners, even without an explicit reference to partnerships in the Convention. As noted above, paragraph 1 contains an exception for certain individuals to the general rule that residence under internal law also determines residence under the Convention. It is not always sufficient for an individual to be a resident under the laws of one of the States (or a citizen of the United States) to be treated as a resident of that State under the Convention. Such an individual, unless he is also a resident of the other State, will be treated under the Convention as a resident of the State in which he is resident under its law (or of which he is a citizen, in the case of the United States) only if the individual has a closer nexus to that State than to any third State. If the individual's State of residence does not have a tax treaty with the third State in question, he will be treated under the Convention as a resident of his State of residence only if he would be a resident of that State and not of the third State under the tie-breaker tests of subparagraphs (a) and (b) of paragraph 2 of Article 4. If, however, the individual's State of residence does have a tax treaty with the third State. then he must be a resident of his State of residence and not of the third State under the residence rules of that second Convention. For example, if a U.S. citizen, or a U.S. green card holder, has a permanent hone in a third State with which the United States has no income tax convention. the person has no permanent home in the United States, and he is not a resident of the Netherlands under Dutch law, such individual would not be treated as a resident of the United States under the Convention. He therefore would not be entitled to treaty benefits. If that individual has a permanent home in both the United States and the third State, and his center of vital interests is in the third State, or if his center of vital interests cannot be determined and his habitual abode is in the third State, he would not be entitled to benefits under the Convention. Similarly, if the individual is a resident of both the United States and Canada under the internal laws of both countries, but under the tie-breaker rules of the U.S. - Canada income tax treaty he is treated as a resident of Canada, that individual would not be treated as a U.S. resident under the Convention, and would not be entitled to claim benefits thereunder. If an individual is considered a resident of each State under its laws, the exception described above does not apply, and a single State of residence is determined by application of the tiebreaker rules of paragraph 2. Paragraph 2(a) provides that such an individual will be resident in the State in which the individual has a permanent home. If the individual has a permanent home available to him in both States, he will be considered to be a resident of the Contracting State to which his personal and economic relations are closest, (i.e., the location of his "centre of vital interests"). Under paragraph 2(b), if he has no centre of vital interests or if he does not have a permanent home available to him in either State, he will be treated as a resident of the Contracting state in which he maintains an habitual abode. Under paragraph 2(c), if he has an habitual abode in both States or in neither of them, he will be treated as a resident of the State of which he is a national. If he is a national of both States or of neither, paragraph 2(d) provides that the competent authorities will attempt by mutual agreement to assign a single State of residence. Paragraph 3 addresses dual-residence issues for persons other than individuals or companies that are considered residents of both States under paragraph 1. Under this paragraph, the competent authorities are instructed to determine a single State of residence by mutual agreement, and determine how the Convention is to apply to such persons. Paragraph 4 addresses corporations that are treated by each State, under its laws, as a resident of that State. A corporation is treated as resident in the United States if it is created or organized under the laws of' the United States or a political subdivision. Under Dutch law a corporation is treated as a resident of the Netherlands if it is either established there or managed and controlled there. Dual residence, therefore, can arise if a U.S. corporation is managed and controlled in the Netherlands. Paragraph 4 provides that the competent authorities will try to determine a single State of residence. In doing so, they are instructed to take into account such factors as the place of incorporation and the place of management. In the event that the competent authorities do not agree on a single State of residence, the paragraph provides that the corporation shall not be considered to be a resident of either the United States or the Netherlands for purposes of deriving any benefits of the Convention, except for the benefit of the U.S. foreign tax credit under paragraph 4 of Article 25 (Methods of Elimination of Double Taxation), and the benefits of Articles 28 (Non-Discrimination), 29 (Mutual Agreement Procedure) and 37 (Entry Into Force). Thus, a State cannot discriminate against a dual resident corporation, and such a corporation can bring issues to the competent authorities. Dual resident corporations may be treated as resident for purposes other than that of obtaining benefits under the Convention. For example, if a dual resident corporation pays a dividend to a resident of the Netherlands, the U.S. paying agent would withhold on that dividend at the appropriate treaty rate, since reduced withholding is a benefit enjoyed by the resident of the Netherlands, not by the dual resident. The dual resident corporation that paid the dividend would, for this purpose, be treated as a resident of the United States under the Convention. Since, by its terms, Article 30 (Exchange of Information and Administrative Assistance) is not limited to residents of the Contracting States, information relating to dual resident corporations can be exchanged. To the extent that the Convention is relevant for dual-resident corporations, it must enter into force for such purposes. Therefore, Article 37 (Entry Into Force) also applies for dual-resident corporations. Paragraph II. of the Memorandum of Understanding clarifies that if a company that is a resident of the Netherlands under paragraph 1 of the Article is treated under U.S. law as a resident of the United States by application of Code section 269B (i.e., because it and a U.S. corporation are stapled entities), the determination of the residence of the entity will be made under the rules of paragraph 4, which allow the competent authorities to determine a single State of residence for a corporation by mutual agreement. The authority of the Internal Revenue Service under section 2698(b) of the Code to prevent avoidance or evasion of Federal income tax through the use of stapled entities is not affected by such an agreement. Therefore, in accordance with the authority provided by section 269B(b), the Internal Revenue Service may, for example, require that such an entity will be treated as being owned (to the extent of the stapled interest) by the entity to which its stock is stapled. However, in accordance with Notice 89-94 C.B. 1989-2, 416, any Netherlands corporation that was stapled to a U.S. corporation as of June 30, 1983, and which was entitled to claim benefits under the prior Convention on that date because it was considered a resident of the Netherlands, will continue for U.S. tax purposes to be considered a Netherlands corporation, and will be eligible to claim treaty benefits to the same extent as any other corporation resident in the Netherlands. ARTICLE 5 Permanent Establishment This Article defines the term "permanent establishment." This definition is relevant under several articles of the Convention. The existence of a permanent establishment in a Contracting State is necessary under Article 7 (Business Profits) for the taxation by that State of the business profits of a resident of the other Contracting State. Since the term "fixed base" in Article 15 (Independent Personal Services) is understood by reference to the definition of "permanent establishment," this Article is also relevant for purposes of Article 15. Articles 10, 12 and 13 (dealing with dividends, interest, and royalties, respectively) provide for reduced rates of tax at source on payments of these items of income to a resident of the other State only when the income is not attributable to a permanent establishment or fixed base that the recipient has in the source State. This Article follows closely both the U.S. and OECD Model provisions. It does not differ significantly from the definition of a permanent establishment in the prior Convention. Paragraph 1 provides the basic definition of the term "permanent establishment." As used in the Convention, the term means a fixed place of business through which the business of an enterprise is wholly or partly carried on. Paragraph 2 contains a list of fixed places of business that will constitute a permanent establishment. The list is illustrative and non-exhaustive. According to paragraph 2, the term permanent establishment includes a place of management, a branch, an office, a factory, a workshop, and a mine, quarry or other place of extraction of natural resources. Paragraph 3 provides rules to determine when a building site, or a construction or installation project constitutes a permanent establishment. Only if the site, project, etc. lasts for more than twelve months does it constitute a permanent establishment. The twelve-month test applies separately to each individual site or project. The twelve-month period begins when work (including preparatory work carried on by the enterprise) physically begins in a Contracting State. A series of contracts or projects that are interdependent both commercially and geographically are to be treated as a single project for purposes of applying the twelve-month threshold test. For example, the construction of a housing development would be considered a single project even if each house in the development is constructed for a different purchaser. If the twelve-month threshold is exceeded, the site or project constitutes a permanent establishment as of the first day that the work in that State began. This interpretation of the Article is based on the Commentaries to paragraph 3 of Article 5 of the OECD Model, which contains language almost identical to that in the Convention. This interpretation, therefore, constitutes the generally accepted international interpretation of the language in paragraph 3 of Article 5 of the Convention. Unlike the U.S. Model, drilling rigs operating offshore on the continental shelf of one of the States are not covered by this construction site rule. Such activities are dealt with under Article 27 (Offshore Activities). Paragraph 4 contains exceptions to the general rule of paragraph 1 that a fixed place of business through which a business is carried on constitutes a permanent establishment. The paragraph lists activities that may be carried on through a fixed place of business, but that will not give rise to a permanent establishment. The use of facilities solely to store, display or deliver merchandise belonging to an enterprise will not constitute a permanent establishment of that enterprise. The maintenance of a stock of goods belonging to an enterprise solely for the purpose of storage, display or delivery, or solely for the purpose of processing by another enterprise will not give rise to a permanent establishment of the first-mentioned enterprise. The maintenance of a fixed place of business solely for activities that have a preparatory or auxiliary character for the enterprise, such as advertising, the supply of information or scientific activities, will not constitute a permanent establishment of the enterprise. Finally, a combination of these activities will not give rise to a permanent establishment if the combination results in an overall activity that is of a preparatory or auxiliary character. This combination rule differs from that in the U.S. Model. In the U.S. Model, any combination of otherwise excepted activities is not deemed to give rise to a permanent establishment, without the additional requirement that the combination, as distinct from each constituent activity, be preparatory or auxiliary. It is assumed that if preparatory or auxiliary activities are combined, the combination generally will also be of a character that is preparatory or auxiliary. If, however, this is not the case, a permanent establishment may result from a combination of activities. Paragraphs 5 and 6 specify the circumstances under which an agent will constitute a permanent establishment of the principal. Under paragraph 5, a dependent agent of an enterprise will be deemed to be a permanent establishment of the enterprise, if the agent has and habitually exercises an authority to conclude contracts in the name of that enterprise. If, however, the agent's activities are limited to those activities specified in paragraph 4, and therefore would not constitute a permanent establishment if carried on by the enterprise through a fixed place of business, the agent will not be a permanent establishment of the enterprise. Under paragraph 6, an enterprise will not be deemed to have a permanent establishment in a Contracting State merely because it carries on business in that State through an independent agent, including a broker or general commission agent, if the agent is acting in the ordinary course of its business. Paragraph 7 clarifies that a company that is a resident of a Contracting State will not be deemed to have a permanent establishment in the other Contracting State merely because it controls, or is controlled by, a company that is a resident of that other Contracting State, or that carries on business in that other Contracting State. The determination of whether or not a permanent establishment exists will be made solely on the basis of the factors described in paragraphs 1 through 6 of the Article. Whether or not a Company is a permanent establishment of a related company, therefore, is based solely on those factors and not on the ownership or control relationship between the companies. ARTICLE 6 Income from Real Property Paragraph 1 provides that income of a resident of a Contracting State derived from real property situated in the other Contracting State may be taxed in the Contracting State in which the property is situated. As clarified in paragraph 3, the income referred to in paragraph 1 means income from any use of real property, including, but not limited to, income from direct use by the owner and rental income from the letting of real property. Income from real property also includes income from agriculture and forestry. This Article does not grant an exclusive taxing right to the situs State, but merely grants it the primary right to tax. The Article does not impose any limitation in terms of rate or form of tax on the situs State. Paragraph 2 provides that the term "real property" has the same meaning that it has under the law of the situs State. In addition, the paragraph specifies certain classes of property which, regardless of internal law definitions, are to be included within the meaning of the term for purposes of the Convention. The definition of "real property" for purposes of Article 6, however, does not include stock in a real property holding company and other interests that are covered in paragraph 1(b) of Article 14 (Capital Gains). Paragraph 4 clarifies that the situs State may tax the real property income of a resident of the other Contracting State even in the absence of a permanent establishment or fixed base in the situs State, notwithstanding the requirements of Articles 7 (Business Profits) and 15 (Independent personal Services) that in order to be taxable, income must be attributable to a permanent establishment or fixed base, respectively. Thus, the situs State may tax income from real property of an enterprise and income from real property used for the performance of independent personal services, regardless of whether the enterprise or individual has a permanent establishment in the situs State. Paragraph 5 contains the provision in the U.S. Model for a binding election by the taxpayer to be taxed on real property income on a net basis. Frequently, when both Contracting States provide for net basis taxation under internal law, this paragraph is not included. Although both Contracting States provide for net basis taxation, the paragraph was included in the Convention at the request of the Netherlands. Paragraph 6 clarifies that the term "real property" includes rights to the exploration or exploitation of the sea bed and subsoil, and the natural resources found in the sea bed and subsoil, and that such real property is located in the State in which the sea bed, subsoil or resources are located. The paragraph also clarifies that such rights or property are considered to pertain to a permanent establishment in that State in the same manner that any real property in a State is considered to pertain to a permanent establishment there. This paragraph is not found in any Model treaty. However, it is consistent with the definition of immovable property in Article 6 of the OECD Model, which includes "rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources and other natural resources." Furthermore, the provision is consistent with subparagraphs (b) and (c) of paragraph 1 of Article 3 (General Definitions) which provides that the terms "the United States" and "the Netherlands" include their continental shelves. ARTICLE 7 Business Profits This Article provides rules for the taxation by one of the States of the business profits of an enterprise of the other. Paragraph 1 contains the basic rule that business profits of an enterprise of one State may not be taxed by the other State unless the enterprise carries on business in that other State through a permanent establishment (as defined in Article 5 (Permanent Establishment)) situated there. Where this condition is met, the State in which the permanent establishment is situated may tax the income of the enterprise, but only so much of the income as is attributable to the permanent establishment. This rule differs from its counterpart in the prior Convention, which contained a limited force of attraction rule. That rule permitted the State in which the permanent establishment is situated to tax income of the enterprise even if not attributable to the permanent establishment, if the income was derived from sources in that State from the sale of goods or merchandise of the same kind as that sold through the permanent establishment or from other transactions of the same kind as those effected through the permanent establishment. Paragraph 2 provides rules for the attribution of business profits to a permanent establishment. It provides that the Contracting States will attribute to a permanent establishment the profits that it would have earned had it been an independent entity, engaged in the same or similar activities under the same or similar circumstances. The computation of the business profits attributable to a permanent establishment under this paragraph is subject to the rules of paragraph 3 for the allowance of expenses incurred for the purpose of earning the income. The profits attributable to a permanent establishment may be from sources within or without a contracting State. Thus, certain items of foreign source income described in Code section 864(c)(4)(B) may be attributed to a U.S. permanent establishment of a Netherlands enterprise and subject to tax in the United States. The concept of "attributable to" in the Convention is narrower than the concept of "effectively connected" in Code section 864(c). The limited "force of attraction" rule in Code section 864(c)(3), therefore, is not applicable under the Convention. Paragraph 2 differs in one respect from the comparable paragraph in the U.S. Model, but conforms in this respect to the OECD Model. In the U.S. Model, the permanent establishment is treated as if it were a "distinct and independent enterprise," and the reference to it dealing wholly independently with the enterprise of which it is a permanent establishment is deleted. The U.S. Model language is intended to make clear that, as described in paragraph 10 of the OECD Commentaries to Article 7, the permanent establishment is to be treated as if it were a totally independent enterprise, (i.e., one that deals independently with all related companies, not just its home office). In the course of the negotiations, the Netherlands negotiators made clear that they subscribed to the interpretation in the OECD Commentaries, but preferred to retain the language from the OECD Model. Thus, there should be no difference in application between paragraph 2 of Article 7 and its analogue in the U.S. Model. Paragraph III. of the Memorandum of Understanding clarifies that n determining the profits of a permanent establishment, only the portion of the income of the enterprise of which the permanent establishment is a part that is attributable to the actual activity of the permanent establishment is to be taken into account. The Memorandum gives an example of an enterprise that has a contract for the survey, supply, installation or construction of industrial, commercial or scientific equipment or premises. If that enterprise has a permanent establishment, the profits attributable to the permanent establishment are determined on the basis of that part of the contract effectively carried out by the permanent establishment. The profits related to the part of the overall contract carried out by the head office are not subject to tax by the State in which the permanent establishment is situated. As noted above, profits may be attributable to the permanent establishment even if they are not from sources in the State in which the permanent establishment is located. Paragraph 3 of the Article provides that in determining the business profits of a permanent establishment, deductions shall be allowed for expenses incurred for the purposes of the permanent establishment. Deductions are to be allowed regardless of where the expenses are incurred. The paragraph specifies that among the expenses for which deductions are allowed are expenses for research and development, interest and other similar expenses. Also included is a reasonable amount of executive and general administrative expenses. The language of this paragraph differs slightly from that in the U.S. Model. The U.S. Model refers to a "reasonable allocation" of the enumerated expenses; the Convention omits this reference. During the negotiations, the Netherlands was concerned that the U.S. Model language could be construed to require both Contracting States to apply the expense allocation rules found in U.S. law, as, for example, in regulation sections 1.861-8 and 1.882-5. Leaving out the reference to "reasonable allocation" is understood to make clear that each State may use its own rules, whether based on tracing or allocation, for attributing expenses to a permanent establishment. Paragraph 3 of Article 24 (Basis of Taxation) refers to paragraphs 1 and 2 of Article 7. It provides that any income, gain or expense attributable to a permanent establishment during its existence is taxable or deductible in the State in which the permanent establishment is situated even if the payment is deferred until after the permanent establishment no longer exists. This paragraph incorporates into the Convention the rule of Code section 864(c)(6). Paragraph 4 provides that no business profits will be attributed to a permanent establishment merely because it purchases goods or merchandise for the enterprise of which it is a permanent establishment. This rule refers to a permanent establishment that performs more than one function for the enterprise, including purchasing. For example, the permanent establishment may purchase raw materials for the enterprise's manufacturing operation and sell the manufactured output. While business profits may be attributable to the permanent establishment with respect to its sales activities, no profits are attributable to its purchasing activities. If the sole activity were the purchasing of goods or merchandise for the enterprise the issue of the attribution of income would not arise, because, under subparagraph 4(d) of Article 5 (Permanent Establishment), there would be no permanent establishment. Paragraph 5 provides that only those business profits derived from a permanent establishment's assets or activities are to be attributed to the permanent establishment. This rule clarifies, as noted in connection with paragraph 2 of the Article, that the Code's limited "force of attraction" principle is not incorporated into the Convention. To assure continuous tax treatment the same method for determining the profits of a permanent establishment is to be used from year to year, unless there is good reason to change. This paragraph differs from the U.S. Model provision in only one respect. In the U.S. Model, the rules of the paragraph apply "for the purposes of this Convention," while in the Convention, as in the OECD Model, the paragraph applies "for the purposes of the preceding paragraphs." Since, when other Articles deal with the taxation of business profits, it is always by reference to Article 7, there is no practical difference between the two versions. Paragraph 6 explains the relationship between the provisions of Article 7 and other provisions of the Convention. Under paragraph 6, where business profits include items of income that are dealt with separately under other articles of the Convention, the provisions of those articles will, except where they specifically provide to the contrary, take precedence over the provisions of Article 7. Thus, for example, the taxation of interest will be determined by the rules of Article 12 (Interest), and not by Article 7, unless, as provided in paragraph 3 of Article 12, the interest is attributable to a permanent establishment, in which case the provisions of Article 7 apply. Paragraph 7 contains a rule not found in the U.S. Model or in most U.S. income tax treaties. The paragraph states that the U.S. Federal excise tax on insurance premiums paid to foreign insurers, to the extent that it is a covered tax under paragraph 1(b) of Article 2 (Taxes Covered) (i.e., to the extent that the risks are not reinsured with a person not entitled to exemption from the tax under this or another Convention), will not be imposed on insurance or reinsurance premiums paid to an insurance business carried on by a Netherlands enterprise, whether or not the business is carried on through a U.S. permanent establishment. This provision of the Convention merely restates the result that obtains under a combination of U.S. law and other provisions of the Convention. Since the excise tax is generally a covered tax under Article 2 (Taxes Covered), the United States may not, pursuant to the provisions of paragraph 1 of Article 7, impose the tax on the income of any Netherlands enterprise that is not attributable to a permanent establishment in the United States. Under Code section 4373, the tax may not be imposed on any amount that is effectively connected with the conduct of a trade or business in the United States. Since any amount attributable, under the Convention, to a permanent establishment in the United States will also be effectively connected with a U.S. trade or business, the tax may also not be imposed on any income of a Netherlands enterprise that is attributable to a permanent establishment in the United States. The Convention does not contain a definition of the term "business profits," as found in paragraph 7 of Article 7 of the U.S. Model. The reason for the inclusion of the definition in Article 7 of the U.S. Model is to make clear that business profits includes two classes of income which, in some countries, are subject to gross basis taxation at source and in the 1977 OECD Model Convention are treated as royalties under Article 12. These classes of income are income from the rental of tangible personal property and income from the rental or licensing of motion picture films or works on film, tape or other means of reproduction for use in radio or television broadcasting. In the Convention neither of these classes of income is included within the definition of royalties in Article 13 (Royalties). Since Article 7 applies to all business profits unless dealt with specifically under another article, these classes of income generally are considered business profits for purposes of the Convention. In some circumstances they might be treated by the Netherlands as "other income" under Article 23 (Other Income). The result, however, will be the same in either event -- no taxation at source, unless the income is attributable to a permanent establishment, in which case it would be taxable on a net basis by the State in which the permanent establishment is located. The absence of a definition of "business profits" in the Convention, therefore, does not affect the taxation of these classes of income. This Article is subject to the saving clause of paragraph 1 of Article 24 (Basis of Taxation). Thus, if, for example, a citizen of the United States who is a resident of the Netherlands derives business profits from the United States that are not attributable to a permanent establishment in the United States, the United States may (subject to the special foreign tax credit rules of paragraph 6 of Article 25 (Methods of Elimination of Double Taxation)) tax those profits as part of the worldwide income of the citizen, notwithstanding the fact that this Article generally would exempt such income of a Netherlands resident from U.S. tax. As with any benefit of the Convention, the enterprise claiming the benefit of Article 7 must be entitled to the benefit under the provisions of Article 26 (Limitation on Benefits) ARTICLE 8 Shipping and Air Transport This Article provides rules governing the taxation of profits from the operation of ships and aircraft in international traffic. The term "international traffic" is defined in subparagraph 1(h) of Article 3 (General Definitions). It is understood, based on the provisions of paragraph 2 of Article 1 (General Scope), that any benefits to which a resident of one of the States is entitled by virtue of the exchange of notes between the United States and the Netherlands under the authority of Code section 883, will continue to be available regardless of any provisions to the contrary in the Convention. Paragraph 1 provides that profits derived by an enterprise of one of the States from the operation of ships or aircraft in international traffic shall be taxable only in that State. By virtue of paragraph 6 of Article 7 (Business profits), profits of an enterprise of a Contracting State that are exempt in the other Contracting State under this paragraph remain exempt even if the enterprise has a permanent establishment in that other Contracting State. Paragraph 2 deals with certain income from the rental of ships or aircraft in international traffic. As indicated in paragraph 5 of the OECD Commentaries to Article 8, income of an enterprise of a Contracting State from the rental of ships or aircraft on a full basis (i.e., with crew) is considered to be income from the operation of ships and aircraft and is, therefore, exempt from tax in the other Contracting State under paragraph 1. Paragraph 2 extends the coverage of the Article to certain income from the bareboat leasing of ships and aircraft. Unlike paragraph 2 in the U.S. Model, however, income from bareboat rentals of ships or aircraft is included within the definition of profits from the operation of ships or aircraft in international traffic in the Convention only to the extent that the rental profits are incidental to profits from the operation of ships and aircraft. Thus, an enterprise that is not in the business of operating ships or aircraft in international traffic and that derives income from renting ships or aircraft would not be able to claim the benefits of Article 8. Income from the non-incidental leasing of ships or aircraft, even if the ships or aircraft are used in international traffic, is treated as business profits. Such non-incidental rental income consequently is taxable in the source State only if it is attributable to a permanent establishment which the lessor has in the source state. It is understood that if, for example, a bank is a resident of one of the States and has a permanent establishment in the other State, and that bank leases an aircraft to an airline in the other State, the rental income will not be attributable to the permanent establishment if the permanent establishment was not involved in negotiating or concluding the lease agreement. The rental income consequently will not be subject to tax by that other State. Similarly, if the activities of the bank in that other State are not sufficient to rise to the level of a permanent establishment, the lease income will not be taxable in that other State. Paragraph 3 clarifies that paragraph 1 applies equally to a proportionate share of the profits derived by an enterprise of a Contracting State from participation in a pool, joint business or international operating agency. This proportionate share is treated as income derived directly from the operation of ships or aircraft in international traffic. Unlike the U.S. Model, Article 8 does not deal with income from the use or rental of containers (including equipment for their transport) that are used for the transport of goods in international traffic. Under the U.S. Model, such income is treated the same as income from the operation in international traffic of ships or aircraft, and, therefore, is taxable only by the State of residence of the enterprise. Under the Convention, such income is treated as business profits, in the same manner as any other income from the rental of tangible personal property, regardless of whether the recipient of the income is a shipping or airline company and its container income is incidental to its income from the operation of ships or aircraft, or whether the recipient is a container leasing company. In either case, if an enterprise of one State derives income from the use or rental of containers, the other State may tax the income only if it is attributable to a permanent establishment in that other State, and may tax only on a net basis. The taxation of gains from the alienation of ships, aircraft or containers is dealt within paragraph 4 of Article 14 (Gains). This Article is subject to the saving clause of paragraph 1 of Article 24 (Basis of Taxation). The United States, therefore, may, subject to the special foreign tax credit rules of paragraph 6 of Article 25 (Methods of Elimination of Double Taxation), tax the shipping or air transport profits of a resident of the Netherlands if that Netherlands resident is a citizen of the United States. As with any benefit of the Convention, the enterprise claiming the benefit of this Article must be entitled to the benefit under the provisions of Article 26 (Limitation on Benefits). ARTICLE 9 Associated Enterprises This Article incorporates into the Convention the general principles of section Code 482. It provides that when related persons (i.e., associated enterprises described in subparagraphs 1(a) and 1(b)) engage in transactions that are mot at arm's length, the Contracting States may make appropriate adjustments to the taxable income of such related persons to reflect the income these persons would have earned with respect to such transactions had there been an arm's length relationship between the persons. The prior Convention contains similar rules. Paragraph 1 deals with the circumstance where an enterprise of a Contracting State is related to an enterprise of the other Contracting State, and the enterprises make arrangements or impose conditions between themselves in their commercial or financial relations different from those that would be made between independent persons. Under these circumstances a Contracting State may adjust the income (or loss) of the enterprise situated in that State to reflect the income that would have been earned in the absence of such a relationship. The paragraph specifies what the term "associated enterprise" means in this context. An enterprise of one Contracting State is associated with an enterprise of the other Contracting State if it participates directly or indirectly in the management, control, or capital of the other. Two enterprises also are associated if any third person or persons participate directly or indirectly in the management, control, or capital of both. The term "control" includes any kind of control, whether or not legally enforceable and however exercised or exercisable. Paragraph 1 contains additional language that is not found in the U.S. Model. This addition clarifies that cost sharing or general services agreements between associated enterprises are not necessarily to be included among the conditions "made or imposed between two enterprises" that are referred to in the first sentence of paragraph 1. Thus, the mere presence of a cost-sharing, or similar, agreement between two related parties does not by itself indicate that the two parties have entered into a non-arm' s length transaction giving rise to am adjustment under paragraph 1. However, any such arrangement may be examined to determine whether, in fact, it does constitute such a transaction. Paragraph 2 provides that where a Contracting State has made an adjustment to the profits of an enterprise of that State that is consistent with the provisions of paragraph 1 (i.e., that was appropriate to reflect arm's length conditions), and the associated enterprise in the other State has been subject to tax on those same profits, that other Contracting State is obligated to make a corresponding, or correlative, adjustment to the tax liability of that associated enterprise. The Contracting State making such an adjustment will take the other provisions of the Convention, where relevant, into account. For example, if the effect of a correlative adjustment is to treat a Netherlands corporation as having made a distribution of profits to its U.S. parent corporation, the provisions of Article 10 (Dividends) will apply, and the Netherlands may impose a withholding tax on the dividend. The rate of the tax will be determined by the provisions of Article 10 (Dividends). The competent authorities are authorized to consult, if necessary, to resolve any differences in the application of these provisions. For example, there may be a disagreement over whether an adjustment made by a Contracting State under paragraph 1 was appropriate. Article 9 of the Convention does not contain a counterpart to paragraph 3 of Article 9 of the U.S. Model. That paragraph does not grant authority that does not otherwise exist; rather, it merely makes clear that, despite the somewhat limited language in paragraph 1 (e.g., the paragraph does not deal with adjustments to credits), the rights of the Contracting States to apply internal law provisions relating to adjustments between related parties are fully preserved. Such adjustments -- the distribution, apportionment, or allocation of income, deductions, credits or allowances --are permitted even if they are different from, or go beyond, those authorized by paragraph 1 of the Article, so long as they accord with the general principles of paragraph 1 (i.e., that the adjustment reflects what would have transpired had the related parties been acting at arm's length). Thus, the absence of paragraph 3 in the Convention does not limit either State's right to implement its own statutory rules relating to adjustments intended to reflect transactions between unrelated parties. This conclusion derives from the view of both States that paragraph 1 of the Article is intended to be illustrative and not restrictive. For example, while paragraph 1 explicitly allows adjustments to deductions in computing taxable income, it does not preclude adjustments to tax credits if such adjustments can be made under internal law, despite the lack of express authority in Article 9 to make such adjustments. Paragraphs IV. and V. of the Memorandum of Understanding relate to Article 9. Paragraph IV. deals with the rules of both States for determining the appropriate amount of interest deductions allowed to their enterprises. The paragraph makes clear that the appropriate deduction may be determined by reference not only to the amount of interest paid with respect to a particular debt claim (i.e., is the rate of interest charged appropriate), but also to the overall debt capital of the enterprise (i.e., is the capital structure of the enterprise appropriate). Any adjustment to the amount of the deduction for interest must be consistent with the arm's length principles of paragraph 1 of Article 9 as those principles are examined and explained in OECD publications regarding thin capitalization. A 1986 report on thin capitalization by the Committee on Fiscal Affairs of the OECD supports the view expressed in paragraph IV. that Article 9 is relevant for determining the appropriate amount of interest either with respect to a particular debt claim or by reference to the overall capital structure of the enterprise. Paragraph V. of the Memorandum of Understanding clarifies the relationship between Article 29 (Mutual Agreement Procedure) and Article 9. Paragraph V. first notes that under Article 29, the competent authorities should attempt to resolve any double taxation that may arise as a result of the application by one of the States of its rules relating to such matters as thin capitalization, earnings stripping or transfer pricing. It then confirms that the competent authorities should sake their determination based on the arm's length principles of paragraph 1 of Article 9. It finally notes that, consistent with the mutual agreement procedures of other income tax Conventions, an agreement reached by the competent authorities under Article 29 in response to an adjustment by one of the States under paragraph 1 of Article 9, may result either in a correlative adjustment by the other State or in a full or partial readjustment by the first State in its original adjustment. If a correlative adjustment is made under paragraph 2, it is to be implemented pursuant to paragraph 2 of Article 29 (Mutual Agreement Procedure), notwithstanding any time limits or other procedural limitations in the law of the Contracting State making the adjustment, provided that the competent authority making the correlative adjustment has received notification of the case within six years from the end of the taxable year to which the case relates. (See the explanation of Article 29 for an explanation of the operation of the notification requirement.) The saving clause of paragraph 1 of Article 24 (Basis of Taxation) does not apply to paragraph 2 of Article 9 (see the exceptions to the saving clause in subparagraph (a) of paragraph 2 of Article 24). Thus, even if the statute of limitations has run, or there is a closing agreement between the Internal Revenue Service and the taxpayer, a refund of tax can be made in order to implement a correlative adjustment arising under paragraph 2 of Article 9. Statutory or procedural limitations, however, cannot be overridden to impose additional tax, because, under paragraph 2 of Article 1 (General Scope) the Convention cannot restrict any statutory benefit. The United States intends that its regulations under Code section 482 will adhere fully to the arm's length standard. In particular, the "commensurate with income" approach for determining royalty rates with respect to intangible property transferred between related parties is to be applied consistently with the arm 's length standard. The commensurate with income approach recognizes that in certain cases it say be appropriate under the arm's length standard to make periodic adjustments to royalty rates between related parties. In particular, as noted in a 1992 OECD Report on the United States Proposed Regulations under Section 482, it is not always possible for the Internal Revenue Service to know what profits were reasonably foreseeable at the time that an intangible was transferred. In such Cases and others periodic adjustments may be warranted. It is anticipated that the commensurate with income approach and the section 482 regulations in general will be applied in a manner Consistent with the principles underlying paragraph 1 of Article 9. ARTICLE 10 Dividends Article 10 provides rules for both source and residence country taxation of dividends and similar amounts paid by a company resident in one State to a resident of the other. Generally, the Article limits the source country's right to tax dividends and amounts treated as dividends or dividend equivalents. Paragraph 1 preserves the residence country's general right to tax dividends arising in the source country by permitting a Contracting State to tax its residents on dividends received from a company that is a resident of the other Contracting State. Paragraph 2 grants the source country the right to tax dividends paid by a company that is a resident of that country. Subject to special rules for dividends paid by certain companies, described below, if the beneficial owner of the dividend is a resident of the other Contracting State, the source country tax is limited to 5 percent of the gross amount of the dividend if the beneficial owner is a company that holds directly at least 10 percent of the voting power of the company paying the dividend. Source country taxation is limited to 15 percent of the gross amount of the dividend in all other cases. Indirect ownership of voting shares (e.g., through tiers of corporations) and direct ownership of nonvoting shares are not considered for purposes of determining eligibility for the 5 percent direct dividend rate. Withholding rates for dividends under the prior Convention are the same, except that the requirements for applicability of the 5 percent rate are somewhat different. Special limitations on the rate of source country taxation are provided in paragraph 2 for dividends paid by U.S. Regulated Investment Companies and Real Estate Investment Trusts ("RICs" and "REITs") and by Netherlands "beleggingsinstellings" (as that term is defined in Article 28 of the Netherlands Corporation Tax Act). Dividends paid by RICs and beleggingsinstellings are denied the 5 percent direct dividend rate and subjected to the 15 percent portfolio dividend rate regardless of the percentage of voting shares held directly by a corporate recipient of the dividend. Dividends paid by a REIT and dividends paid by a beleggingsinstelling that invests in real estate to the same extent as is required of a REIT are generally taxed at source at full statutory rates. A beleggingsinstelling will be considered to invest in real estate to the same extent as is required of a REIT if it would satisfy the requirements under Code sections 856(c)(3) and (5). However, in two circumstances dividends paid by such entities are taxed at source at the 15 percent portfolio dividend rate -- if the beneficial owner of the dividend is an individual who owns less that a 25 percent interest in the REIT or the beleggingsinstelling, or if the REIT dividend is owned by a beleggingsinstelling or if the dividend paid by the beleggingsinstelling is beneficially owned by a RIC or a REIT. The denial of the 5 percent withholding rate at source to all RIC, REIT and beleggingsinstellings shareholders, and the denial of the 15 percent rate to most shareholders of REITs and their Dutch equivalents, is intended to prevent the use of these conduit entities to gain unjustifiable benefits for certain shareholders. For example, a Netherlands corporation that wishes to hold a diversified portfolio of U.S. corporate shares say hold the portfolio directly and pay a U.S. withholding tax of 15 percent on all of the dividends that it receives. Alternatively, it may place the portfolio of U.S. stocks in a RIC, in which the Netherlands corporation owns most of the shares, but in which the corporation has arranged to have a sufficient number of small shareholders to satisfy the RIC diversified ownership requirements. Since the RIC is a pure conduit, there are no U.S. tax Costs to the Netherlands corporation of interposing the RIC as an intermediary in the chain of ownership. In the absence of the special rules in paragraph 2, however, the interposition would transform portfolio dividends into direct investment dividends, taxable only at 5 percent. Similarly, a resident of the Netherlands may hold U.S. real property directly, and pay U.S. tax either at a 30 percent rate on the gross income or, generally, at the rates specified in Code sections 1 or 11 on the net income. As in the preceding example, by placing the real estate holding in a REIT, the Dutch investor could transform real estate income into dividend income, and in the process, absent the special rule, transform, at no tax cost, high-taxed income into much lower-taxed income. In the absence of the special rule, if the REIT shareholder is a Netherlands corporation that owns at least a 10 percent interest in the REIT, the withholding rate would be 5 percent: in all other cases it would be 15 percent. In either event, with one exception, a tax of 30 percent or more would be significantly reduced. The exception is the relatively small individual investor who might be subject to a U.S. tax of 15 percent of the net income even if he earned the real estate income directly. Under the special rule in paragraph 2, such individuals, defined as those holding less than a 25 percent interest in the REIT, remain taxable at source at a 15 percent rate. The term "beneficial owner", as used in paragraph 2, is not defined in the Convention, and is, therefore, defined as under the internal law of the country imposing tax (i.e., the source country). The beneficial owner of the dividend for purposes of Article 10 is the person to which the dividend income is attributable for tax purposes under the laws of the source state. Thus, if a dividend paid by a corporation of one of the States is received by a nominee or agent that is a resident of the other State on behalf of a person that is not a resident of that other State, the dividend is not entitled to the benefits of this Article. However, a dividend received by the nominee on behalf of a resident of that other State would be entitled to the benefits. Paragraph VI. of the Memorandum of Understanding elaborates on the definition of dividends and on the concept of beneficial ownership of dividends. It specifies that the beneficial owner of dividends who, instead of holding directly the shares themselves, holds depository receipts or trust certificates representing the underlying shares may claim the benefits of reduced source country taxation under paragraph 2 of the Article. The paragraph also deals with the status under Article 10 of dividends paid in respect of shares that have been loaned. It makes clear that when a person loans shares (or other rights that generate income that is treated as income from shares for tax purposes) and receives from the borrower of the shares an obligation to pay any amounts that the borrower receives as dividends during the term of the loan, the lender of the shares or other rights is treated as the beneficial owner of the dividends paid with respect to such shares or other rights. That person is, therefore, entitled to the benefits of paragraph 2 of Article 10 with respect to such payments. Paragraph 3 makes clear that paragraph 2 does not affect the taxation of the profits out of which the dividends are paid, but affects the taxation only of the dividend itself. Paragraph 4 defines the term dividends as used in the Convention. Paragraph 4 generally conforms to paragraph 3 of Article 10 of the OECD Model. The term includes income from shares or other rights participating in profits, as well as other income derived from other corporate rights that is subjected to the same taxation treatment as income from shares by the laws of the Contracting State of which the company making the distribution is a resident. In the case of the Netherlands, the term also includes income from profit-sharing bonds, and in the case of the United States, the term includes income from debt obligations that carry the right to participate in profits. Paragraph 5 excludes dividends paid with respect to holdings that form part of the business property of a permanent establishment or fixed base from the general source country limitations of paragraph 2. Such dividends will be taxed on a net basis using the rates and rules of taxation generally applicable to residents of the state in which the permanent establishment or fixed base is located, as modified by Articles 7 (Business Profits) or 15 (Independent Personal Services) of the Convention. The rule in paragraph 3 of Article 24 (Basis of Taxation) dealing with deferred income and expenses of a permanent establishment or fixed base applies to paragraph 5 of this Article. Thus, dividend income that is attributable to a permanent establishment or fixed base, but is deferred until after the permanent establishment or fixed base no longer exists, may nevertheless be taxed by the State in which the permanent establishment or fixed base was located. Paragraph 6 bars one State from imposing any tax on dividends paid by a company resident in the other State, except insofar as such dividends are otherwise subject to net basis taxation in the first-mentioned Contracting State because such dividends are paid to a resident of such first-mentioned Contracting State, or the holding in respect of which the dividends are paid forms part of the business property of a permanent establishment or pertains to a fixed base situated in such first-mentioned State. Furthermore, except as provided in Article 11 (Branch Tax), paragraph 6 prevents one State from taxing a company resident in the other on its undistributed profits regardless of where those undistributed profits arise. Notwithstanding the foregoing limitations on source country taxation of dividends, the saving clause of paragraph 1 of Article 24 (Basis of Taxation) permits the United States to tax dividends received by its residents and citizens, subject to the special foreign tax credit rules of paragraph 6 of Article 25 (Methods of Elimination of Double Taxation), as if the Convention had not come into effect. As with any benefit of the Convention, a resident of one of the States claiming the benefit of this Article must be entitled to the benefit under the provisions of Article 26 (Limitation on Benefits). ARTICLE 11 Branch Tax Article 11 provides for the imposition of a branch profits tax. Paragraph 1 provides the basic authority under the Convention for a State to impose an additional tax (e.g., a branch profits tax such as that imposed by section 884(a) of the Code) on a company that is resident in the other Contracting State and that has a permanent establishment in the first-mentioned State or that is subject to net basis taxation in such State under Article 6 (Income from Real Property) or under paragraph 1 of Article 14(Capital Gains). Paragraph 1 defines the base to which the tax is applied. That base is the portion of the business profits of a company attributable, under the Convention, to the permanent establishment and the net income subject to tax under Article 6 or paragraph 1 of Article 14, reduced by corporate taxes (other than the branch tax) paid by the branch, and further reduced, but not below zero, by the increases in net equity attributable to the permanent establishment, and increased, but not in excess of accumulated profits, for decreases in net equity attributable to the permanent establishment. This definition of the base subject to the branch tax is consistent with the definition under U.S. law of the dividend equivalent amount that is subject to the branch profits tax under Code section 884. Paragraph 4 confirms this result by providing that in the case of the United States, the base of the tax is the "dividend equivalent amount," as the term is defined under United States law, and as that statutory definition may be amended from time to time, but only to the extent that the amended definition remains in conformity with the principles described in paragraph 1. For example, the United States may impose its branch profits tax on business profits of a Netherlands company attributable to a permanent establishment in the United States. In addition, the United States may impose its branch profits tax on income of a Netherlands corporation subject to taxation on a net basis because the Netherlands corporation has elected under Code section 882(d) to treat income from real property not otherwise taxed on a net basis as effectively connected income, or because the gain arises from the disposition of a United States Real Property Interest other than an interest in a United States corporation. The United States may not impose its branch profits tax on the business profits of a Netherlands corporation that are effectively connected with a U.S. trade or business but that are mot attributable to a permanent establishment and are not otherwise subject to U.S. taxation under Article 6 or paragraph 1 of Article 14. Although the Article is drafted in a reciprocal fashion, thus allowing both States to impose a branch tax, as of the time of signature of the Convention only the United States imposed such a tax. Paragraph 2 of Article 11 provides that the term "accumulated profits," as used in paragraph 1 in defining the base of the branch tax, refers only to profits earned in the taxable years for which the Convention was in effect, less the amount of profits that were taxed under Article 11. This rule effectively limits the United States' right to impose its branch profits tax to profits earned in taxable years after the effective date of the Convention. Given that the prior Convention prohibits imposition of the tax, the Dutch delegation regarded its agreement to permit imposition of the branch tax in any form as a concession on its part, Since the United States delegation, in conformity with the directive of Congress to renegotiate those treaties that did not permit the branch tax, insisted that the Convention permit the imposition of the tax, the delegations compromised by agreeing to a provision permitting the U.S. to impose its branch profits tax but not with respect to earnings attributable to periods during which the United States was barred by treaty from imposing the tax. Paragraph 3 provides that the branch profits tax permitted by this Article shall not be imposed at a rate exceeding the direct dividend withholding rate of five percent that is provided for in paragraph 2(a) of Article 10 (Dividends). Paragraph 5 provides that the branch tax imposed by paragraph 1, consistently with U.S. law, will not be imposed on gain from the disposition of shares or other corporate rights that are subject to tax under paragraph 1 of Article 14 (Capital Gains), (i.e., shares in a company the greater part of the assets of which consist of real property situated in the State of residence of the company). It may, however, be imposed on other real property gains that are subject to tax under paragraph 1 of Article 14. As with any benefit of the Convention, a corporation that is a resident of one of the States claiming the benefits of this Article must be entitled to those benefits under the provisions of Article 26 (Limitation on Benefits). ARTICLE 12 Interest Article 12 provides rules for source and residence country taxation of interest. Paragraph 1 grants to the residence State the exclusive right to tax interest derived and beneficially owned by its residents Thus, the exemption at source for interest in the prior Convention is generally carried forward to this Convention. Paragraph 2 defines the term "interest" as used in the Convention to mean income from debt claims of every kind, whether or not the claim is secured by a mortgage. The term "interest," however, does not include income from debt claims that carry the right to participate in the profits of the debtor. Such income is included within the definition of dividends in Article 10 (Dividends) and is, therefore, subject to the provisions of that Article. Thus, for example, income from a debt obligation of a Netherlands resident that carries the right to participate in profits is not covered by Article 12, even if such income is treated as interest under the law of the United States. If, however, a U. S. parent receives a Netherlands source payment from a Netherlands subsidiary that is treated as a dividend for purposes of Netherlands taxation, but is characterized as interest under U.S. law, the U.S. parent will not be allowed a deemed-paid foreign tax credit with respect to Netherlands income tax attributable to that payment. The definition of interest in paragraph 2 includes income from Government securities and from bonds or debentures, including premiums or prizes attaching to such securities, bonds or debentures. The definition also includes as interest an excess inclusion with respect to a residual interest in a real estate mortgage investment conduit. A special rule is provided in paragraph 7 for this category of interest. Penalty charges for late payment are excluded from the definition of interest. Paragraph 3 provides an exception to the general rule of paragraph 1 that bars a source country tax on interest. The exception applies in cases where the beneficial owner of the interest carries on business through a permanent establishment in the source State or performs independent personal services from a fixed base situated in the source State and the debt claim in respect of which the interest is paid forms part of the business property of such permanent establishment or fixed base. In such cases the provisions of Article 7 (Business Profits) or Article 15 (Independent Personal Services) will apply and the source State will generally retain the right to impose tax on such interest income. The rule in paragraph 3 of Article 24 (Basis of Taxation) dealing with deferred income and expenses of a permanent establishment or fixed base applies to paragraph 3 of this Article. Thus, interest income that is attributable to a permanent establishment or fixed base, but is deferred until after the permanent establishment or fixed base no longer exists, may nevertheless be taxed by the State in which the permanent establishment or fixed base was located. Paragraph 4 provides a source rule for interest. It provides that interest shall be deemed to arise in a State when the payer is the State itself, or a political subdivision, local authority or resident of that State. There is an exception, however, to the general rule that interest arises in the State of residence of the payer. The exception arises when the payer, even if he is a third-State resident, has a permanent establishment or a fixed base in one of the States and the interest in connection with which the interest is paid was incurred in connection with, and is borne by, that permanent establishment or fixed base. The exception also applies in the case where the person paying the interest is subject to the branch tax under Article 11 (Branch Tax) and the interest paid is allocable to the income subject to the branch tax. In those cases, the interest is deemed to arise in the State in which the permanent establishment or fixed base is situated or in which the income is subject to the branch tax. Paragraph 5 deals with cases where there is a special relationship between the payer and the beneficial owner of interest. The provisions of Article 12 apply only to interest payments that would have been made absent such special relationships (i.e., an arm's length interest payment). Any excess amount of interest paid remains taxable according to the laws of the United States and the Netherlands respectively, with due regard to the other provisions of the Convention. Thus, for example, if the excess amount would be treated as a distribution of profits, such amount could be taxed as a dividend rather than as interest, but the tax would be subject to the rate limitations of paragraph 2 of Article 10 (Dividends). Paragraph 6 limits the right of one State to impose tax on interest payments made by a resident of the other. The paragraph provides for the imposition of tax under those circumstances only with respect to (1) interest paid to a resident of the first-mentioned State, (2) interest attributable to a permanent establishment or a fixed base located in that first-mentioned state, or (3) interest that arises in the first-mentioned State and is not paid to a resident of the other State. Thus, if a Netherlands company derives income from the United States that is subject to the United States branch profits tax, even if the company has no permanent establishment in the United States (e.g., because such company makes an election to be taxed on a net basis under section 882(d) of the Code or such company disposes of a United States Real Property Interest), such interest is treated, by virtue of paragraph 4, as arising in the United States, and the United States retains the right to tax interest payments made by such company. Interest paid by a U.S. permanent establishment of a Netherlands company to a resident of the Netherlands, however, is not subject to U.S. tax by virtue of the source country exemption in paragraph 1 of Article 12. Paragraph 6 also provides that the excess of the amount of interest deductible in one State by a company resident in the other that is subject to the branch tax in the first-mentioned State, over the interest actually paid by such permanent establishment or paid in connection with other income subject to the branch tax, shall be treated as interest derived and beneficially owned by a resident of that other State. Thus, the Article 12 exemption from source country taxation will generally prevent the United States from collecting the excess interest tax imposed by section 884(f) of the Code on a Netherlands resident. Although paragraph 2 includes an excess inclusion with respect to a residual interest in a U.S. real estate mortgage investment conduit (REMIC) within the definition of interest, paragraph 7 provides that the exemption at source for interest provided for in paragraph 1 does not apply to such income. This class of income is subject to the statutory 30 percent U.S. rate of tax at source. The legislation that created REMICs in 1986 provided that such excess inclusions were to be taxed at the full 30 percent statutory rate, regardless of any then-existing treaty provisions to the contrary. Providing for the 30 percent rate in the Convention, therefore, conforms the treatment of excess inclusions with respect to residents of the Netherlands to Congressional intent. Article l of the Protocol added a new paragraph 8 to the Article to deal with the treatment of interest in the context of the so-called "triangular case". The inclusion of such a rule was provided for in paragraph 4 of Article 24 of the Convention prior to the Protocol. The term "the triangular case" refers to the use of the following structure by a resident of the Netherlands to earn, in this case, interest income from the United States. The resident of the Netherlands, who is assumed to qualify for benefits under one or more of the provisions of Article 26 (Limitation on Benefits), sets up a permanent establishment in a third jurisdiction that imposes only a low rate of tax on the income of the permanent establishment. The Netherlands resident lends funds into the United States through the permanent establishment. The permanent establishment, despite its third-jurisdiction location, is an integral part of a Dutch resident. Therefore the income that it earns on those loans, absent the provisions of paragraph 8, is entitled to exemption from U.S. withholding tax under the Convention. Under current Netherlands law, under a Netherlands income tax treaty with the host jurisdiction of the permanent establishment, or in the case of the Netherlands Antilles or Aruba, under Netherlands Kingdom law, the income of the permanent establishment is exempt from Netherlands tax. Thus, the interest income is exempt from U.S. tax, is subject to little tax in the host jurisdiction of the permanent establishment, and is exempt from Netherlands tax. Although the paragraph is drafted reciprocally, as a practical matter, it will apply only with respect to U.S. source interest that is attributable to a third-jurisdiction permanent establishment of a Dutch resident, because the United States does not exempt the profits of a third-jurisdiction permanent establishment of a U.S. resident from U.S. tax, either by statute or by treaty. The descriptions in this explanation, therefore, are in the context of a resident of the Netherlands deriving U.S. source income. It was mutually recognized by the two States that the multiple non-taxation resulting from this structure is an abuse that must be corrected. Proposed Netherlands legislation to correct the problem could not be enacted prior to ratification of the Convention, and, in any event, the proposed legislation would not deal with the issue with respect to Netherlands tax treaties or Kingdom legislation. When the legislation is enacted, and Dutch treaties and Kingdom legislation are amended to remove the exemption in abuse cases, the provision of paragraph 8 will be applicable less frequently. Paragraph 8 replaces the U.S. source exemption for interest provided by paragraph 1 with a 15 percent U.S. withholding tax under the following circumstances. First, the profits of the permanent establishment arising from the U.S. source interest are subject to a combined effective rate of tax in the host jurisdiction of the permanent establishment and the Netherlands that is less than a specified threshold. That threshold is 50 percent of the generally applicable rate of company tax in the Netherlands (i.e., 17.5 percent under present Netherlands law) for interest arising in the United States prior to January 1, 1998 and beneficially owned by a Netherlands resident. For interest arising after that date, the threshold rises to 60 percent (i.e., 21 percent under present Netherlands law). In determining the aggregate rate of taxation to which the profits of the permanent establishment are subject it is necessary to add together any Netherlands tax paid on the profits and the taxes paid in the third jurisdiction. In general, the principles employed under Code section 954(b)(4) will be employed to determine whether the profits are subject to an effective rate of taxation that is above the specified threshold. Notwithstanding the level of tax on the profits of the permanent establishment, however, the source exemption will continue to be granted if the income is derived in connection with or is incidental to an active trade or business carried on in the third jurisdiction by the permanent establishment. The business of making or managing investments is not considered to be an active trade or business, unless these are banking or insurance activities carried on by a bank or insurance company. Paragraph III. of the Agreed Minutes to the Protocol makes clear that the business of making or managing investments includes group financing or making portfolio investments. As a result, only banks or insurance companies could obtain the benefits of the active trade or business exception with respect to income derived from related party financing or portfolio investment. Under the income tax convention between the Netherlands and Switzerland a specified percentage (usually 10 percent) of the income of a Swiss permanent establishment of a Netherlands resident will be allocated to and included in the taxable income of the Netherlands resident. The remainder of the income will be exempt from tax in the Netherlands. Income allocated to the Dutch taxing jurisdiction pursuant to the Netherlands-Switzerland treaty (or otherwise) is not considered to be "attributable" to the Netherlands (rather than the permanent establishment) for purposes of paragraph 8. Rather, the U.S. withholding tax imposed under paragraph 8 applies to the entire amount of the interest paid to the third-jurisdiction permanent establishment. Therefore, if a Swiss permanent establishment of a Dutch resident lends funds of the resident to related parties in the United States, the U.S. source interest generated by those loans will be subject to a U.S. withholding tax of 15 percent, instead of the exemption provided in paragraph 1, if the Dutch tax and the Swiss tax results in an effective rate less than the threshold specified for the taxable year in question. If, on the other hand, the permanent establishment is engaged in, say, a manufacturing operation in Switzerland, and places some of its working capital temporarily in the bonds of a related U.S. company, the interest on those bonds would continue to be exempt from U.S. tax because the income would be incidental to the active business in Switzerland of the permanent establishment. If, regardless of the nature of the activity of the permanent establishment, the host jurisdiction of the permanent establishment imposes an effective tax rate in excess of, say, 25 percent, the interest would be exempt from tax in the United States. Notwithstanding the limitations on source country taxation of interest contained in this Article, the saving clause of paragraph 1 of Article 24 (Basis of Taxation) permits the United States to tax interest received by its residents and citizens, subject to the special foreign tax credit rules of paragraph 6 of Article 25 (Methods of Elimination of Double Taxation), as if the Convention had not come into effect. As with any benefit of the Convention, a resident of one of the States claiming the benefit of this Article must be entitled to the benefit under the provisions of Article 2E (Limitation on Benefits). ARTICLE 13 Royalties Article 13 provides rules for source and residence country taxation of royalties. Paragraph 1 grants to the residence State the exclusive right to tax royalties arising in the other State, and derived and beneficially owned by a resident of the first-mentioned State. Thus, the exemption at source for royalties in the prior Convention is carried forward to the Convention. Paragraph 3 generally follows the U.S. Model and defines the term "royalties" for purposes of the Convention to mean payments of any kind received as a consideration for the use of, or the right to use, any copyright of a literary, artistic, or scientific work: for the use of, or the right to use, any patent, trademark, trade name, brand name, design or model, plan, secret formula or process; or for information concerning industrial, commercial, or scientific experience. The term also includes gains derived from the alienation of any such right or property that are contingent on the productivity, use, or further alienation thereof. Payments received in connection with the use or right to use cinematographic films, or works on film, tape, or other means of reproduction used for radio or television broadcasting are specifically excluded from the definition of royalties. Such payments are covered by the provisions of Article 7 (Business Profits). The reference to "other means of reproduction" makes clear that future technological advances in the field of radio and television broadcasting will not affect the exclusion of payments relating to the use of such means of reproduction from the definition of royalties. Paragraph 3 of Article 13 provides an exception to the source country exemption for royalties in cases where the beneficial owner of the royalties carries on business through a permanent establishment in the source state or performs independent personal services from a fixed base situated in the source state and the royalties are attributable to the permanent establishment or fixed base. In such cases the provisions of Article 7 (Business Profits) or Article 15 (Independent Personal Services) will apply, and the source state will generally retain the right to tax such royalties on a net basis. The rule in paragraph 3 of Article 24 (Basis of Taxation) dealing with deferred income and expenses of a permanent establishment or fixed base applies to paragraph 3 of this Article. Thus, royalty income that is attributable to a permanent establishment or fixed base, but is deferred until after the permanent establishment or fixed base no longer exists, may nevertheless be taxed by the State in which the permanent establishment or fixed base was located. Paragraph 4 deals with cases involving special relationships between the payor and beneficial owner of a royalty. Paragraph 4 provides that the provisions of Article 13 apply to royalty payments between related persons only to the extent that such payments would have been made absent such special relationships (i.e., an arm's length royalty payment). Any amount in excess of an arm's length payment remains taxable according to the laws of the source State, with due regard to the other provisions of the Convention. If, for example, the excess amount is treated as a distribution of profits under the national law of the source State, such excess amount will be taxed as a dividend rather than as a royalty payment, but the tax imposed on the dividend payment will be subject to the rate limitations of paragraph 2 of Article 10 (Dividends). Paragraph 5 is not found in the U.S. or OECD Models. It limits the extent to which one State may tax royalties paid by a resident of the other State. Subparagraphs (a) and (b) of paragraph 5 permit taxation of such royalties when they are paid to a resident of the first-mentioned State (subparagraph (a)), or when they are attributable to a permanent establishment of fixed base situated in that first-mentioned State (subparagraph (b)). Even without these two subparagraphs these taxing rights could be exercised under the Convention by the State of residence or the State in which the permanent establishment or fixed base is located, under paragraph 1 of Article 24 (Basis of Taxation)1 Article 7 (Business Profits) or Article 15 (Independent Personal Services). Subparagraphs (c) and (d) deal with taxation by one State of a royalty paid by a resident of the other State to a resident of a third State for the use of an intangible in the first-mentioned State. Subparagraph (c) provides that if a royalty is borne by a permanent establishment or fixed base located in one of the States, and the contract in connection with which the royalty was paid was concluded in connection with that permanent establishment or fixed base, the State where the permanent establishment or fixed base is located may tax the royalty if it is not paid to a resident of the other State. The rate of the tax imposed on the royalty may be limited by reference to the tax treaty, if any, in force between the taxing State and the third State. Thus, for example, if a new process is developed by a Canadian company and licensed for use in the United States by a U.S. permanent establishment of a Dutch company, assuming that the royalties are paid by the branch, and deducted by it for U.S. tax purposes, then under U.S. law the Netherlands resident (i.e., the U.S. permanent establishment) is required to withhold U.S. tax on the royalty payment at a 10 percent rate, the rate applicable to royalties under the U.S. -Canada treaty. This result would also obtain absent the explicit statement in subparagraph 5(c) because the royalty is U.S. source under U.S. law, and it is not covered by the exemption in paragraph 1 of Article 13 since it would not be beneficially owned by a Netherlands resident. Subparagraph (d) provides an additional case in which a State nay tax royalties paid by a resident of the other to a third-country resident. Under Code section 861(a)(4), and, implicitly, under the U.S. Model, any royalty paid for the use of an intangible in the United States, regardless of the residence of the payor, is U.S. source, which, subject to any limitations in the tax treaty between the United States and the country of residence of the beneficial owner, may be taxed by the United States. Under the Convention, however, in addition to the circumstances described in subparagraph (c), one State may tax a royalty paid by a resident of the other State only if: (1) it is for the use of a property in the first-mentioned State, (2) it is not paid to a resident of that other State, (3) the payor of the royalty has also received a royalty in respect of the use of that same property in the first-mentioned State, and that royalty is either paid by a resident of that first-mentioned State or borne by a permanent establishment or fixed base situated in that State, and (4) the use of the intangible is not a component part of or directly related to the active conduct of a trade or business in which the payor (i.e., the resident of the other State) is engaged. The phrases "component part of" or "directly related to the active conduct of a trade or business" are to be understood in the same manner as those phrases are understood in paragraph 2 of Article 26 (Limitation on Benefits). For example, a Canadian resident licenses a patent for a process used in the automotive industry to a resident of the Netherlands, who is not engaged in the automotive industry, and the Netherlands resident sub-licenses the patent to an automobile producer in the United States. The U.S. producer pays a royalty to the resident of the Netherlands for the use of the patent in the United States, and the Netherlands resident, in turn, pays a royalty to the Canadian resident for that same U.S. use of the patent. The royalty paid by the U.S. producer to the Netherlands resident would be exempt from U.S. tax under the provisions of paragraph 1 of Article l3. The royalty paid by the Netherlands resident to the resident of Canada, however, would be subject to U.S. tax under subparagraph (d). The rate would be set at 10 percent, under the provisions of the U.S. - Canada treaty. If, on the other hand, the Netherlands resident was also engaged in automobile production, the royalty paid by the Netherlands resident to the Canadian resident would not be subject to U.S. taxation. Article 2 of the Protocol added a new paragraph 6 to the Article to deal with the treatment of royalties in the context of the so-called "triangular case." The inclusion of such a rule was provided for in paragraph 4 of Article 24 of the Convention prior to the Protocol. The rule in this paragraph is closely analogous to that found in paragraph 8 of Article 12 (Interest), which also was added by the Protocol. The principal difference between this paragraph and paragraph 8 of Article 12 is that this paragraph deals with U.S. source royalties that are attributable to a permanent establishment of a resident of the Netherlands located in a third jurisdiction. Paragraph 6 replaces the U.S. source exemption for royalties provided by paragraph 1 with a 15 percent rate of U.S. tax at source on the gross royalty payment under the following circumstances. First, the profits of the permanent establishment are subject to a combined effective rate of tax in the host jurisdiction of the permanent establishment and the Netherlands that is less than a specified threshold. That threshold is 50 percent of the generally applicable rate of company tax in the Netherlands (i.e., 17.5 percent under present Netherlands law) for royalties arising in the United States prior to January 1, l998 and beneficially owned by a Netherlands resident. For royalties arising after that date, the threshold rises to 60 percent (i.e., 21 percent under present Netherlands law). Notwithstanding the level of tax on the profits of the permanent establishment, however, the source exemption will continue to be granted if the royalty is derived from the licensing of an intangible that has been developed in the third jurisdiction by the permanent establishment. Thus, if an Antilles permanent establishment of a Dutch resident develops a patent that is licensed to a resident of the United States, the royalties paid to the permanent establishment by the U.S. licensee in respect of that patent would continue to be exempt from U.S. tax at source under the provisions of paragraph 1. If, however, the permanent establishment is merely sub-licensing patents that have been developed elsewhere, the 15 percent U.S. tax at source provided for by paragraph 6 will apply, unless the combination of Antilles and Netherlands tax on the profits of the permanent establishment exceeds the 50 or 60 percent threshold, as appropriate, provided for in paragraph 6. The determination of the effective rate of tax borne by the permanent establishment is made as described under paragraph 8 of Article 12. Notwithstanding the limitations on source country taxation of royalties contained in this Article, the saving clause of paragraph 1 of Article 24 (Basis of Taxation) permits the United States to tax royalties received by its residents and citizens, subject to the special foreign tax credit rules of paragraph 6 of Article 25 (Methods of Elimination of Double Taxation), as if the Convention had not come into effect. As with any benefit of the Convention, a resident of one of the States claiming the benefit of this Article must be entitled to the benefit under the provisions of Article 26 (Limitation on Benefits) ARTICLE 14 Capital Gains Article 14 provides rules for source and residence country taxation of gains from the alienation of property. Paragraph 1 of Article 14 preserves the situs country right to tax gains derived from the alienation of real property situated in the situs state (the "source State"). Thus, paragraph 1 permits gains derived by a resident of one State from the alienation of real property located in the other State to be taxed by such other State. For this purpose, the term "real property situated in the other State" includes real property referred to in Article 6 (Income from Real Property) (i.e., interests in the real property itself) and certain indirect interests in such property. Such indirect interests include shares or other comparable interests in a company that is (or is treated as) a resident of the source State, the assets of which company consist or consisted wholly or principally of real property situated in the source State. Companies treated as residents of the source State include non-U.S. corporations that have elected under section 897(i) of the Code to be treated as U.S. corporations. In addition, interests in a partnership, trust, or estate, to the extent that the assets of such entity consist of real property situated in the source State, are included in this definition. Finally, paragraph 1 provides that in all events the term "real property situated in the other State" includes a United States real property interest in the United States, as that term is defined in the Internal Revenue Code on the date of signature of the Convention, and as amended (without changing the general principles of paragraph 1). Thus, the United States preserves its right to collect the tax imposed by section 897 of the Code on gains derived by foreign persons from the disposition of United States real property interests, including gains arising from indirect dispositions described in section 897(h). For this purpose, the source rules of section 861(a)(5) of the Code shall determine whether a United States real property interest is situated in the United States. Paragraph VII. of the Memorandum of Understanding provides that in determining whether the stock of a corporation resident in the United States is a "United States real property interest," the United States will take into account the fair market value of all assets of the corporation, including intangible assets. It is intended that this provision will be interpreted consistently with Treasury Regulation sections l.897-2(b)(1) and l.897-l(f)(1)(ii), and include all business assets, including intangible property (whether or not appearing as an asset on the balance sheet for tax purposes), in the analysis of whether the stock of a corporation is a United States real property interest. The definition of "real property situated in the other State" applies solely for purposes of Article 14. Therefore, this definition has no effect on the right to tax income covered in other articles of the Convention. Paragraph 2 provides a transitional rule reflecting the fact that Article XI of the prior Convention exempted certain gains from the sale or exchange of capital assets from taxation in the source State, provided the taxpayer had no permanent establishment in that State. Paragraph 2 applies to deemed, as well as actual, alienations or dispositions. Paragraph 2 applies exclusively to certain gains described in paragraph 1. Paragraph 1 will apply to transactions notwithstanding section 1125(c) of the Foreign Investment in Real Property Tax Act, Public Law 96-499 ("FIRPTA"), which generally provided that, in the case of persons entitled to the benefits of income tax treaties that exempted gains from the disposition of real property interests from U.S. tax, such persons would be subject to the provisions of section 897 with respect to their gains from the disposition of United States real property interests after January 1, 1985. This provision represents a departure from U.S. tax treaty policy. Most recent treaties do not contain such a provision. One exception is the convention between the United States and Canada. This provision, however, is significantly more limited than its Canadian counterpart in that the provision in the Convention applies only to gains attributable to dispositions of stock and does not apply to gains attributable to direct holdings of real property. The Canadian provision applied to both direct and indirect holdings. Furthermore, the Canadian provision effectively exempted Canadian investors from tax on gains accruing up to the effective date of that convention. Paragraph 2 of Article 14, however, only would apply to gains accruing prior to 1985, and permits full U.S. tax on gains arising after 1985. If paragraph 2 applies to the alienation of an item of real property, the gain otherwise subject to tax in the situs State will be reduced by the amount of the gain attributable to the period during which the property was held up to and including December 31, 1984. The gain attributable to such period is normally determined by dividing the total gain by the number of full calendar months the property was held by the alienator, including, in the case of an alienation described in subparagraph 2(a)(ii), the number of months in which a predecessor in interest held the property, and multiplying such monthly amount by the number of full calendar months ending on or before December 31, 1984 during which the property was held. The following example illustrates the operation of this rule. Example. A is an individual who has been a resident of the Netherlands since June 18, 1980. A acquired stock in a USRPHC on January 1, 1970. On December 31, l996, A sells the stock of the USRPHC. A's gain on the sale is $500. In the absence of paragraph 2, the full amount of the gain would be taxable to A under section 897 of the Code. Pursuant to paragraph 2, the amount of the gain that is taxable to A is reduced by $269.23, (i.e., the number of months during which the stock was held (312)), divided by the gain realized ($500), multiplied by the number of months prior to December 31, 1984 during which A held the stock (168). Upon a clear showing, however, a taxpayer may prove that a greater portion of the gain was attributable to the specified period. Thus, in the United States the fair market value of the alienated property at December 31, 1984 may be established under paragraph 2 in the manner and with the evidence that is generally required by U.S. Federal income, estate, and gift tax regulations. For this purpose a taxpayer may use valid appraisal techniques for valuing real estate such as the comparable sales approach (see Rev. Proc. 79-24, 1979-1 C.B. 565) and the reproduction cost approach. If more than one property is alienated in a single transaction each property will be considered individually. A taxpayer who desired to make this alternate showing for U.S. tax purposes must so indicate on his U.S. income tax return for the year of the sale or exchange and must attach to the return a statement describing the relevant evidence. The U.S. competent authority or his authorized delegate will determine whether the taxpayer has satisfied the requirements of paragraph 2. The amount of gain that is reduced by reason of the application of paragraph 2 is not to be treated for U.S. tax purposes as an amount of "nontaxed gain" under section 1125(d)(2)(B) of FIRPTA, where that section otherwise would apply. (Note that gain not taxed by virtue of the prior Convention is "nontaxed gain.") Paragraph 2 applies to gains realized from the disposition of real property situated in the other State (as defined in paragraph 1) if the gain could not be taxed by the other State under the provisions of the prior Convention. Under Article XI of the prior Convention, sales of capital assets, including shares of stock, generally could not be taxed in the other State. Article XI did not apply, however, to gains from the disposition of direct holdings of real property. Rather, Article V of the prior Convention permitted situs State taxation of gains arising from the disposition of direct holdings of real property. Therefore, paragraph 2 applies only to dispositions of stock in companies that are described in subparagraph (b) of paragraph 1. Thus, paragraph 2 applies to dispositions of stock in United States Real Property Holding Companies, but not to dispositions of direct holdings in real property. When a person who has continuously been a resident of one of the States since June 18, 1980 alienates real property that is described in paragraph 2, the gain subject to tax in the other State may be reduced if the resident either (i) owned the alienated property continuously from June 18, 1980 until the date of alienation, or (ii) acquired the property in a transaction qualifying as a non-recognition transaction in the other State, and the resident has owned the property continuously since the acquisition, and the resident's initial basis in the alienated property is equal either to the basis of the property that the resident exchanged for the alienated property, or to the basis of the acquired property in the hands of the person transferring the property to the resident. For this purpose, a transaction qualifying for non-recognition is a transaction in which gain resulting therefrom is effectively deferred for tax purposes, but is not permanently forgiven. Thus, in the United States, certain tax-free organizations, reorganizations, liquidations and like-kind exchanges will qualify as non-recognition transactions. However, a transfer of United States real property at death would not constitute a non-recognition transaction for purposes of paragraph 2, as the recipient of the property will acquire the property with a basis equal to the property's fair market value as of death. Only transaction in which the property has a basis in the hands of the recipient that is a carryover or substituted basis will qualify as a non-recognition transaction for purposes of paragraph 2. If a transaction is a non-recognition transaction for tax purposes, the transfer of non-qualified property, or "boot", which may cause some portion of the gain on the transaction to be recognized, will not cause the transaction to lose its character as a non-recognition transaction for purposes of paragraph 2. In addition, a transaction that would have been a non-recognition transaction in the United States but for the application of section 897(d) and 897(e) of the Code also will constitute a non-recognition transaction for purposes of paragraph 2. Further, a transaction that is not a non-recognition transaction under United States law, but to which non-recognition treatment is granted pursuant to the agreement of the competent authority under paragraph 8 of this Article, is a non-recognition transaction for purposes of paragraph 2. However, a transaction that is not a non-recognition transaction under United States law does not become a non-recognition transaction for purposes of paragraph 2 merely because the basis of the property in the hands of the transferee is reduced under section 1125(d) of FIRPTA. Paragraph 2 is subject to several further restrictions. Subparagraph (b) provides that paragraph 2 will not apply unless the resident and any other person that owned the property during the period from January 1, 1992 through the date of alienation, was entitled to the benefits of Article 14 under Article 26 (Limitation on Benefits) or would have been so entitled had the Convention been in effect. Each person that owned the property during this period must have been so qualified throughout the portion of that period in which it owned the property. Further, during the period from June 18, 1980 through December 31, 1991, each person who owned the property must have been a resident of one of the States under the prior Convention. Each person that owned the property during this period must have been such a resident throughout the portion of that period in which it owned the property. Thus, for example, in order for paragraph 2 to be available to a Netherlands resident who, did not own the asset on June 18, 1980, the asset must have been owned by residents of either State continuously since June 18, 1980 and must have been transferred only in transactions that were non-recognition transaction for United States tax purposes. Finally, subparagraph (c) provides that paragraph 2 will not apply to certain alienations of property. Subparagraph (c)(i) provides that paragraph 2 does not apply to alienations of property forming part of the property of a permanent establishment or pertaining to a fixed base situated in the other States at any time on or after June 18, 1980. Subparagraph (c)(ii) provides that paragraph 2 does not apply to alienations of property that was acquired directly or indirectly by any person on or after June 18, 1980 in a transaction that did not qualify for non-recognition, or in a transaction in which it was acquired in exchange for am asset that did not qualify for non-recognition. This subparagraph clarifies the requirements under subparagraph (a)(ii). Finally, subparagraph (c) (iii) provides that paragraph 2 does not apply to alienations of property that was acquired directly or indirectly by any person on or after June 18, 1980 in exchange for property described in subparagraphs (c) (i) or (c) (ii). or for property the alienation of which could have been taxed by the other State under the provisions of the prior Convention. The following examples illustrate the application of paragraph 2. The examples do not, however, fully describe the United States and Netherlands tax consequences resulting from the described transactions. Any condition for the application of paragraph 2 that is not discussed in an example is assumed to be satisfied. Example 1. A, an individual resident of the Netherlands, owned stock in a United States Real Property Holding Corporation ("USRPHC") on June 18, 1980. On January 1, 1982, A transferred the stock to X, a Netherlands corporation, in exchange for 100 percent of the stock of X, a transaction qualifying as a reorganization under section 368(a)(1)(B) of the Code. A's gain on the transaction was exempt from United States tax under Article XI of the prior Convention. Since the transaction qualifies as a non-recognition transaction for United States tax Purposes, in accordance with subparagraph 2(a) (ii) X is entitled to the benefits of paragraph 2 on a subsequent disposition of the stock of the USRPHC occurring after the entry into force of the Convention. Alternatively, if A had transferred the stock to X after the entry into force of the Convention. A would be entitled to the benefits of paragraph 2, pursuant to subparagraph 2(a)(ii), on a subsequent disposition of the stock. Example 2. The facts are the same as in Example1, except that A is a corporation resident in the Netherlands. The results are the same as in Example 1. If, however, A disposes of the stock after January 1, 1992, and under Article 26 (Limitation on Benefits), A would not qualify for the benefits of Article 14, paragraph 2 will not apply by reason of subparagraph 2(b). Example 3. The facts are the same as in Example l, except that A transfers an apartment building located in the United States rather than stock in a USRPHC. Because the prior Convention would not have exempted the gain on such transaction from United States tax, paragraph 2 is inapplicable. Example 4. The facts are the same as in Example l, except that X is a U.S. corporation. If the transfer by A to X occurred on January 1, 1982, A's gain on the transaction would have been exempt from U.S. tax under Article XI of the prior Convention. Consequently, A would be entitled to the benefits of paragraph 2, pursuant to subparagraph 2(a)(ii), on a subsequent disposition of the stock of X occurring after the entry into force of the Convention. If the transfer from A to X occurred after the entry into force of the Convention, A would be entitled to the benefits of paragraph 2, pursuant to subparagraph 2(a)(i), with respect to any U.S. taxation of the gain resulting from the transfer to X, because A would have held the property continuously during the period from June 18, 1980 through the date of alienation. A also would be entitled to the benefits of subparagraph 2, pursuant to subparagraph 2(a)(ii), on a subsequent disposition of the stock of X. Paragraph 2 would not apply, however, to a disposition by X of the USRPHC stock. Example 5. B, a corporation resident in the Netherlands, owns all the stock of C, which also is a corporation resident in the Netherlands. C owns stock in a USRPHC. Both B and C would qualify for the benefits of Article 14 under Article 26 (Limitation on Benefits). After the entry into farce of the Convention, B liquidates C pursuant to a liquidation under section 332 of the Code. The transaction is treated as a non-recognition transaction for U.S. tax purposes. C is entitled to the benefits of paragraph 2, pursuant to subparagraph 2(a)(i), with respect to any gain taxed under section 897(d) of the Code, and B is entitled to the benefits of paragraph 2, pursuant to subparagraph (2)(a)(ii), on a subsequent disposition of the USRPHC stock. Example 6. The facts are the same as in Example 5, except that C is a U.S. corporation. B is entitled to the benefits of paragraph 2, pursuant to subparagraph 2(a)(i), with respect to any gain taxed as a result of the liquidation of C. B also is entitled to the benefits of paragraph 2, pursuant to subparagraph 2(a) (ii), on a subsequent disposition of the stock of the USRPHC. The U.S. tax consequences to C are governed by the internal law of the United States. Examp1e 7. A and B are corporations resident in the Netherlands. Both A and B would qualify for the benefits of Article 14 under Article 26 (Limitation on Benefits). A owns stock in a USRPHC that it acquired prior to June 18, l980. B owns an apartment building in the United States that it acquired prior to June 18, 1980. After the entry into force of the Convention, A exchanges the stock in the USRPHC for the apartment building pursuant to a taxable exchange. A is entitled to the benefits of paragraph 2, pursuant to subparagraph 2(a)(i), because it has held the stock of the USRPHC continuously since June 18, 1980, with respect to any gain realized on the exchange. By reason of subparagraph 2(c)(iii), A is not entitled to the benefits of paragraph 2 on a subsequent sale of the stock of the USRPHC, because the stock was not acquired in a non-recognition transaction. Example 8. The facts are the same as in Example 7, except that B contributes the apartment building to the USRPHC in exchange for 80 percent of the stock of the USRPHC in a transaction described in section 351 of the Code. B is not entitled to the benefits of paragraph 2, because United States tax on the gain arising from a disposition of the building was not prohibited by the prior Convention. In addition, pursuant to subparagraph 2(c)(iii), paragraph 2 also does not apply to a subsequent disposition of the USRPHC stock by B, because the USRPHC stock was acquired in exchange for property (the apartment building) the alienation of which could have been taxed by the United States under the prior Convention. Paragraph 3 of Article 14 preserves the source country right to tax gains from the alienation of certain types of personal property. Paragraph 3 provides that gains from the alienation of personal property forming part of the business property of a permanent establishment that an enterprise of a State has in the other State or of personal property pertaining to a fixed base available to a resident of a State for the purpose of performing independent personal services, including such gains from the alienation of such permanent establishment (alone or with the whole enterprise) or of such fixed base, may be taxed in the other State. This provision permits gains from the alienation by a resident of a State of an interest in a partnership, trust or estate that has a permanent establishment situated in the other State to be taxed as gains attributable to such permanent establishment under paragraph 3. Thus, for example, the United States may tax gains derived from the disposition of an interest in a partnership that has a permanent establishment in the United States, regardless of whether the assets of such partnership consist of personal property as defined in Article 14. Paragraph 4 contains an exception from the rule set forth in paragraph 3. This exception relates to deemed alienations of tangible depreciable personal property forming part of the business property of a permanent establishment that an enterprise of one of the States has in the other State or of tangible depreciable personal property pertaining to a fixed base available to a resident of one of the States in the other State for the purpose of performing personal services, if such permanent establishment or fixed base is described under paragraph 3 of Article 27 (Offshore Activities). This paragraph limits the scope of Netherlands domestic law, which generally provides for tax on any appreciation in the value of equipment employed by a permanent establishment in the Netherlands between the date that the equipment is introduced into the Netherlands and the data it is removed. Paragraph 4 provides that, notwithstanding paragraph 3 of Article 14, such gains are taxable only in the State of residence of the enterprise if the period during which the tangible depreciable personal property forms part of the business property of such permanent establishment or pertains to such fixed base is less than 3 months and provided that the actual alienation of the tangible personal property does not take place within 1 year after the date of its deemed alienation. Furthermore, in cases in which such gain is taxable only in the State of residence of the enterprise, the depreciable basis of the property will be based on the lower of book value or fair market value as of the date that the property became part of the business property of the permanent establishment or first pertained to the fixed base for purposes of determining the profits of the permanent establishment or fixed base in the other State. Paragraph 5 of Article 14 provides a further exception from the rule set forth in paragraph 3. Paragraph 5 provides that profits derived from alienating ships and aircraft operated in international traffic and from personal property such as containers pertaining to such operations of such ships and aircraft are taxable only in the State in which the enterprise is resident. Paragraph 6 of Article 14 provides that gains described in Article 13 (Royalties) shall be taxable in accordance with the provisions of Article 13. This paragraph applies to gains derived from the alienation of rights to intangible property if the amount of the gain is contingent on the productivity, use of disposition thereof, which are described in paragraph 2 of Article 13. Treatment of gains attributable to intangible property that are not described in paragraph 2 of Article 13 is governed by paragraph 7 of Article 14. Subject to the special rules of paragraphs 8 and 9, paragraph 7 of Article 14 grants to the residence State the exclusive right to tax gains from the alienation of property other than those specifically referred to in the preceding paragraphs of Article 14. Paragraph 8 of Article 14 provides rules for coordination of Netherlands and United States rules with respect to the recognition of gain on corporate organizations, reorganizations, amalgamations or similar transactions. Where a resident of one of the States alienates property in such a transaction, and gain or income with respect to such alienation is not recognized or is deferred for purposes of taxation in that State, then the alienator may request the competent authority of the other State to agree to defer any tax arising from such transaction to the same extent that such tax would have been deferred if the alienator had been a resident of that other State. The provisions of this paragraph are inapplicable to defer recognition of corporate-level gain by liquidating corporations under Code section 367(e)(2) because the person recognizing the gain in such a transaction is the liquidating corporation, a U.S. resident. Furthermore, deferral under this paragraph may not exceed the period of time or amount of any deferral in the alienator's State of residence. In addition, the competent authorities of both States must be satisfied that any tax deferred under paragraph 8 can be collected upon a later alienation and that the collection of the tax is adequately secured. This provision means, for example, that the United States competent authority may agree to defer recognition of gain with respect to a transaction if the alienator, a resident of the Netherlands, would otherwise recognize gain for U.S. tax purposes, would not have recognized gain currently if the alienator had been a U.S. resident, and would not recognize gain under Netherlands law. Paragraph 8 contemplates that the competent authorities will develop procedures for implementation of paragraph 8. Furthermore, paragraph VIII. of the Memorandum of Understanding provides that the relief provided under paragraph 8 of Article 14 shall not be available if the tax that otherwise would be imposed cannot be reasonably imposed or collected in the future. In order to ensure that any deferred United States tax may be collected in the future, the United States competent authority may require the alienator or shareholders of a corporation that is a party to the transaction to reduce the basis of any stock received pursuant to the reorganization by closing agreement in order to ensure that the tax that otherwise would have been imposed may be collected at a later time. If such adjustments cannot be made, then the relief described in paragraph 8 will not be available. Paragraph 9 of Article 14 provides an exception from the general exemption from source country tax contained in paragraph 7 for gains derived by certain individuals from the alienation of shares forming part of a 25 percent interest in a company resident in the source State. Under this rule, if an individual was a resident of a State and becomes a resident of the other State under the rules of Article 4 (Residence), and such individual derives gains from the disposition of all or part of a 25 percent interest in a company that is resident in the first-mentioned State, the first-mentioned State may tax such gain under its national law, provided the alienation giving rise to the gain occurs within 5 years of the date on which the individual ceased to be a resident of the first-mentioned State. For purposes of determining whether an individual controls at least 25 percent of any class of shares of a company, the alienator's shares are aggregated with any shares owned by "related individuals." Related individuals for this purpose means the alienator's spouse and relatives (by blood or marriage) in the direct line (ancestors and lineal descendants) and relatives (by whole or half blood or marriage) in the second degree in the collateral line (siblings or their spouses). Notwithstanding the foregoing limitations on source country taxation of certain gains, the saving clause of paragraph 1 of Article 24 (Basis of Taxation) permits the United States to tax gains realized by its residents and citizens, subject to the special foreign tax credit rules of Article 25 (Methods of Elimination of Double Taxation), as if the Convention had not come into effect. As with any benefit of this Convention, a resident of one of the States claiming the benefit of this Article must be entitled to the benefit under the provisions of Article 26 (Limitation on Benefits). ARTICLE 15 Independent Personal Services The Convention deals in separate articles with different classes of income from personal services. Article 15 deals with the general class of income from independent personal services and Article 16 deals with the general class of dependent personal service income. Exceptions or additions to these general rules are found in Articles 17 through 22 for directors' fees (Article 17); performance income of artistes and athletes (Article 18); pensions in respect of personal service income, social security benefits, annuities, and alimony (Article 19): government service salaries and pensions (Article 20); the income of visiting professors and teachers (Article 21), and students and trainees (Article 22). Article 15 provides the general rule that an individual who is a resident of a Contracting State and who derives income from the performance of personal services in an independent capacity will be exempt from tax in respect of that income by the other Contracting State unless certain conditions are satisfied. The income may be taxed in the other Contracting State if the services are not performed in the State of residence of the individual, and the income is attributable to a fixed base that is regularly available to the individual in that other State for the purpose of performing his services. If, however, the individual is a Netherlands resident who performs independent personal services in the United States, and he is also a U.S. citizen, the United States may, by virtue of the saving clause of paragraph 1 of Article 24 (Basis of Taxation), tax his income without regard to the restrictions of this Article, subject to the special foreign tax credit rules of paragraph 6 of Article 25 (Methods of Elimination of Double Taxation). This rule differs in one significant respect from that in the U.S. Model. Under the U.S. Model, a Contracting State only may tax income if it is both attributable to a fixed base in that State and is derived from services performed in that State. In the OECD Model, by contrast, income attributable to a fixed base, wherever performed, may be taxed by the State in which the fixed base is situated ("the host State"). The rule in the Convention represents a compromise between these two positions. A State may tax income from the performance of independent personal services by a resident of the other State if the income is attributable to a fixed base in the first State, unless the services are performed in the other State. Thus, if a U.S. resident derives income from the performance of independent personal services in Belgium, but that income is attributable to a fixed base regularly available to that individual in the Netherlands, the Netherlands may tax the income. If, however, income attributable to the fixed base in the Netherlands is derived from services performed in the United States, that income say not be taxed by the Netherlands. In the former case, the United States also may tax this income, but will grant a credit to the taxpayer pursuant to Article 25 (Methods of Elimination of Double Taxation) for the Netherlands taxes paid. The term "fixed base" is not defined in the Convention, but its meaning is understood to be analogous to that of the term "permanent establishment," as defined in Article 5 (Permanent Establishment). Similarly, some rules of Article 7 (Business Profits) for attributing income and expenses to a permanent establishment are relevant for attributing income to a fixed base. However, the taxing right conferred by this Article with respect to income from independent personal services is somewhat more limited than that provided in Article 7 for the taxation of business profits. In both Articles 7 and 15 the income of a resident of one Contracting State must be attributable to a permanent establishment or fixed base in the other in order for that other State to have a taxing right. In Article 15, however, the income also must be attributable to services that are not performed in the individual's State of residence, while Article 7 is not concerned with the place of performance of the income-generating activities, so long as the income is attributable to the permanent establishment. Paragraph 2 notes that the term "professional services" includes independent scientific, literary, artistic, educational or teaching activities, as well as the independent activities of physicians, lawyers, engineers, architects, dentists, and accountants This list is clearly not exhaustive. The term includes all personal services performed by an individual for his own account, whether as a sole proprietor or a partner, where he receives the income and bears the risk of loss arising from the services. Income from services in which capital is a material income producing factor will, however, generally be governed by the provisions of Article 7 (Business Profits). The taxation of income of an individual from independent services described in Articles 17 through 22 is governed by the provisions of those Articles rather than Article 15. The rule in paragraph 3 of Article 24 (Basis of Taxation) dealing with deferred income and expenses of a permanent establishment or fixed base applies to paragraph 1 of this Article. Thus, income, gain or expense that is attributable to a fixed base, but is deferred until after the fixed base is no longer available to the performer of the services may nevertheless be taxed or deducted, as the case may be, by the State in which the fixed base was located. The rule in paragraph 3 of Article 24 dealing with gain from the alienation of property that had formed part of the business property of a permanent establishment or a fixed base also applies to paragraph 1 of Article 15. Thus, if an item of tangible personal property is used in connection with the derivation by an individual resident of one State of income attributable to a fixed base in the other, and that property is alienated after the property no longer forms part of the business property of the fixed base, but within three years of that time, the State in which the fixed base was located may tax the gain. The taxing rule in paragraph 1 of the Article differs from that in the prior Convention. Under Article XVI of the prior Convention the host State could tax income from independent personal services performed by a resident of the other State only if the person performing the services vas present in the host State for a period or periods aggregating more than 183 days in the taxable year. ARTICLE 16 Dependent Personal Services This Article deals with the taxation of remuneration derived by a resident of a Contracting State as an employee. Under paragraph 1, remuneration in respect of employment derived by an individual who is a resident of a Contracting State generally may be taxed only by his State of residence. To the extent his remuneration is derived from an employment exercised in the other State ("the host State"), the remuneration may also be taxed by the host State, subject to the conditions specified in paragraph 2. In such a case the individual's State of residence will relieve double taxation in accordance with the provisions of Article 25 (Methods of Elimination of Double Taxation). Consistent with the general rule of construction that the more specific rule takes precedence over the more general, income dealt within Articles 17 (Directors' Fees), 19 (Pensions, Annuities, Alimony), 20 (Government Service) and 21 (Professors and Teachers) is governed by the provisions of those articles rather than this Article. Notwithstanding paragraph 1, paragraph 2 provides that the host State may not tax the remuneration of a resident of the other State (described in paragraph 1) derived from sources within the host State (i.e., the services are performed there), if three conditions are satisfied: (1) the individual is present in the host State for a period or periods not exceeding 183 days in the taxable year; (2) the remuneration is paid by, or on behalf of, an employer who is not a resident of the host State; and (3) the remuneration is not borne as a deductible expense by a permanent establishment or fixed base that the employer has in the host State. If a foreign employer pays the salary of an employee, but a host State corporation or permanent establishment reimburses the foreign employer in a deductible payment which can be identified as a reimbursement, neither condition (2) nor (3), as the case may be, will be considered to have been fulfilled. Conditions (2) and (3) are intended to assure that a State will not be required both to allow a deduction to the payor for the amount paid and to exempt the employee on the amount received. In order for the remuneration to be exempt from tax in the host State, all three conditions must be satisfied. Paragraph 3 contains a special rule applicable to remuneration for services performed by an individual who is a resident of a State as an employee aboard a ship or aircraft operated in international traffic. Such remuneration may be taxed only in the State of residence of the employee if the services are performed as a member of the regular complement of the ship or aircraft. The "regular complement" includes the crew. In the case of a cruise ship, it may also include others, such as entertainers, lecturers, etc., employed by the shipping company to serve on the ship. The use of the term "regular complement" is intended to clarify that a person who exercises his employment as, for example, an insurance salesman, while aboard a ship or aircraft is not covered by this paragraph. The comparable provision in the OECD Model provides a different rule. Under paragraph 3 in the OECD Model such income may be taxed (on a non-exclusive basis) in the Contracting State in which the place of effective management of the employing enterprise is situated. The United States does not use this rule in its Model, because under U.S. law, a taxing right over an employee of an enterprise managed in the United States (or an employee of a U.S. resident) cannot be exercised with respect to non-U.S. source income unless the employee is also a U.S. citizen or resident. If a U.S. citizen who is resident in the Netherlands performs dependent services in the United States and meets the conditions of paragraph 2, or is a crew member on a Dutch ship or airline, and would, therefore, be exempt from U.S. tax were he not a U.S. citizen, he is nevertheless taxable in the United States on his remuneration by virtue of the saving clause of paragraph 1 of the Article 24 (Basis of Taxation), subject to the special foreign tax credit rule of paragraph 6 of Article 25 (Methods of Elimination of Double Taxation). ARTICLE 17 Directors’ Fees This Article provides that one of the States may tax the fees or other remuneration paid by a company which is a resident of that State for services performed by a resident of the other State in his capacity as a director, "bestuurder" or "commissaris" of the company. The latter two terms refer to positions in Netherlands corporations that are analogous to the position of director. For this purpose, "other remuneration" includes fixed salaries (or the portion thereof) paid for services performed as a director. Only the State of residence of the director, however, may tax any portion of the remuneration that is derived in respect of services performed in that State. This rule is an exception to the more general rules of Article 15 (Independent Personal Services) and Article 16 (Dependent Personal Services). Thus, for example, in determining whether a non-employee director's fee is subject to tax in the country of residence of the corporation, whether the fee is attributable to a fixed base is not relevant. The preferred U.S. policy is to treat a corporate director in the same manner as any other individual performing personal services --- outside directors would be subject to the provisions of Article 15 (Independent Personal Services) and inside directors would be subject to the provisions of Article 16 (Dependent Personal Services). The United States has also accepted provisions in a number of treaties under which the State of residence of the corporation can tax the remuneration of a director who is a resident of the other State only to the extent that the remuneration is far services performed in that State. The preferred Netherlands position, on the other hand, is that reflected in the OECD Model, in which a resident of one Contracting State who is a director of a corporation which is resident in the other Contracting State is subject to tax in that other State in respect of his directors' fees regardless of where the services are performed. The provision in Article 17 of the Convention, therefore, represents a compromise between these two positions. The State of residence of the corporation may tax nonresident directors, with no threshold, but only with respect to remuneration for services that are not performed in the other State. This Article is subject to the saving clause of paragraph 1 of the Article 24 (Basis of Taxation). Thus, if a U.S. citizen who is a Netherlands resident is a director of a U.S. corporation, the United States may tax his full remuneration regardless of the place of performance of his services, subject, however, to the special foreign tax credit provisions of paragraph 6 of Article 25 (Methods for Elimination of Double Taxation). The prior Convention contains no special rule dealing with corporate directors. They are subject to the normal rules regarding the taxation of persons performing personal services. ARTICLE 18 Artistes and Athletes This Article deals with the taxation by one State of artistes (i.e., performing artists and entertainers) and athletes resident in the other State from the performance of their services as such. The Article applies both to the income of an entertainer or athlete who performs services on his own behalf and one who performs his services on behalf of another person, either as an employee of that person, or pursuant to any other arrangement. The rules of this Article take precedence over those of Articles 15 (Independent Personal Services) and 16 (Dependent Personal Services). This Article applies, however, only with respect to the income of performing artists and athletes. Others involved in a performance or athletic event, such as producers, directors, technicians, managers, coaches, etc., remain subject to the provisions of Articles 15 and 16. Paragraph 1 describes the circumstances in which one State may tax the performance income of an entertainer or athlete who is a resident of the other State. Income derived by a resident of one State from his personal activities as an entertainer or athlete exercised in the other State may be taxed in that other State if the amount of the gross receipts derived by the individual for the taxable year exceeds $10,000 (or its equivalent in Netherlands guilders as of January 1 of that year). The $10,000 includes expenses reimbursed to the individual or borne on his behalf. If the gross receipts exceed $10,000, the full amount, not just the excess, may be taxed in the State of performance. The OECD Model provides for taxation by the country of performance of the remuneration of entertainers or athletes with no dollar or time threshold. The United States introduces the dollar threshold test in its treaties to distinguish between two groups of entertainers and athletes --- those who are paid very large sums of money for very short periods of service, and who would, therefore, normally be exempt from host country tax under the standard personal services income rules, and those who earn only modest amounts and are, therefore, not clearly distinguishable from those who earn other types of personal service income. Paragraph 1 applies notwithstanding the provisions of Articles 15 (Independent Personal Services) or 16 (Dependent Personal Services). Thus, if an individual would otherwise be exempt from tax under those Articles, but is subject to tax under this Article, he may be taxed in accordance with Article 18. An entertainer or athlete who receives less than the $10,000 threshold amount, and who is, therefore, not subject to tax under the provisions of this Article, may, nevertheless, be subject to tax in the host country under Articles 14 or 15 if the tests for taxability under those Articles are met. For example, if an entertainer who is an independent contractor earns only $9,500 of income for the calendar year, but the income is attributable to a fixed base regularly available to him in the State of performance (such as a cocktail lounge in which he regularly performs), that State may tax his income under Article 15. Since it is frequently not possible to know until year end whether the income an entertainer or athlete derived from performance in a Contracting State will exceed $10,000, nothing in the Convention precludes that State from withholding tax during the year and refunding after the close of the year if the taxability threshold has not been met. If, at the end of the year, it is determined that the entertainer or athlete is not subject to host-country tax under the provisions of paragraph 1 of the Article, the exemption is effected by means of a refund of the tax withheld upon application after the end of the taxable year concerned. Paragraph 1 specifies that such application must be submitted within three years from the end of that year. Income derived from one State by an entertainer or athlete who is a resident of the other in connection with his activities as such, but from other than actual performance, such as royalties from record sales and payments for product endorsements, is not covered by this Article, but by other articles of the Convention, as appropriate, such as Article 13 (Royalties) or Article 15 (Independent personal Services). For example, if an entertainer receives royalty income from the sale of recordings of a concert given in a State, the royalty income would be exempt from source country tax under Article l3, even if the remuneration from the concert itself may have been covered by this Article. Paragraph 2 is intended to eliminate the potential for abuse when income from a performance by an entertainer or athlete does not accrue to the performer himself, but to another person. Foreign entertainers commonly perform in the United States as employees of, or under contract with, a company or other person. The relationship may truly be one of employee and employer, with no abuse of the tax system either intended or realized. On the other hand, the "employer" may, for example, be a company established and owned by the performer, which is merely acting as the nominal income recipient in respect of the remuneration for the entertainer's performance. The entertainer may be acting as an "employee", receiving a modest salary, and arranging to receive the remainder of the income from his performance in another form or at a later time. In such case, absent the provisions of paragraph 2, the company providing the entertainer's services could attempt to escape host country tax because it earns business profits but has no permanent establishment in that country. The entertainer may largely or entirely escape host country tax by receiving only a small salary in the year the services are performed, perhaps small enough to place him below the dollar threshold in paragraph 1. He would arrange to receive further payments in a later year, when he is not subject to host country tax, perhaps as salary payments, dividends or liquidating distributions. Paragraph 2 seeks to prevent this type of abuse while at the same time protecting the taxpayer's right to the benefits of the Convention when there is a legitimate employee-employer relationship between the performer and the person providing his services. Under paragraph 2, when the income accrues to a person other than the performer, and the performer (or persons related to him) participate, directly or indirectly, in the profits of that other person, the income may be taxed in the contracting State where the performer's services are exercised, without regard to the provisions of the Convention concerning business profits (Article 7) or independent personal services (Article 15). Thus, even if the "employer" has no permanent establishment or fixed base in the host country, its income may be subject to tax there under the provisions of paragraph 2. Taxation under paragraph 2 is imposed on the person providing the services of the entertainer or athlete. This paragraph does not affect the rules of paragraph 1, which apply to the entertainer or athlete himself. To the extent of salary payments to the performer, which are treated under paragraph 1, the income taxable by virtue of paragraph 2 to the person providing his services is reduced. For purposes of paragraph 2, income is deemed to accrue to another person (i.e., the person providing the services of the entertainer or athlete) if that other person has control over, or the right to receive, gross income in respect of the services of the entertainer or athlete. Direct or indirect participation in the profits of a person may include, but is not limited to, the accrual or receipt of deferred remuneration, bonuses, fees, dividends, partnership income or other income or distributions. The paragraph 2 override of the protection of Articles 7, (Business Profits) and 15 (Independent Personal Services) does not apply if it is established that neither the entertainer or athlete, nor any persons related to the entertainer or athlete, participate directly or indirectly in the profits of the person providing the services of the entertainer or athlete. Thus, for example, assume that a circus owned by a U.S. corporation performs in Amsterdam, and the Netherlands promoters of the performance pay the circus, which, in turn, pays salaries to the clowns. The circus has no permanent establishment in the Netherlands. Since the clowns do not participate in the profits of the circus, but merely receive their salaries out of the circus' gross receipts, the circus is protected by Article 7 and its income is not subject to Netherlands tax. Whether the salaries of the clowns are subject to Netherlands tax depends on whether they exceed the $10,000 threshold in paragraph 1, and, if not, whether they are taxable under Article 16 (Dependent Personal Services). This exception to the paragraph 2 override of the Articles 7 and 15 protection of persons providing the services of entertainers and athletes for non-abusive cases is not found in the OECD Model. The policy reflected in this exception is, however, consistent with the stated intent of Article 17 of the 1977 Model, as indicated in its Commentaries. The Commentaries to Article 17 of the 1977 OECD Model state that paragraph 2 is intended to counteract certain tax avoidance devices, in which income is diverted from the performer to another person in order to minimize the total tax on the remuneration. It is, therefore, consistent not to apply these rules in non-abusive cases. This Article is subject to the provisions of the saving clause of paragraph 1 of a 24 (Basis of Taxation). Thus, if am entertainer or athlete who is resident in the Netherlands is a citizen of the United States, the United States may tax all of his income from performances in the United States without regard to the provisions of this Article, subject, however, to the special foreign tax credit provisions of paragraph 6 of Article 25 (Methods of Elimination of Double Taxation). The prior Convention contains no special rules for the taxation of the income of entertainers and athletes. Such income is subject to the general rules for the taxation of personal service income. ARTICLE 19 Pensions, Annuities, Alimony This Article deals with the taxation of private (i.e., non-government) pensions, annuities, social security, and similar benefits, and alimony payments. Paragraph 1 provides that private pensions and other similar remuneration derived and beneficially owned by a resident of a Contracting State in consideration of past employment are generally taxable only in the State of residence of the recipient. The paragraph also provides for exclusive residence country taxation of annuities. Subject to special rules in paragraphs 2 and 3, this rule applies to all forms of payment. Treatment of such payments under the prior Convention is essentially the same as under the Convention, except that the rules of the prior Convention apply only to periodic payments. The rules of this paragraph do not apply to items of income which are dealt within Article 20 (Government Service), including pensions in respect of government service, or to social security benefits, which are dealt within paragraph 4 of Article 19. The term "annuity" as used in this Article is defined in paragraph 5 to mean a stated sum paid periodically at stated times during life or during a specified or ascertainable period of time under an obligation to make the payment in return for adequate and full consideration in money or money's worth. Annuities are similarly defined under the prior Convention. Under paragraph 2, if an individual who is a resident of one of the States receives a payment of the type referred to in paragraph 1 in respect of employment exercised in the other State, and the payment is not periodic, or is a lump-sum payment in lieu of an annuity, and the individual was a resident of that other State at any time during the five-year period preceding the date of the payment, that other State may also tax the payment. This is not the grant of an exclusive taxing right. Thus, for example, if an individual who has been a resident of the Netherlands, and who worked in the Netherlands, retires to the United States and becomes a resident of the United States, and that individual receives, two years after giving up his Netherlands residence, a lump-sum pension in respect of his employment in the Netherlands, that lump-sum pension may be taxed by both the United States and the Netherlands. Pursuant to paragraph 7 of Article 25 (Methods of Elimination of Double Taxation), the source State generally will grant a credit against its tax on such payment in respect of taxes imposed on the payment in the State of residence of the recipient. It is preferred, though not uniform, U.S. treaty policy not to distinguish in treatment between periodic and lump-sum pensions. It is the policy of the Netherlands, however, to preserve by treaty the right of the Netherlands to tax any lump-sum pension payment made in consideration of employment in the Netherlands. The concern of the Netherlands is that the lump-sum payment Right avoid tax altogether, or be subject to only a low rate of tax, even though the contributions on which the payment is based had been deductible for Netherlands tax purposes. Under the prior Convention, the Netherlands does preserve this taxing right. The rule in paragraph 2, therefore, represents a compromise between the United States and Netherlands positions. Paragraph 3 modifies the rule in paragraph 2 with respect to certain lump-sum payments otherwise dealt within paragraph 2. The portion of any such lump-sum payment that is contributed by the recipient to a pension plan or retirement account will not be taxable in the source State if certain conditions are met. Paragraph 2 will not to apply if the lump-sum payment that is rolled over into a pension plan or retirement account would not have been subject to current taxation in the State of the recipient's residence, had the payor been resident in the recipient's State of residence, and instead, would have been deferred until the amount of the payment is withdrawn from the pension plan or retirement account into which it was placed. Thus, if a lump-sum payment from a Netherlands pension plan is invested in a U.S. Individual Retirement Account ("IRA") and not taxed until the funds are withdrawn from the IRA, the payment will be free of Netherlands tax. Under these circumstances, the tax avoidance concerns of the Netherlands would not be present. Paragraph 4 provides that pensions and other payments made by one of the States under the provisions of its social security system and other public pensions paid to a resident of the other State or to a citizen of the United States will be taxable only in the paying State. Pensions in respect of government service are not covered by this rule but by the rule of paragraph 2 of Article 20 (Government Service). The term "other public pensions" is defined in paragraph IX. of the Memorandum of Understanding to refer to United States tier 1 Railroad Retirement benefits. The reference to U.S. citizens is necessary to ensure that a social security payment by the Netherlands to a U.S. citizen not resident in the United States will not be taxable by the United States. This paragraph is one of the exceptions listed in paragraph 2(a) of Article 24 (Basis of Taxation) to the saving clause of paragraph 1 of that Article. Thus, the United States will not tax social security benefits paid by the Netherlands to a U.S. citizen who is a resident of the Netherlands. Paragraph 6 deals with alimony payments. It provides that alimony payments to a resident of one of the States are taxable only by that State. The term "alimony" is defined for purposes of this paragraph as periodic payments made pursuant to a written separation agreement or a decree of divorce, separate maintenance, or compulsory support, and lump-sum payments in lieu of such periodic payments. In addition, for a payment to be treated as "alimony" for purposes of this Article, it must be taxable to the recipient under the laws of his State of residence. It is standard U.S. treaty policy to provide a rule for child support payments that is the opposite of that provided for alimony. Under that rule child support payments by a resident of one State to a resident of the other are taxable only in the State of residence of the payor. The Convention contains no such rule. Child support payments, therefore, fall under the rule for "other income" in paragraph 1 of Article 23 (Other Income) that provides for exclusive taxation by the State of residence of the recipient. Such payments, however, are not currently taxable to the recipient under either Dutch or U.S. law (IRC section 71). The provisions of this Article (except those of paragraph 4 dealing with social security benefits) are subject to the saving clause of paragraph 1 of Article 24 (Basis of Taxation). Thus, for example, a periodic pension, annuity, or an alimony payment received by a resident of the Netherlands who is a U.S. citizen may be taxed by the United States, regardless of the provision for exclusive residence taxation for those classes of income. ARTICLE 20 Government Service Subparagraphs (a) and (b) of paragraph 1 deal with the taxation of government compensation (other than a pension). Subparagraph (a) provides that wages, salaries, and similar compensation paid by one of the States or by its political subdivisions or local authorities to any individual are generally exempt from tax by the other State. Under subparagraph (b), such payments are, however, taxable in the other State and only in that State, if the services are rendered in that other State and the individual is a resident of that State who is either a national of that State or a person who did not become resident of that State solely for purposes of rendering the services. Paragraph 2 deals with the taxation of a pension paid by, or out of funds created by, one of the States or a political subdivision or a local authority thereof to an individual in respect of services rendered to that State or subdivision or authority. Subparagraph (a) provides that such a pension is taxable only in that State. Subparagraph (b) provides an exception under which such a pension is taxable only in the other State if the individual is a resident of, and a national of, that other State. Pensions paid to retired civilian and military employees of a Government of either State are intended to be covered under paragraph 2. Social security and similar benefits paid by a state in respect of services rendered to that State or a subdivision or authority are also intended to be covered. Paragraphs 1 and 2 are similar to paragraphs 1 and 2 of Article 19 (Government Service) of the OECD Model Treaty. These paragraphs differ from Article 19 of the U.S. Model under which such remuneration, including a pension, is taxable only in the Contracting State that pays it. Paragraph 3 provides that the provisions of Articles 16 (Dependent Personal Services), 17 (Directors' Fees), and 19 (Pensions, Annuities, Alimony) shall apply to remuneration and pensions in respect of services rendered in connection with a business carried on by one of the States or a political subdivision or a local authority thereof. This treatment is consistent with the U.S. and OECD and Models, both of which exclude payments in respect of services rendered in connection with a business carried on by the governmental entity paying the compensation or pension. Under paragraph 2(b) of Article 24 (Basis of Taxation), the saving clause (paragraph 1 of Article 24) does not apply to the benefits conferred by one of the States under Article 20 if the recipient of the benefits is neither a citizen of that State, nor, in the case of the United States, is a lawful permanent resident (i.e., a "green card" holder). Thus, for example, a Netherlands resident who receives a pension paid by the Netherlands in respect of services rendered to the Government of the Netherlands shall be taxable on this pension only in the Netherlands unless the individual is a U.S. citizen or acquires a U.S. green card. ARTICLE 21 Professors and Teachers Paragraph 1 provides an exemption from tax in one State for an individual who visits that State for a period not exceeding two years for the purpose of teaching or engaging in research at a university, college or other recognized educational institution in that State if the individual is a resident of the other Contracting State immediately before his visit begins. The exemption applies to any remuneration for such teaching or research. The exemption from tax applies for a period not exceeding two years from the date he first visits the Contracting State (the "host State") for the purpose of teaching or engaging in research at a university, college or other recognized educational institution there. If a professor or teacher remains in the host State for more than the specified two-year period, he may be subject to tax in that State, under its law, for the entire period of his presence. However, if the competent authorities so agree in a particular case, the exemption may apply for two years even if the individual's stay exceeds two years. It is anticipated that the competent authorities would agree to such an extension only in cases where the departure of the individual is delayed beyond the end of the two-year period because of unforeseen circumstances. The host State exemption will apply if the teaching or research is carried on at an accredited university, college, school or other recognized educational institution. Paragraph 2 provides that Article 21 shall apply to income from research only if such research is undertaken by the individual in the public interest and not primarily for the benefit of some other private person or persons. As stated in paragraph 3 of Article 22 (Students and Trainees), an individual may not claim the benefits of this Article if, during the immediately preceding period, he has claimed the benefits of Article 22. There is no provision in the U.S. or OECD Models dealing with professors and teachers. It is not standard U.S. treaty policy to provide benefits to visiting teachers by treaty. It is included in the Convention because a similar provision is found in the prior Convention. Under the prior Convention, however, the exemption applied for two years even if the individual's stay exceeded a two year duration. Under paragraph 2(b) of Article 24 (Basis of Taxation), the saving clause (paragraph 1 of Article 24) does not apply to the benefits conferred by one of the States under Article 21 if the recipient of the benefits is neither a citizen of that State, nor, in the case of the United States, is a lawful permanent resident (i.e., a "green card" holder). Thus, a Netherlands resident who visits the United States for two academic years as a professor and becomes a U.S. resident according to the Code, other than by virtue of acquiring a green card, would continue to be exempt from U.S. tax in accordance with this Article so long as he is not a U.S. citizen and does not acquire immigrant status in the United States. The saving clause does apply to U.S. citizens and immigrants. ARTICLE 22 Students and Trainees Article 22 deals with the taxation of visiting students and business apprentices, and certain other researchers and trainees. Paragraph 1 deals with individuals who are residents of one of the States (or who were residents of that State immediately before visiting the other State) and who are temporarily present in the other State (the "host State") in one of two capacities: (1) as a full-time student at a recognized educational institution in the host State, or (2) as a business apprentice. Such an individual will be exempt under paragraph 1 from tax in the host State on two types of receipts: (1) on payments remitted from outside the host State, which are for the purpose of the student's or trainee's maintenance, education or training, and (2) on remuneration for personal services performed in the host State on any amount that does not exceed $2,000 (or its equivalent in Netherlands guilders) for any taxable year. If the amount earned exceeds the $2,000 threshold, the exemption continues to apply to the first $2,000. The excess is taxable according to the internal law of the host State. The $2,000 exemption does not reduce any personal exemptions and deductions otherwise allowable under internal law. Paragraph 2 deals with an individual who is temporarily present in the host State for the purpose of study and who, immediately before his visit, is a resident of the other State. The individual dealt within paragraph 2 is temporarily present in the host State for a period not exceeding three years for the purpose of study, research or training, and is the recipient of a grant, allowance or award either from a scientific, educational, religious or charitable organization, including host-State organizations, or under a technical assistance program entered into by one of the States or by a political subdivision or local authority thereof. Such an individual is exempt in the host State on the amount of the grant, allowance or award. He is also exempt on remuneration for personal services performed in the host State on any amount that does not exceed $2,000 (or its equivalent in Netherlands guilders) for any taxable year. Unlike the personal services exemption in paragraph 1, however, the services must be performed in connection with, or be incidental to, the individual's study. research or training. Thus, for example, up to $2,000 earned by a graduate student as a research assistant in his academic field would be exempt under paragraph 2. A similar amount earned, say, as a dishwasher in a campus restaurant would not be exempt under paragraph 2, though it may be exempt under paragraph 1. As with the exempt earned income provision in paragraph 1, if the amount earned exceeds the $2,000 threshold, the exemption still applies to the first $2,000. The excess is taxable according to the internal law of the host State. The $2,000 exemption does not reduce any personal exemptions and deductions otherwise allowable under internal law. It is not standard U.S. treaty policy, particularly in treaties with developed countries, to include an earned income exemption for visiting students. This provision was agreed to in this treaty because it was important to the Netherlands government, and essentially does no more than retain a provision from the prior Convention. Paragraph 3 provides that an individual may not claim the benefits of this Article if, during the immediately preceding period, he has claimed the benefits of Article 21 (Professors and Teachers). As noted in connection with Article 21, the benefits of that Article may not be claimed immediately after claiming the benefits of this Article. By virtue of paragraph 2(b) of Article 24 (Basis of Taxation), the saving clause (paragraph 1 of Article 24) does not apply to the benefits conferred by one of the States under Article 22 if the recipient of the benefits is neither a citizen of that State, nor, in the case of the United States, is a lawful permanent resident (i.e., a "green card" holder). Thus, a Netherlands resident who visits the United States under a U.S. Government grant to do research for two years at the National Institutes of Health, and becomes a U.S. resident during that period according to the Code, but other than by virtue of acquiring a green card, would continue to be exempt from U.S. tax in accordance with this Article so long as he is not a U.S. citizen and does not acquire immigrant status in the United States. The saving clause does apply to U.S. citizens and immigrants. ARTICLE 23 Other Income This Article provides the rules for the taxation of items of income not dealt within the other articles of the Convention. An item of income is "dealt with" in an article when an item in the same category is a subject of the article, whether or not any treaty benefit is granted to that item of income. This Article deals both with classes of income that are not dealt with elsewhere, such as, for example, lottery winnings, and with income of the same class as income dealt within another article of the Convention, but from sources in third States, and, therefore, not a subject of the other Article, if that Article deals only with items of that class of income from sources within one of the States. Paragraph 1 contains the general rule that such items of income derived by a resident of one of the States will be taxable only in the State of residence. This exclusive right of taxation applies irrespective of whether the residence State exercises its right to tax the income covered by the Article. Paragraph 2 contains an exception to the general rule of paragraph 1 for income, other than income from real property, that is attributable to a permanent establishment or fixed base maintained in a Contracting State by a resident of the other Contracting State. The taxation of such income is governed by the provisions of Articles 7 (Business Profits) and 15 (Independent Personal Services). Thus, in general, third-country income which is attributable to a permanent establishment maintained in the United States by a resident of the Netherlands would be taxable by the United States. There is an exception to this rule for income from real property, as defined in paragraph 2 of Article 6 (Income from Real Property). If, for example, a Netherlands resident derives income from real property located outside the United States which is attributable to the resident's permanent establishment or fixed base in the United States, only the Netherlands and not the United States may tax that income. This special rule for foreign-situs real property is consistent with the general rule, also reflected in Article 6 (Income from Real Property), that only the situs and residence States may tax real property income. Even if such property is part of the property of a permanent establishment or fixed base in a Contracting State, that State may not impose tax if neither the situs of the property nor the residence of the owner is in that State. The rule in paragraph 3 of Article 24 (Basis of Taxation) dealing with deferred income and expenses of a permanent establishment or fixed base applies to paragraph 2 of this Article. Thus, income, gain or expense that is from third-country sources and that is attributable to a permanent establishment or fixed base, but is deferred until after the permanent establishment or fixed base no longer exists, may nevertheless be taxed or deducted, as the case Ray be, in the State in which the permanent establishment or fixed base was located. The rule in paragraph 3 of Article 24 dealing with gain from the alienation of property that had formed part of the business property of a permanent establishment or a fixed base also applies to paragraph 2 of Article 23. Thus, if an item of tangible personal property is used in connection with the derivation by a resident of one State of income attributable to a permanent establishment or fixed base in the other, but derived from sources outside either State, and that property is alienated after the property no longer forms part of the business property of the permanent establishment or fixed base, but within three years of that tine, the State in which the permanent establishment or fixed base was located may tax the gain. This Article is subject to the saving clause of paragraph 1 of Article 24 (Basis of Taxation). Thus, the United States Ray tax the income of a Netherlands resident not dealt with elsewhere in the Convention, if that Netherlands resident is a citizen of the United States, subject, however, to the special foreign tax credit provisions of paragraph 6 of Article 25 (Methods for the Elimination of Double Taxation). ARTICLE 24 Basis of Taxation There is no precise counterpart to Article 24 in other U.S. treaties. Provisions similar to paragraphs 1 and 2 of the Article, however, do appear in Article 1 of the U.S. Model, and the provisions of paragraph 3 appear in one of several forms in all recent U.S. treaties. Paragraph 1 contains the traditional saving clause, and paragraphs 2 (a) and (b) contains the exceptions. These are found in paragraphs 3 and 4 of Article 1 (General Scope) of the U.S. Model. Under paragraph 1 both States reserve their right, except as provided in paragraph 2, to tax their residents and nationals notwithstanding any Convention provisions to the contrary. The concept of "residence" for purposes of the Convention is defined in Article 4 (Resident). The term "national" is defined in Article 3 (General Definitions) to include individuals possessing the nationality or citizenship of one of the States as well as legal persons, partnerships and associations deriving their status as such from the laws in force in one of the States. In the U.S. Model the term "citizen" is used in the saving clause in place of the term "national." In general, the effect of this somewhat broader language in the Convention as compared with that in the U.S. Model will be minimal. A corporation that derives its status as a U.S. national from the laws in force in the United States is also a U.S. resident, and is, therefore, covered in the same way in the U.S. Model as in the Convention. A U.S. partnership that derives its status as such from the laws in force in the United States will not be a U.S. resident under the Convention because it will not be subject to U.S. tax. It will not, therefore, be affected by the saving clause. The saving clause operates as follows: If, for example, a Netherlands resident performs independent personal services in the United States and the income from the services is not attributable to a fixed base in the United States, Article 15 (Independent Personal Services) would normally prevent the United States from taxing the income. If, however, the Netherlands resident is also a citizen of the United States, the saving clause permits the United States to include the remuneration in the worldwide income of the citizen and subject it to tax under the normal Code rules. (For special foreign tax credit rules applicable to the U.S. taxation of certain U.S. income of its citizens resident in the Netherlands see paragraph 6 of Article 25 (Methods of Elimination of Double Taxation)). Residence, for the purpose of the saving clause, is determined under Article 4 (Resident). If, therefore, an individual who is not a U.S. citizen is a resident of the United States under the Code, and is also a resident of the Netherlands under Dutch law, and that individual has a permanent home available to his in the Netherlands and not in the United States, he would be treated as a resident of the Netherlands under Article 4 and for purposes of the saving clause. The United States would not be permitted to apply its statutory rules to that person if they are inconsistent with the Convention. Also under paragraph 1, the United States reserves its right to tax former U.S. citizens, who are not nationals of the Netherlands, whose loss of citizenship had as one of its principal purposes the avoidance of U.S. income tax. Such a former citizen is taxable in accordance with the provisions of section 877 of the Code for 10 years following the loss of citizenship. This provision is somewhat narrower than the "former citizen" rules in most recent U.S. treaties in two respects. First, it applies only to former citizens who are not citizens of the Netherlands. Second, it applies only in cases where the principal purpose of expatriation has been the avoidance of income tax, not all taxes, as in most U.S. treaties. Paragraph 2 acts forth certain exceptions to the saving clause in cases where its application would contravene policies underlying provisions of the Convention that are intended to extend benefits of one of the States to its citizens and residents. Subparagraph 2(a) lists certain provisions of the Convention that will be applicable to all the citizens and residents of a State, despite the general saving clause rule of paragraph 1: (1) Paragraph 2 of Article 9 (Associated Enterprises) grants the right to a correlative adjustment, and, particularly, permits the override of the statute of limitations for the purpose of refunding tax under such a correlative adjustment. (2) Paragraph 4 of Article 19 (Pensions, Annuities, Alimony) deals with social security benefits. Its inclusion in the exceptions to the saving clause means that social security benefits paid by the Netherlands to a U.S. resident will, as intended, be taxed only by the Netherlands. (3) Article 25 (Methods of Elimination of Double Taxation) confers the benefit of double taxation relief by a State on its citizens and residents. To apply the saving clause to this Article would render the Article meaningless. (4) Article 28 (Non-Discrimination) prohibits discriminatory taxation by one State on the citizens and residents of the other. These prohibitions are intended to apply even if the citizen or resident is also a citizen or resident of the taxing State. (5) Article 29 (Mutual Agreement Procedure) may confer benefits by a State on its citizens and residents. For example, the statute of limitations may be waived for refunds, the competent authorities are permitted to use a definition of a term which differs from the internal law definition, or they may refer an issue to an arbitration panel. As with the foreign tax credit, these benefits are intended to be granted by a State to its citizens and residents. Subparagraph 2(b) provides a different set of exceptions to the saving clause. The effect of this provision is to extend certain benefits to persons who are not citizens of one of the States, and, in the case of the United States, to persons who are not lawful permanent residents (i.e., "green card" holders). If, for example, beneficiaries of these provisions come to the United States from the Netherlands and remain in the United States long enough to become residents under the Code, but do not acquire immigrant status (i.e., they do not become "green card" holders) and are not citizens of the United States, the United States will continue to grant these benefits even if they conflict with the Code rules. The benefits preserved by this paragraph are the host country exemptions for the following items of income: Government service salaries and pensions under Article 20 (Government Service); certain income of visiting teachers under Article 21 (Professors and Teachers); certain income of students and trainees under Article 22 (Students and Trainees); and the income of diplomatic and consular officers under Article 33 (Diplomatic Agents and Consular Officers). Paragraph 3 of the Article elaborates on the following provisions: paragraphs 1 and 2 of Article 7 (Business Profits), paragraph 5 of Article 10 (Dividends), paragraph 3 et Article 12 (Interest), paragraph 3 of Article 13 (Royalties), paragraph 3 of Article 14 (Capital Gains), paragraph 1 of Article 15 (Independent Personal Services) and paragraph 2 of Article 23 (Other Income). This paragraph incorporates the rule of Code section 864(c)(6) into the Convention. Like the Code section on which it is based, Paragraph 4 of the Protocol provides that any income or gain attributable to a permanent establishment or a fixed base, depending on the context, during its existence is taxable in the Contracting state where the permanent establishment or fixed base is situated even if the payments are deferred until after the permanent establishment or fixed base no longer exists. The provision in paragraph 3 clarifies that expenses attributable to the permanent establishment or fixed base during its existence may be deducted from the deferred income at such time as that income is subject to tax. The preceding rule regarding the taxation of deferred income and the allowance of appropriate expenses against such income will not affect any rules in the internal laws of the States relating to the accrual of income and expenses. For example, income arising from an installment sale that is recognized for U.S. tax purposes in years subsequent to the year of the sale will be recognized in accordance with section 453 of the Code. Paragraph 3 also contains a rule dealing with the taxation of gain from the alienation of personal property which, at any time, had formed part of the business property of a permanent establishment or a fixed base that a resident of one of the States had in the other. That other State may tax that part of the gain that is attributable to the period during which the property formed part of the business property of the permanent establishment or fixed base. The tax may be imposed at the time that the gain is realized and recognized under the laws of the taxing State, but only if that date is within three years of the time that the property ceased to be part of the business property of the permanent establishment or fixed base. This incorporates into the Convention a rule similar to that of Code section 864(c)(7). Under the Code rule, if an asset which had been part of the business property of a U.S. trade or business (or, in a treaty context, of a permanent establishment or fixed base in the United States) is alienated within ten years of its removal from the U.S. trade or business (or permanent establishment/fixed base), the gain realized on such alienation is subject to U.S. tax. Under the rule in paragraph 3, a right of the State in which the permanent establishment or fixed base exists or existed to tax each gains is confirmed, but the taxable gain is limited to that portion which accrued during the time that the asset formed part of the business property of the permanent estab1ishment or fixed base, and the look-back period is limited to three years. Article 24 of the Convention prior to the Protocol contained a paragraph 4 that was deleted by the Protocol. That paragraph identified the issue of the so-called "triangular case" and called for negotiation of a Protocol to deal with it if the problem bad not been resolved by Dutch legislative action prior to the Senate Foreign Relations Committee hearings on the Convention. Articles 1 and 2 of the Protocol amend Articles 12 (Interest) and 13 (Royalties) to deal with this issue. ARTICLE 25 Methods of Elimination of Double Taxation This Article describes the manner in which each State undertakes to relieve double taxation. The United States uses the foreign tax credit method exclusively. The Netherlands uses a combination of foreign tax credit and examination methods, depending on the nature of the income involved. Paragraphs 1, 2, 3 and 8 set forth rules for double taxation relief in the Netherlands, subject to certain special provisions in paragraphs 6 and 7. Paragraphs 1 and 2 deal with those items of income in respect of which double taxation is eliminated by the Netherlands by means of exemption; paragraphs 3 and 8 deal with those items of income for which the Netherlands will provide a foreign tax credit under the Convention. Paragraph 1 clarifies that, notwithstanding the fact that under the exceptions to the saving clause (paragraphs 2(a) and (b) of Article 24 (Basis of Taxation)) the Netherlands may not tax certain income of its citizens and residents from U.S. Government service or U.S. social security benefits, and despite the fact that these items of income are exempt from Netherlands tax under paragraph 2 of Article 25, the Netherlands may include these items of income for purposes of computing the exemption with progression under paragraph 2. Thus, such items are included in income solely for the purpose of determining the rate of tax on other items of income that are taxable in the Netherlands. Paragraph 2 provides that the Netherlands will exempt, with progression, a number of items of income received by a resident or a national of the Netherlands that, under the Convention, may be taxed by the United States. The following items of income are specified: U.S. situs real property taxable by the united States under Article 6 (Income from Real Property): profits attributable to a U.S. permanent establishment and taxable by the united States, to the extent such income is subject to united States tax under Article 7 (Business Profits): dividends, interest, and royalties attributable to a U.S. permanent establishment or fixed base and, therefore, taxable on a net basis by the United states under paragraph 5 of Article 10 (Dividends), paragraph 3 of Article 12 (Interest) or paragraph 3 of Article 13 (Royalties), respectively: gains from the disposition of U.S. situs real property or a U.S. real property interest, or gain from the alienation of personal property forming part of the property of a U.S. permanent establishment or fixed base, and taxable in the United States under paragraphs 1 and 3 of Article 14 (Capital Gains); income from the performance of independent personal services in the United States, to the extent such income is subject to U.S. tax under Article 15 (Independent Personal Services); income from the performance of dependent personal services in the United States which is taxable by the United States under paragraph 1 of Article 16 (Dependent Personal Services); social security benefits taxable by the United States under paragraph 4 of Article 19 (Pensions, Annuities, Alimony): remuneration and pensions for Government service taxable by the United States under Article 20 (Government Service); and income attributable to a permanent establishment or fixed base taxable by the United States under paragraph 2 of Article 23 (Other Income). Although no Netherlands tax is imposed in respect of these items of income, they are included in income for purposes of determining the appropriate rate of tax to be imposed on those items of income that remain taxable in the Netherlands (i.e., exemption with progression). The reduction in Netherlands tax is calculated in conformity with the law of the Netherlands for the avoidance of double taxation. The requirement that income described in Article 7 (Business Profits) be subject to United States tax in order to be exempt from Netherlands tax was added by Article 4 of the Protocol. Under paragraph 3, United States tax on certain items of income is allowed as a credit against Netherlands tax. A credit is allowed for dividends subject to U.S. withholding tax under paragraph 2 of Article 10 (Dividends), and for directors' fees and remuneration of entertainers and athletes subject to U.S. tax under Articles 17 (Directors' Fees) and 18 (Artistes and Athletes), respectively. The credit for direct investment dividends is equal to the 5 percent U.S. tax imposed under subparagraph 2(a) of Article 10 (Dividends). The credit is 15 percent for portfolio dividends that are taxable under subparagraph 2(b) of Article 10. The Netherlands credit for REIT dividends is limited to 15 percent, notwithstanding the fact that REIT dividends, other than those beneficially owned by individuals holding less team a 25 percent interest in the REIT, are subject to the full U.S. statutory rate of withholding of 30 percent. The credit for the remuneration of directors, entertainers and athletes is to be the amount of the U.S. tax imposed on the income. A limitation on the foreign tax credit is provided, based on Netherlands law. The basic provision for the United States foreign tax credit is found in paragraph 4, subject to certain special provisions in paragraphs 5, 6 and 7. Under paragraph 4, the United States agrees to allow to its nationals and residents a credit against U.S. tax for the appropriate amount of income taxes paid or accrued to the Netherlands. The credit under the Convention is allowed in accordance with the provisions and subject to the limitations of U.S. law, as that law may be amended over time, so long as the general principle of this Article (i.e. the allowance of a credit) is retained. Thus, although the Convention provides for a foreign tax credit the terms of the credit are determined by the provisions, at the time a credit is given, of the U.S. statutory credit. Subparagraph 4(b) provides for a deemed-paid credit, consistent with section 902 of the Code, to a U.S. corporation in respect of dividends received from a Netherlands corporation in which the U.S. corporation owns at least 10 percent of the voting stock. This credit is for the tax paid by the Netherlands corporation on the earnings out of which the dividends are considered paid. As indicated, the U.S. credit under the convention is subject to the limitations of U.S. law, which generally limit the credit against U.S. tax to the amount of U.S. tax due with respect to net foreign source income within the relevant foreign tax credit limitation category (See Code section 904(a)). Nothing in the Convention prevents the limitation of the U.S. credit from being applied on a per-country or overall basis or on some variation thereof. In general, where source rules are provided in the Convention for purposes of determining the taxing rights of the Contracting States, these are consistent with the Code source rules for foreign tax credit and other purposes. where, however, there is an inconsistency between Convention and Code source rules, the Code source rules (e.g., Code section 904(g)) will be used to determine the limits for the allowance of a credit under the Convention. (Paragraph 6 of the Article provides an exception to this general rule with respect to certain U.S. source income of U.S. citizens resident in the Netherlands.) Paragraph 4 also provides that the Netherlands income taxes specified in paragraphs 1(a) and 2 of Article 2 (Taxes Covered) are to be treated as income taxes for purposes of allowing a credit under the paragraph. It was the understanding of the negotiators that each of the Netherlands income taxes specified in Article 2 for which credit is allowed under paragraph 4 are creditable taxes under the Code. Paragraph 5 provides special rules for the U.S. foreign tax credit for the Netherlands profit share imposed on oil-related income. Although the Convention explicitly includes the profit share as a covered tax under Article 2 (Taxes Covered), paragraph 5 of Article 25 limits the extent to which the profit share may be credited against U.S. tax liability wham paid or accrued by U.S. residents. Unlike the other Dutch taxes described in Article 2 (Taxes Covered) it has not been determined whether the profit share paid or accrued by U.S. residents is creditable under U.S. Treasury Department regulations. While generally it is no longer U.S. policy to provide a treaty credit for foreign taxes on oil and gas extraction income like the Dutch profit share, the U.S. income tax treaties with the Netherlands' North Sea competitors, the United Kingdom and Norway, do so. From a policy perspective, it is desirable to treat the North Sea oil-producing states similarly for this purpose. Moreover, as explained below, in many cases the limited creditability of the profit share in accordance with paragraph 5 will not result in any cost to the U.S. fisc. Given these considerations, the U.S. agreed in the negotiations to provide a limited credit for the profit share, in accordance with the rules set forth under paragraph 5. The profit share is imposed on income from petroleum reconnaissance, exploration, and production activities in the Netherlands. For this purpose, the Netherlands includes its territorial sea and the Dutch part of the continental shelf. Under Dutch law, the profit share is levied to the extent that the calculated profit share exceeds the company tax. However, the profit share actually due is a deduction in computing the taxable base for purposes of imposing the company tax. The company tax is equal to 35 percent of the taxable income less the profit share paid. The profit share generally is equal to 50 percent of the taxable income, with a credit for the company tax. Determining each amount requires solution of simultaneous equations. The following example illustrates the interaction of the Dutch company tax and profit share. Assume that a taxpayer recognizes $100 of income from Dutch sources that is subject to both the profit share and the company tax. The Dutch profit share and company tax with respect to this income are calculated as follows: Profit $100 Company Tax Rate 35% Profit Share Tax Rate 50% A = Company Tax B = Profit Share A = .35 (100-B) B = (.5 x 100)-A A = $26.92 B = $23.08 Thus, the total amount of taxes paid in the Netherlands (i.e., profit share plus company tax) is $50.00. In many cases, the fact that a limited credit is allowed under paragraph 5 will result in no current reduction in the U.S. tax burden of the person claiming the credit. If the tax were not creditable, the profit share would be treated as a deductible expense for U.S. tax purposes, and would be deducted from the U.S. taxpayer’s income for purposes of determining its U. S. foreign tax credit limitation. Thus, under the above example, the taxpayer's taxable income for U.S. tax purposes would be $76.92 (i.e., $100 minus the $23.08 in profit share). The taxpayer's U.S. foreign tax credit limitation would be $26.92 (i.e., 35% of $76.92). Since the taxpayer paid $26.92 in company tax under the facts of the example, the taxpayer would have no U.S. income tax liability with respect to the income subject to the profit share even if the profit share were not creditable. The amount of U.S. credit for the company tax is computed under the generally applicable rules of paragraph 4 of Article 25. It is intended that the taxpayer will be permitted to claim a total credit in respect of company tax and profit share in an amount up to the product of the current U.S. rate and the amount of income derived from Netherlands sources. The amount of U.S. credit for the profit share is limited by paragraph 5 to the "appropriate amount." The appropriate amount is defined as the product of the "creditable profit share income base" and the maximum U.S. statutory tax rate applicable to the taxpayer for the taxable year. The "creditable profit share income base" is defined in subparagraph 5(a) as the excess of "the income subject to the company tax (excluding income not subject to the profit share) that is derived from sources within the Netherlands (before deduction of the profit share due) aver the "creditable company income tax base." The "creditable company income tax base" is defined in subparagraph 5(b) as the "effective company income tax rate" divided by the maximum U.S. statutory tax rate applicable to the taxpayer for the taxable year, multiplied by the income subject to the company income tax (excluding the income not subject to the profit share) that is derived from sources within the Netherlands (before deduction of the profit share due). To clarify the intention of the negotiators, the delegations have exchanged letters expressing their agreement that for all U.S. tax purposes, including the U.S. limitation on the company tax, the term "creditable company income tax base" shall in no case exceed the income subject to the company income tax (excluding the income subject to the profit share), as determined under the principles of U.S. tax law. The "effective company income tax rate" is defined in subparagraph 5(c) as the company income tax paid on the income subject to the company tax (excluding the income not subject to the profit share) divided by the income subject to the company income tax, excluding the income not subject to the profit share and before deduction of the profit share. Paragraph 5 provides that the appropriate amount is subject to any other limitations imposed by the law of the United States, as it may be amended from time to time, that apply to taxes creditable under sections 901 and 903 of the Code. Thus, the total amount of U.S. credit with respect to the profit share and company tax may not exceed an amount equal to the income base for company tax purposes, without deduction of the profit share (but reduced by the amount of any income not subject to the profit share), multiplied by the maximum U.S. corporate income tax rate for the year. The term "the income subject to the company tax (excluding income not subject to the profit share)" in subparagraphs 5(a), (b) and (C) is not defined in the Convention. Accordingly, pursuant to paragraph 2 of Article 3 (General Definitions), this term is te be defined in accordance with U.S. tax law principles. The application of this paragraph is illustrated by the following examples. Example l. A U.S. person with a permanent establishment in the Netherlands is subject to the company tax and the profit share. The amount of taxable income for that year determined under U.S. and Dutch principles is $100. The person paid company tax of $26.92 and profit share of $23.08 with respect to this income. First, the "effective company tax rate" is determined in accordance with subparagraph 5 (c) by dividing the company tax paid by the income subject to the company tax. without deduction of the profit share, or .2692 (i.e. $26.92/$100). Second, the "creditable company income tax base" is determined in accordance with subparagraph 5(b) by dividing the effective company tax rate by an amount equal to the maximum U.S. rate, multiplied by the income subject to the company tax, without deduction of the profit share, or $76.91 (i.e., .2692/.3500 x $100). The limitation on the credit for the company income tax paid is the product of the U.S. tax rate and the creditable company income tax base, or $26.92 (i.e., .35 x $76.91). Third, in accordance with subparagraph 5(a), the "creditable profit share income base" is equal to the excess of the income subject to the company tax over the creditable company income tax base, or $23.09 (i.e., $100 - $76.91). Finally, the "appropriate amount,"(i.e. the limitation on the credit for the profit share), is the product of the creditable profit share income base and the maximum U.S. rate, or $8.08 (i.e. $23.09 x .35). The limitation on the company tax is the amount paid, $26.92. The total tax paid to the Netherlands that is eligible for the foreign tax credit is $26.92 plus $8.08, or $35.00. The U.S. taxpayer paid a total of $50.00 ($23.08 in profit share, plus $26.92 in company tax) to the Netherlands. Consequently, the U.S. taxpayer pays no U.S. income tax with respect to the $100 Netherlands source income and has $15 ($23.08 - $8.08) in excess profit share to utilize in a carryover or carryback year. subject to the restrictions of the Convention. Example 2. The facts are the same as in Example 1, except that the amount of taxable income determined under U.S. principles is $90 rather than $100. First, the "effective company tax rate" is determined in accordance with subparagraph 5(c) by dividing the company tax paid by the income subject to the company tax, without deduction of the profit share, or .2991 (i.e., $26.92/$90). Second, the "creditable company income tax base" is determined in accordance with subparagraph 5(b) by dividing the effective company tax rate by an amount equal to the maximum U.S.. rate, multiplied by the income subject to the company tax, without deduction of the profit share, or $76.91 (i.e., .2991/.3500 x $90). The limitation on the credit for the company income tax paid is the product of the U.S. tax rate and the creditable company income tax base, or $26.92. Third, in accordance with subparagraph 5(a), the "creditable profit share income base" is equal to the excess of the income subject to the company tax over the creditable company income tax base, or $13.09 (i.e., $90 - $76.91). Finally, the "appropriate amount" is equal to the product of the U.S. tax rate and the creditable profit share income base, or $4.58 (i.e., $13.09 x .35). The credit for the company tax is the amount paid, $26.92. The total tax paid to the Netherlands that is eligible for the foreign tax credit is $26.29 plus $4.58, or $31.50. The U.S. taxpayer paid a total of $50.00 ($23.08 in profit share, plus $26.92 in company tax) to the Netherlands. Consequently, the U.S. taxpayer pays no U.S. income tax with respect to the $90 in Netherlands source income and has $18.50 ($23.08 - $4.58) in excess profit share to utilize in a carryover or carryback year, subject to the restrictions of the Convention. The Convention permits a limited carryback and carryover of the profit share on oil and gas extraction income from oil and gas wells in the Netherlands that, under the special limitation provided by paragraph 5, cannot be credited in the year paid or accrued. The profit share may be carried to those years specified under U.S. law and credited in those years subject to the Convention's special limitation as applied in those years. Other limitations, such as those provided by Code section 907, also may apply. The profit share is not eligible for a foreign tax credit under paragraph 4. If the provisions of the Convention are relied upon to claim a foreign tax credit for the profit share, the limitations of paragraph S apply, whether or not the profit share is paid in the taxable year, and all Dutch income taxes lust be treated as provided in the Convention. Thus, with respect to income taxes paid or accrued to the Netherlands on income other team oil and gas income from reconnaissance, exploration, and production activities in the Netherlands, the credit allowed under paragraph 4 to such persons under the Convention is limited to the U.S. income tax attributable to such other income. Paragraph 6 of Article 25 provides special rules for the tax treatment in both States of certain types of income derived from U.S. sources by U.S. citizens who are resident in the Netherlands. Since U.S. citizens are subject to United States tax at ordinary progressive rates on their worldwide income, the U.S. tax on the U.S. source income of a U.S. citizen resident in the Netherlands may exceed the U.S. tax that may be imposed under the Convention on an item of U.S. source income derived by a resident of the Netherlands who is not a U.S. citizen. Subparagraph (a) of paragraph 6 provides special Netherlands credit rules with respect to items of income for which the Netherlands allows a foreign tax credit rather than an exemption under paragraph 2 (and which are not subject to the special credit rules of paragraph 7), and which are either exempt from U.S. tax or subject to reduced rates of U.S. tax under the provisions of the Convention when received by Netherlands residents who are not U.S. citizens. The Netherlands foreign tax credit allowed by paragraph 6(a) under these circumstances, to the extent consistent with Netherlands law, need not exceed the U.S. tax which may be imposed under the provisions of the Convention, other than tax imposed solely by reason of the U.S. citizenship of the taxpayer under the provisions of the saving clause of paragraph 1 of Article 24 (Basis of Taxation). Thus, if a U.S. citizen resident in the Netherlands receives U.S. source portfolio dividends, the Netherlands foreign tax credit would be limited to 15 percent of the dividend --- the U.S. tax that may be imposed under subparagraph 2(b) of Article 10 (Dividends) --- even if the shareholder is subject (before the special U.S. foreign tax credit and source rules provided for in subparagraphs 3(b) and 3(c)) to a U.S. rate of tax of 36 percent because of his U.S. citizenship. With respect to royalty or interest income, the Netherlands would allow no foreign tax credit, because Netherlands residents are exempt from U.S. tax on these classes of income under the provisions of Articles 12 (Interest) and 13 (Royalties). Subparagraph 6(b) eliminates the potential for double taxation that can arise as a result of the absence of a full Netherlands foreign tax credit, because of subparagraph 6(a). for the U.S. tax imposed on its citizens resident in the Netherlands. The subparagraph provides that the United states will credit the Netherlands income tax paid, after allowance of the credit provided for in subparagraph 6(a). It further provides that in allowing the credit, the United States will not reduce its tax below the amount that is allowed as a creditable tax in the Netherlands under subparagraph 6(a). Since the income described in this paragraph is U S. source income, special rules are required to resource some of the income as Netherlands source in order for the United States to be able to credit the Netherlands tax. This resourcing is provided for in subparagraph 6(c), which deems the items of income referred to in subparagraph 6(a) to be from Netherlands sources to the extent necessary to avoid double taxation under subparagraph 6(b). The following two examples illustrate the application of paragraph 6 in the case of a U.S. source portfolio dividend received by a U.S. citizen resident in the Netherlands. In both examples, the U.S. rate of tax on the Netherlands resident udder paragraph 2(b) of Article 10 (Dividends) of the Convention is 15 percent. In both examples the U.S. income tax rate on the U.S. citizen is 36 percent. In example I the Netherlands income tax rate on its resident (the U.S. citizen) is 25 percent (below the U.S. rate), and in example II the Netherlands rate on its resident is 40 percent (above the U.S. rate). Example I Example II Subparagraph 6(a) U.S. dividend declared $100.00 $100.00 National U.S. Withholding tax per Article l0(2)(b) 15.00 15.00 Netherlands taxable income 100.00 100.00 Netherlands tax before credit 25.00 40.00 Netherlands foreign tax credit 15.00 15.00 Net post-credit Netherlands tax 10.00 25.00 Subparagraphs 6(b) and (c) U.S. pre-tax income $100.00 $100.00 U.S. pre-credit citizenship tax 36.00 36.00 Notional U.S. withholding tax 15.00 15.00 U.S. tax available for credit 21.00 21.00 Income resourced from U.S. to Netherlands 58.33 58.33 U.S. tax on resourced income 21.00 21.00 U.S. credit for Netherlands tax 10.00 21.00 Net post-credit U.S. tax 11.00 0.00 Total U.S. tax 26.00 15.00 In both examples, in the application of subparagraph 6(a), the Netherlands credits a 15 percent U.S. tax against its residence tax on the U.S. citizen. In example I the net Netherlands tax after foreign tax credit is 10.00; in the second example it is 20.00. In the application of subparagraphs 6(b) and (c), from the U.S. tax due before credit of 36.00, the United States subtracts the amount of the U.S. source tax of 15.00, against which no U.S. foreign tax credit is be allowed. This provision assures that, at a minimum, the United States will collect the tax that it is due under the Convention as the source country. In both examples, the maxim amount of U.S. tax against which credit for Netherlands tax may be claimed is 21.00. Initially, all of the income in these examples was U.S. source. In order for a U.S. credit to be allowed against 21.00 of U.S. tax, the amount of income that, given a tax rate of 36 percent, generates a tax of 21.00 must be resourced as Netherlands source. Thus, 58.33 of income (21.00 divided by .36) is resourced. In example I. , the Netherlands tax was 10.00. When this amount is credited against the U.S. tax on the resourced Netherlands income, there is a net U.S. tax of 11.00 due after credit. In example II, the Netherlands tax was 25, but, because of the resourcing, only 21.00 is eligible for credit, since, under subparagraph 6(c), the amount of resourcing is limited to that necessary to avoid double taxation. Thus, even though the Netherlands tax was 25.00 and the U.S. tax available for credit was 21.00, there is no excess credit available for carryover. Paragraph 7 provides special credit rules for three items of income in respect of which the former State of residence of the income recipient is given a taxing right under the Convention. These are lump-sum pensions derived by a resident of one of the States in respect of an employment exercised in the other State and lump-sums derived by a resident of that State, paid in lieu of the right to receive annuities, if the recipient had been a resident of the other State at any time during the preceding five year period (paragraph 2 of Article 19 (Pensions, Annuities, Alimony), and gain realized by a resident of one State on the sale of shares of a corporation resident in the other State where the alienator (alone or together with related individuals) owns at least 25 percent of any class of shares of the corporation (paragraph 9 of Article 14 (Gains)). These are not exclusive taxing rights. Both States have the right to tax. Paragraph 7 of Article 25 provides, with respect to these items of income, that the State of former residence, rather than the present State of residence of the recipient of the income is required to give the credit. The paragraph provides a limit equal to that part of the income tax, before the paragraph 7 credit is taken, attributable to that income. The paragraph also provides that, where the United States is required to give a credit under this paragraph, the source of the items of income in respect of which credit is allowed shall be deemed to be the Netherlands to the extent necessary to allow the granting of the credit under this paragraph, even if the income is from U.S. Sources under the Internal Revenue Code. Paragraph 8 was added by Article 4(2) of the Protocol. It provides that in cases in which the United States imposes a withholding tax of 15 percent on interest (in accordance with paragraph 8 of Article 12 (Interest)) or royalties (in accordance with paragraph 6 of Article 13 (Royalties)), and the income subject to the withholding tax is included in the basis of taxation by the Netherlands and is not exempt from tax in the Netherlands, the Netherlands generally will extend a credit equal to 15 percent of the interest or royalties paid. This Article is not subject to the saving clause of paragraph 1 of Article 24 (Basis of Taxation), by virtue of the exception in paragraph 2(a). Thus, the United States will allow a credit to its citizens and residents in accordance with the Article, even if such credit were to provide a benefit not available under the Code. ARTICLE 26 Limitation on Benefits Article 26 assures that source basis tax benefits granted by a Contracting State pursuant to the Convention are limited to the intended beneficiaries --- residents of the other Contracting State --- and are not extended to residents of third States that do not have a substantial business in, or business nexus with, the other Contracting State. For example, a resident of a third State might establish an entity resident in a Contracting State for the purpose of deriving income from the other Contracting State and claiming source State benefits with respect to that income. Absent Article 26, the entity generally would be entitled to benefits am a resident of a Contracting State, as long as it qualified as a resident of a Contracting State under Article 4 (Resident) and the form of the transaction was respected by the competent authorities of the Contracting States. Article 26 is unprecedented in its complexity and level of detail. Such detail is normally not desirable from the standpoint of simplicity and because it increases the chance of inadvertent error. In this case, however, the two delegations each had a significant concern that only could be addressed by additional complexity. The Netherlands delegation was concerned that a provision modeled after the provisions in such recent agreements as the U.S. - Germany convention would be too general to provide sufficient certainty to legitimate Dutch investors in the United States. The Netherlands therefore asked that more precise guidance be provided under the provision. In addition, the United States was willing to agree to somewhat looser standards for entitlement to benefits than the analogous provisions of other recent conventions only if there were adequate safeguards that the beneficiaries of these provisions had a sufficient nexus to the Netherlands to be entitled to treaty benefits from a policy perspective. As with the Dutch desire for certainty, these safeguards often manifested themselves in increased complexity. In the end, therefore, the delegations were driven by two concerns, each of which resulted in increased complexity. The structure of Article 26 is as follows: Paragraphs 1 through 4 set forth a series of tests under which a resident of a Contracting State may be entitled to treaty benefits. Satisfaction of any of these tests will entitle that person to income or all of the benefits of the Convention in the other Contracting State. Paragraph 5 Sets forth a base erosion test that is employed under certain provisions of other paragraphs of the Article. Paragraph 6 sets forth a special test for shipping and air transport. Paragraph 7 provides that the competent authority of the source State may grant treaty benefits to a parson not otherwise entitled to benefits under the other paragraphs of the Article. Finally, Paragraph 8 defines several terms that are employed in Article 26. It is anticipated that as the competent authorities and taxpayers gain me experience with the concepts in this Article, some of which are relatively new, further guidance will be developed and made public with the objective of alleviating the compliance burden for taxpayers attempting to establish their entitlement to benefits under Article 26. Paragraph X. of the Memorandum of Understanding reflects this view, providing that while a taxpayer must be able to provide upon request sufficient evidence to establish the taxpayer's entitlement to benefits, the competent authorities will attempt to develop reasonable procedures for periodic reporting of the facts necessary to support a claim to benefits. It is anticipated that these procedures will permit a taxpayer to enjoy the benefits of the Convention without providing annual evidence of such entitlement, as long as the taxpayer has adequately documented its entitlement to benefits for a particular year and there has been no relevant change in the facts and circumstances. The operative rules of paragraphs 1 through 7 apply numerous terms that are defined in paragraph 8. These definitions are described first, followed by a description of the rules of paragraphs 1 through 7 that apply these definitions. Defined Terms - Paragraph 8 Subparagraphs (a) through (m) of paragraph 8 set forth thirteen defined terms that are used in Article 26. These definitions are discussed below. Principal Class of Shares - Subparagraph 8(a) The tern "principal class of shares" is defined in subparagraph 8(a). It is relevant for the publicly-traded tests under subparagraph 1(c). The principal class of shares is the class of shares that represents the majority of the voting paver and value of the company. In most cases this class will be the ordinary or common shares of the company. If no single class of shares represents the majority of the voting power and value of the company, the principal class of shares will be the classes of shares that in the aggregate possess more than 50 percent of the voting power and value of the company. Authorized but unissued shares are not considered for purposes of determining voting power. In addition, the principal class of shares must include any "disproportionate class of shares," which is defined in subparagraph 8(c) (discussed below). Further, the competent authorities may agree to consider any restrictions or limitations on voting rights of issued shares in determining voting power. For instance, the voting power of stock with restricted voting rights could be discounted or disregarded by the competent authorities. They also may identify, by mutual agreement procedure, a principal class of shares that differs from that identified in accordance with the rules set forth in paragraph 8. Shares - Subparagraph 8(b) The term shares itself is not defined. In accordance with paragraph 2 of Article 3 (General Definitions), the term shall have the meaning that it has under the tax law of the State concerning the taxes to which the Convention applies. Therefore, in determining whether a Netherlands company qualifies for treaty benefits with respect to income derived from the United States, the term "shares" will have the meaning associated with that term in the United States for purposes of United States domestic tax law. Subparagraph 8 (b) provides that in addition to the commonly understood meaning attached to the term, "shares" also shall include depository receipts and trust certificates thereof. This provision reflects the practice in the Netherlands for shareholders of some publicly-traded companies to place their shares in a trust company, or "administratiekantoor." The trust then issues trust certificates, or "certificaten van aandelen," to the shareholders. The trust certificates are then listed and traded on a stock exchange in lieu of the share certificates. Paragraph I, of the Agreed Minutes to the Protocol clarifies that it is understood that such instruments will be considered to possess the rights (including voting rights) attached to the shares that they replace. Therefore, the shares of a company will include the trust certificates that replace the principal class of shares of a publicly-traded company, and the actual share certificates that the trust certificates replace will be disregarded. Similarly, American Depository Receipts ("ADRs"), which are frequently issued to United States investors in foreign corporations in order to evidence their ownership of the underlying foreign shares and to facilitate their holding and trading of such interests, will be treated as the equivalent of the underlying shares. Disproportionate Class of Shares - Subparagraph 8(c) Subparagraph 8(c) sets forth the definition of a disproportionate class of shares. Subparagraph 8(a) provides that such a class of shares must be included within the principal class of shares. A disproportionate class of shares of a company resident in a State is any class of shares that entitles the shareholder to a disproportionately higher participation in the earnings that the company generates in the other State through particular assets or activities of the company. Such participation may take any form, including (but not limited to) dividends and redemption payments. A disproportionate class of shares would include so-called alphabet stock that entitles the holder to earnings in the source state produced by a particular division of the company. The following examples illustrate the application of this subparagraph. Example l. NLCo is a corporation resident in the Netherlands. NLCo has two classes of shares: Common and preferred. The Common shares are listed on the Amsterdam Stock Exchange and are substantially and regularly traded. The Preferred shares have no voting rights and are entitled to receive dividend. equal in amount to interest payments that NLCo receives from unrelated borrowers in the United state. The Common shares account for more than 50 percent of the value of NLCo and for 100 percent of the voting power. Because the owner of the Preferred shares is entitled to receive payments corresponding to the U.S. source interest income earned by NLCo, the preferred shares are considered to be a disproportionate class of shares. Pursuant to subparagraph 8(a), the principal class of shares of NLCo includes the Common and preferred shares. Example 2. USCo is a corporation resident in the United States. USCo has two classes of shares: Common and preferred. The Common shares are listed on the New York stock Exchange and are substantially and regularly traded. The preferred shares have no voting rights and are entitled to receive dividends equal in amount to the income earned by a division of USCo that sells widgets in the United States. Because the preferred shares do not entitle the owner to receive dividends or other payments corresponding to Netherlands-source income received by USCo, the preferred shares are not considered a disproportionate class of shares for purposes of subparagraph 8(c). Recognized Stock Exchange - Subparagraph 8(d) Subparagraph 8(d) provides that the term "recognized stock exchange" generally means (i) any stock exchange registered with the Securities and Exchange commission as a national securities exchange for purposes of the Securities Exchange Act of 1934: (ii) the Amsterdam Stock Exchange; (iii) the NASDAQ System or the parallel market of the Amsterdam Stock Exchange: and (iv) any other stock exchange agreed upon by the competent authorities of the States. Paragraph VI. of the Agreed Minutes to the Protocol sets forth the agreement of the competent authorities that the principal stock exchanges of Frankfurt, London, Paris, Brussels, Hamburg, Madrid, Milan, Sydney, Tokyo and Toronto will be considered to be recognized stock exchanges. Other exchanges may be added by agreement of the competent authorities. With respect to "closely held companies" (discussed below), stock exchanges listed under (iii), above, will not be considered to be recognized stock exchanges. In addition, the stock exchanges described in (iv), above, also will not be considered to be recognized stock exchanges with respect to closely held companies if the competent authorities agree to exclude them. Closely Held Company - Subparagraph 8(e) Subparagraph 8(e) defines the term "closely held company." A company will be considered to be a closely held company if 50 the principal class of shares (as defined under subparagraph 8(a)) is owned by persons who are not "qualified persons" (as defined in subparagraph 8(g)) or "residents of a member state of the European Communities" (as defined in subparagraph 8(i)), each of whom owns, directly or indirectly, alone or together with related persons more than 5 percent of such shares for more than 30 days during a taxable year. For this purpose, paragraph XXIII. of the Memorandum of Understanding clarifies that it is understood that "related persons" means associated enterprises (as meant in Article 9 (Associated Enterprises) and their owners. Since Article 9 is understood to incorporate into the Convention the general principles of section 482 of the Code, the United States competent authority will consider persons to be related persons if they are related persons within the meaning of section 482. The following examples illustrate the application of this subparagraph. Example l. A Netherlands company has one class of shares. Five individuals who are residents of Hong Kong each own 10 percent of the company's shares for at least 30 days during the taxable year. Since residents of Hong Kong are not qualified residents or residents of a member State of the European Communities, the company would be considered a closely held company. Example 2. The facts are the same as in Example 1, except that all the shares of the Netherlands company are held by another Netherlands company, and the individuals each own 10 percent of the shares of the second Netherlands company. Since the definition of closely held company includes indirect ownership of shares, the company also would be considered to be a closely held company under these facts. Example 3. The facts are the same as in Example 1, except that four residents of Hong Kong each own 12 percent of the company's shares for at least 30 days during the taxable year and a fifth resident of Hong Kong owns 4 percent of the company's shares for at least 30 days during the taxable year. No other shareholder owns more than 5 percent of the shares for any 30 day period during the taxable year. Although these individuals in the aggregate own more than 50 percent of the company's shares, the company is not a closely held company because only persons who own sore than 5 percent of the shares are considered for this purpose. The individual with 4 percent of the shares therefore is disregarded, and only 48 percent of the company's ownership falls under the definition in subparagraph 8(e). Example 4. The facts are the same as in Example 3, except that the individual with 4 percent of the shares of the company is the spouse of one of the persons holding 12 percent of the shares of the company. Applying the principles of Code section 482, it is determined that the spouses are related persons within the meaning of that provision. The company will be considered to be a closely held company because ownership by related persons and their owners is aggregated. Therefore, three persons are considered each to own 12 percent of the shares of the company, and a fourth person is considered to own 16 percent of the shares. Substantially and Regularly Traded - Subparagraph 8(f) Subparagraph 8(f) provides that a class of shares will be considered to be "substantially and regularly traded" on one or more recognized stock exchanges if trades in such class are effected on one or more such exchanges in other then de minimis quantities in every month of the taxable year for which benefits of the Convention are claimed and the aggregate number of shares of that class traded on such exchanges during the previous taxable year is at least 6 percent of the average number of shares outstanding in that class during such previous year. If a company's principal class of shares (as defined In subparagraph 8(a)) consists of more than one class of shares, the classes of shares that comprise the principal class of shares are aggregated for purposes of applying this subparagraph. If, however, the company has a disproportionate class of shares (as defined in subparagraph 8(c)), this subparagraph is applied independently to the disproportionate class of shares and to the other class or classes of shares that comprise the principal class of shares. Thus, if a company's principal class of shares consists of three classes of shares, one of which is a disproportionate class of shares, this subparagraph would be applied twice: once to the disproportionate class of shares, and once to the other two classes that comprise the principal class of shares. Any pattern of trades conducted in order to meet this test will be disregarded. Thus, for example, trades between related parties that do not affect the overall control of the company or trades in which it is understood that the shares will he resold to the seller at a future date may be disregarded if such trades were undertaken with the principal purpose of creating trading volume in order to qualify for treaty benefits. Paragraph XXIV. of the Memorandum of Understanding sets forth the understanding of the negotiators that it is not necessary for a person claiming the benefits of the Convention to establish that it has not engaged in a pattern of trades designed to satisfy the requirement of this subparagraph. It may be necessary, however, for such person to rebut such evidence when presented with it by one of the competent authorities. This understanding does not affect the obligation of the taxpayer, as described in paragraph X. of the Memorandum of Understanding, to provide reasonable evidence of its entitlement to benefits under the Convention upon request. The following examples illustrate the application of this subparagraph. Example l. NL-l is a corporation resident in the Netherlands. It is not a closely held company. NL-l has one class of shares that is listed and traded on the Amsterdam Stock Exchange. In determining whether these shares meet the substantially and regularly traded requirement of this subparagraph for the l996 taxable year, it is established that NL-l 's monthly turnover was at least l percent of the total outstanding shares for the 1996 taxable year, and that 20 percent of the shares outstanding during the 1996 taxable year were traded during the 1995 taxable year. NL-l satisfies the substantially and regularly traded requirement. Example 2. NL-2 is a corporation resident in the Netherlands. It is not a closely held company. NL-2 has three classes of shares: Common, Preferred A and Preferred B. In accordance with subparagraph 8(a), the principal class of shares of NL-2 is considered to consist of the Common and Preferred A shares. The Common and Preferred A classes must in the aggregate satisfy the substantially and regularly traded requirement under this subparagraph. The Common and Preferred A shares are listed and traded on the Amsterdam Stock Exchange. The Preferred B shares are privately held. In determining NL-2's entitlement to benefits under the Convention with respect to the 1996 taxable year, the trading records of the Common and Preferred A shares for the 1995 and 1996 taxable year are examined. These records indicate that the Common shares were substantially and regularly traded within the meaning of subparagraph 8(f). The records also indicate that less than 6 percent of the outstanding Preferred A shares were traded in 1995, but that more than 6 percent of the combined Common and Preferred A shares were traded. Although the Preferred A shares would not be considered to be substantially and regularly traded If they were analyzed in isolation both the Common and Preferred A shares are analyzed together for purposes of this test. Therefore the principal class of shares of NL-2 will be considered to be substantially and regularly traded. Example 3. The facts are the same as in Example 2, except that the Preferred B shares are a disproportionate class of shares and the principal class of shares therefore includes the Preferred B shares in accordance with subparagraph 8(a). As described in Example 2, the Common and Preferred A shares are considered to be substantially and regularly traded. Since the Preferred B shares are a disproportionate class of shares, the substantially and regularly traded test under subparagraph 8(f) also must be applied to the Preferred B shares. Since the Preferred B shares are privately held, they are not considered to be substantially and regularly traded, and the principal class of shares of NL-2 is not considered to be substantially and regularly traded for purposes of subparagraph 8(f). Examp1e 4. The facts are the same as in Example 2, except that NL-2 's shares are listed and traded on the Amsterdam Stock Exchange and the Hamburg Stock Exchange. For the 1995 taxable year, 4 percent of the outstanding Common and Preferred A shares were traded on the Amsterdam Stock Exchange, and 4 percent were traded on the Hamburg Stock Exchange. The requirement under subparagraph 8(f)(ii) that at least 4 percent of the aggregate number of shares of the principal class of shares be traded during the preceding taxable year is satisfied. See also Example 5 under the discussion of subparagraph l(c)(i). Qualified Person - Subparagraph 8(g) A qualified person is defined in subparagraph 8(g) to mean a person entitled to the benefits of the Convention pursuant to paragraph 1 of Article 26, and a citizen of the United States. Since a company only will be considered to be a qualified person if it is entitled to the benefits of the Convention under paragraph 1 of Article 26, It will not be considered a qualified person if it is entitled to the benefits of the Convention under another paragraph of Article 26. Thus, a company qualifying for the benefits of the Convention under the headquarters company rule of paragraph 3 of Article 26 would not be considered a qualified person. Member State of the European Communities - Subparagraph 8(h) Subparagraph 8(h) defines the term ·member state of the European Communities to mean (unless the context requires otherwise), the Netherlands and any other member state of the European Communities with which bath States have in effect a comprehensive income tax Convention. As of the date of this Explanation, the Netherlands has in effect a comprehensive income tax Convention with all the members of the European Communities, and the United States has such Conventions in effect with all members except for Portugal. Therefore, for purposes of this definition, all the members of the European Communities are included except for Portugal. This definition is ambulatory; if both States and Portugal conclude a comprehensive income tax convention, Portugal would be included within the definition. Conversely, if one of the Contracting States terminated its convention with a particular member of the EC, or a member of the EC removed itself from the EC, that state would no longer be considered a member state of the European Communities for purposes of the Convention. This definition encompasses all parts of a state, unless the context requires otherwise. The context requires otherwise if a particular part of the territory of a particular state is not encompassed by all the provisions of the convention between a Contracting State and such third state. For instance, the Channel Islands or the Isle of Man would not be considered part of the United Kingdom for this purpose, as the United States-United Kingdom Income Tax Convention does not apply to such jurisdictions. Resident of a Member State of the European Communities - Subparagraph 8 (i) Subparagraph 8(i) defines the term "resident of a member state of the European Communities" as a person that meets three requirements: (i) the parson would be considered a resident of such member state under the principles of Article 4 (Resident) of the Convention; (ii) would be entitled to the benefits of the Convention under the principles of paragraph 1 of Article 26, applied as if such member state were the Netherlands; and (iii) such parson is otherwise entitled to the benefits of the Convention between that person's state of residence and the United States. A person will meet the first requirement if that person would satisfy the provisions of Article 4 (Resident) of the Convention if that Article were applicable to the state of residence of the person. Thus, that person must be liable to tax in that state by reason of his domicile, residence, etc., as provided in Article 4. A person will meet the second requirement if that person would be entitled to the benefits of the Convention under paragraph 1 of Article 26 if the third state were the Netherlands. Thus, a company resident in a third state would be required to qualify under subparagraph 1(c) or (d) in order to satisfy this requirement. A company that only could qualify under other paragraphs of Article 26, such as the substantial business presence test of paragraph 2 or the headquarters company rule of paragraph 3, would not satisfy this requirement. Paragraph VII. of the Agreed Minutes clarifies that a person will be considered to be "otherwise" entitled to the benefits of the Convention between that person's state of residence and the United States (the "second convention") if that person is entitled to the benefits of the second convention with respect to the items of income derived from the United States under all provisions of the second convention, with the exception of provisions relating to limitation on benefits. However, such person also must satisfy any relevant provision relating to the limitation on benefits in the second Convention if Article 26 does not contain a provision of the "same or similar nature" as a provision in the second convention. Thus, the person generally must satisfy only the provisions of the second convention other than that convention's limitation on benefits provisions. It only would be required to satisfy a provision related to limitation on benefits in the second convention if that provision contained a provision of a different nature than the provisions contained in Article 26. A provision is of the same or similar nature as one contained in Article 26 if the substance of the tests imposed is similar; (i.e., a test requiring public ownership for a company would be of a similar nature to paragraph 1), and a provision requiring a substantial business presence in one of the states would be of a similar nature to paragraph 2 of Article 26. Thus, a resident of Germany would not be required to satisfy the provisions of Article 28 of the United States-Germany income tax convention because Article 28 of that convention does not contain provisions that are of a different nature than those contained in Article 26. A provision will not be considered to be of a same or similar nature as the provisions in Article 26 if it is of a different kind than those contained in Article 26. For instance, if the limitation on benefits article of a convention between the United States and a member stats of the European Communities contained a provision that denied treaty benefits to all companies of a particular type, or companies that were resident of a particular territory of that state, then such provisions would be of a different nature than the provisions of Article 26, because Article 26 does not have a provision that denies treaty benefits to a particular category of corporations or to residents of a particular territory of the Netherlands. In such a case it would be necessary for a resident of that state to satisfy that portion of the limitation on benefits article of the second convention in order to satisfy this subparagraph. Not-for-Profit Organizations - Subparagraph 8(j) Subparagraph 8(j) provides that the not-for-profit organizations referred to in subparagraph 1(e) include, but are not limited to, pension funds, pension trusts, private foundations, trade unions, trade associations, and similar organizations. In addition, a pension fund, trust or similar entity that is organized for the purpose of providing retirement or other employment benefits and that is organized under the laws of a State shall be entitled to the benefits of the Convention if the organization sponsoring such fund, trust or similar entity is entitled to the benefits of the Convention under Article 26. Thus, a Netherlands pension fund established by a Netherlands publicly-traded corporation that is entitled to the benefits of the Convention under paragraph 1 of Article 26 would be entitled to the benefits of the Convention without regard to whether more than half its participants are qualified persons. Indirect Ownership - Subparagraph 8(k) Subparagraph 8(k), as amended by Article S of the Protocol, provides that for purposes of the tests set forth under subparagraph l(c)(ii) and clauses (A) and (B) of subparagraph 1(c) (iii), all companies in a chain of ownership that are used to satisfy the ownership requirements of such provision must be a resident of one of the States or a resident of a member state of the European Communities. The following examples illustrate the application of this rule. Example l. NL-l is a corporation resident in the Netherlands. 100 percent of its shares are held by UKCo, a United Kingdom corporation that is a resident of a member state of the European Communities. All the shares of UKCo are owned by NL-2, a Netherlands corporation whose shares are listed and traded as described in paragraph 1(c)(i). NL-l is not a conduit company as defined in subparagraph 8(m). NL-l is entitled to the benefits of the Convention under subparagraph 1(c)(ii) because more than 50 percent of its shares are held indirectly by NL-2 a publicly-traded corporation resident in the Netherlands satisfying the publicly-traded test of subparagraph l(c)(i). Subparagraph 8(k) permits NL-l to trace its ownership through UKCo because UKCo is a resident of a member State of the European Communities. Example 2. The facts are the same as in Example 1, except that 50 percent of the shares of UKCo are held by NL-2 and 50 percent by NL-3, a closely held corporation resident in the Netherlands that is owned by persons who are individual residents of a third state. Since the stock of NL-3 is not listed and traded as described in subparagraph 1(c)(i), its ownership of UKCo shares is not considered for purposes of the test set forth under subparagraph l(c)(ii), and only 50 percent of the shares of NL-l meet the requirements of such test (i.e., the portion of UKCo's interest in NL-l that is attributable to NL-2). Therefore NL-l does not satisfy the test set forth under subparagraph 1(c)(ii). Example 3. The facts are the same as in Example 1, except that UKCo is a corporation resident in the Cayman Islands ("CaymanCo"). Since CaymanCo is not a resident of a member state of the European Communities or a resident of the United States, NL2's indirect ownership of NL-l through CaymanCo is not considered for purposes of the test set forth under subparagraph 1(c)(ii). Paragraph XXV. of the Memorandum of understanding describes situations in which a corporation resident in one of the States that is entitled to the benefits of the Convention acquires control of a corporation resident in a third state that in turn controls a second corporation resident in the first State. In such cases, the second corporation would not be entitled to the benefits of the Convention, notwithstanding its ultimate ownership by the first corporation, if the intermediate corporation resident in a third state is not a resident of a member state of the European Communities. In such cases, this paragraph provides that the competent authority of the other State, in considering a request for benefits under paragraph 7 of Article 26, will consider favorably a plan or reorganization submitted by the second corporation, if such plan would result in the second corporation being entitled to the benefits of the Convention within a reasonable transition period. The following example illustrates the intended application of paragraph XXV. of the Memorandum of Understanding. Example. NL-l is a corporation resident in the Netherlands. All of the shares of NL-l are owned by CaymanCo, a corporation resident in the Cayman Islands. NL-l is not entitled to the benefits of the Convention. NL-2, a publicly-traded corporation resident in the Netherlands that is entitled to the benefits its of the Convention under paragraph 1 acquires all the shares of CaymanCo. If NL-2 directly owned the shares of NL-l, NL-l would be entitled to the benefits of the Convention. Since NL-2 indirectly controls NL-l through CaymanCo, however, in accordance with subparagraph 8(k) NL-2 's indirect ownership of NL-l is disregarded for purposes of the tests set forth under subparagraph 1(c). In connection with a request to the U.S. competent authority under paragraph 7, NL-2 submits to the United States competent authority a plan of reorganization pursuant to which the stock of NL-2 is to be distributed to NL-1 in connection with a liquidation of CaymanCo within one year of the acquisition of the shares of CaymanCo by NL-2. After the reorganization, NL-2 will be entitled to the benefits of the Convention under paragraph 1. Based on the plan of reorganization, the United States competent authority may decide to grant NL-2 the benefits of the Convention during the transitional period between the acquisition of the CaymanCo shares by NL-2 and the reorganization, taking into account the other factors listed under paragraph 7. Newly-Established Companies, Etc. - Subparagraph 8(l) Subparagraph 8(1) provides that for purposes of paragraphs 2, 3 and 5, the competent authorities may by mutual agreement establish transition rules for newly-established business operations, corporate groups and headquarters companies. This provision is intended to permit the competent authorities to apply the referenced provisions flexibly in cases in which the taxpayer cannot satisfy the requirements of such provisions due to the fact that their relevant operations are recently established. Conduit Company - Subparagraph 8(m) Subparagraph 8(m) defines the term "conduit company," which is relevant for purposes of the tests set forth under subparagraphs l(c)(ii) and (iii). A conduit company generally is any company that makes payments of interest, royalties and any other payments included in the definition of deductible payments under subparagraph 5(c) in a taxable year in an amount equal to or greater than 90 percent of its aggregate receipts of such items during the same year. Banks and insurance companies shall not be considered to be conduit companies, however, if they are engaged in the active conduct of a banking or insurance business and are managed and controlled by associated enterprises that are qualified persons (as defined in subparagraph 8(g)). Paragraph XIII. of the Memorandum of Understanding provides that it is understood that a bank only will be considered to be engaged in the active conduct of a banking business if it regularly accepts deposits from the public or makes loans to the public, and an insurance company only will be considered to be engaged in the active conduct of an insurance business if its gross income consists primarily of insurance or reinsurance premiums, and investment income attributable to such premiums. Whether two enterprises are associated enterprises viii be determined without regard to whether they are residents of different states. The following examples illustrate the application of this subparagraph. Example 1. NL-1 is a corporation resident in the Netherlands. NL-1 receives $100 of interest income during its 1996 taxable year. It does not receive any royalties or other deductible payments during the year. It pays $90 in interest during the same year. NL-1 is a conduit company because it made payments of items classified as deductible payments equal to at least 90 percent of its receipts of such items. Example 2. The facts are the same as in Example 1, except that NL-l is a bank engaged in the active conduct of a banking business, and NL-1 is managed and controlled by NL-2, a corporation entitled to the benefits of the Convention under paragraph 1. Since NL-1 is a bank engaged in the active conduct of a banking business and is managed and controlled by an associated enterprise that is a qualified person NL-1 is not a conduit company. Example 3. The facts are the same as in Example 1, except that in addition to its receipts of interest income, WL-1 also receives $10 in royalty income during the 1996 taxable year. It has no royalty expenses. Since the conduit company test applies only if the aggregate receipts of items classified as deductible payments are equal to or greater than 90 percent of the company' 5 receipts of such items, NL-1's royalty and interest receipts are aggregated for purposes of subparagraph 8(n). Consequently, NL-1's payments of deductible payments ($90) are 81.8 percent of its receipts of such items (i.e., $100 in interest and $10 in royalties, or $110). NL-1 therefore is not a conduit company. Ownership Tests - Paragraph 1 Paragraph 1 provides that a resident of one of the States that derives income from the other State will be entitled to all the benefits of the Convention if that person is described in subparagraphs 1(a), (b), (c), (d), or (e). First, subparagraph 1(a) provides that an individual resident of one of the contracting States will be entitled to treaty benefits. For this purpose, residence is determined under Article 4 (Resident). Second, subparagraph 1(b) extends treaty benefits to a State, or a political subdivision or local authority thereof. It is unlikely that persons falling into either of these categories can be used to exploit the Convention by deriving income from the other State on behalf of a third-country person. If an individual receives income as a nominee of a person not entitled to treaty benefits, the benefits of the convention will be denied with respect to such income under the articles of the Convention that grant the benefit, as those articles require that the beneficial owner of the income be a resident of a Contracting State. Subparagraph 1(c) provides four alternative tests under which a company may be entitled to the benefits of the Convention. These tests relate to certain publicly-traded corporations, subsidiaries of publicly-traded corporations, certain Netherlands corporations with specified Dutch and EC ownership, and "conduit companies" (as defined in subparagraph 8(m)). These tests are described below. Publicly-Traded Corporations - Subparagraph 1(c)(i) First, subparagraph l(c)(i) provides that a company will be entitled to the benefits of the convention if the "principal class of its shares" is listed on a "recognized stock exchange" in either of the States and the shares of that class are "substantially and regularly traded" on one or more recognized stock exchanges. As discussed above, the term "principal class of shares" is defined in subparagraph 8(a), the term "recognized stock exchange" is defined in subparagraph 8(d), and the term "substantially and regularly traded" is defined in subparagraph 8(f). The following examples illustrate the application of this subparagraph. Example 1. NLCo is a corporation resident in the Netherlands. NLCo has one class of shares that is listed and traded on the Amsterdam Stock Exchange. The shares of NLCo are traded in more than de minimis amounts in every month of the 1997 taxable year. In addition, the aggregate number of NLCo shares traded during the preceding taxable year (1996) exceeded 6 percent of the average number of outstanding shares during 1996. NLCo is entitled to the benefits of the Convention under subparagraph 1(c)(i). Example 2. The facts are the same as in Example 1, except that NLCo's shares are listed on the parallel market of the Amsterdam Stock Exchange and a second, non- Dutch and non-U.S. stock exchange described in Paragraph VI. of the Agreed Minutes to the Protocol, as authorized by subparagraph 8(d)(iv). NLCo is not a closely held company as defined in subparagraph 8(e). NLCo shares are not traded in substantial volume on the parallel market of the Amsterdam Stock Exchange, but they are substantially and regularly traded on the second stock exchange. NLCo is entitled to the benefits of the Convention under subparagraph l(c)(i). Although its shares are not substantially and regularly traded on the parallel market of the Amsterdam Stock Exchange, subparagraph 1(c) (i) only requires that the principal class of NLCo's shares be listed on a recognized exchange in either of the States. The shares also must be substantially and regularly traded, but this requirement may be satisfied through substantial and regular trading on any recognized stock exchange, including the stock exchanges described under subparagraph 8(d)(iv). Example 3. The facts are the same as in Example 2, except that NLCo is a closely held company as defined in subparagraph 8(e). NLCo is not entitled to the benefits of the convention under subparagraph 1(c)(i). Subparagraph 8(d) provides that with respect to a closely held company, the term "recognized stock exchange" does not include the stock exchanges mentioned under subparagraph 8(d)(iii), which includes the parallel market of the Amsterdam Stock Exchange. There fore, for purposes of subparagraph 1(c) (i), the shares of NLCo are not considered to be listed on a recognized stock exchange located in either of the States. Example 4. USCo is a corporation resident in the United States. USCo has two classes of shares: Common and Alphabet. The Common shares are listed on the New York Stock Exchange and are substantially and regularly traded. The common shares account for all the voting power of USCo and more than 50 percent of its value. The Alphabet shares entitle the owner to receive the profits attributable to USCo’s income from Netherlands sources. The Alphabet shares are owned by an individual resident in a third state. The Alphabet shares constitute a disproportionate class of shares within the meaning of subparagraph 8(c). In general, subparagraph 8(a) provides that the principal class of shares includes those shares that account for more than 50 percent of the vote and value of the company. Notwithstanding this general rule, any disproportionate class of shares also is treated as belonging to the principal class of shares. Therefore, for purposes of subparagraph 1(c)(i), the principal class of shares includes a disproportionate class of shares even if other classes of shares account for more than 50 percent of the vote and value of the company. Consequently, in this example the principal class of shares of USCo includes both the Common and Alphabet shares. Each class must satisfy the tests set forth under subparagraph l(c)(i) in order for the company to be entitled to the benefits of the Convention under that provision. Since the Alphabet shares are not publicly-traded, USCO is not entitled to the benefits of the Convention under subparagraph l(c)(i). Example 5. NLCo is a corporation resident in the Netherlands. It is not a closely held company. NL-2 has three classes of shares: Common, Preferred A and Preferred B. In accordance with subparagraph 8(a), the principal class of shares of NLCo is considered to consist of the Common and Preferred A shares. The Common shares are listed and traded on the Amsterdam Stock Exchange. The Preferred A shares are listed and traded on the Hamburg Stock Exchange. The combined shares of the and Preferred A classes would satisfy the volume requirements under subparagraph 8(f) and therefore would be considered to be substantially and regularly traded. Since, however, the principal class of the shares of NLCo consists of both the Common and preferred A shares, both classes must be listed on a recognized stock exchange located in either State. Since the Preferred A shares are not listed on a recognized stock exchange located in either State, NLCo is riot entitled to the benefits of the Convention under subparagraph 1(c)(i). Subsidiaries a! Publicly-Traded Corporations - Subparagraph 1(c)(ii) Subparagraph l(c)(ii) provides a test under which certain companies that are directly or indirectly controlled by companies satisfying the publicly-traded test of subparagraph 1(c)(i) may be entitled to the benefits of the Convention. Under this test, a company will be entitled to the benefits of the Convention if more than 50 percent of the aggregate vote and value of all of its shares is owned, directly or indirectly, by five or fewer companies that are resident of either State, the principal classes of the shares of which are listed and traded as described in subparagraph 1(c)(i). In addition, the company may not be a conduit company (as defined in subparagraph 8(m)). Under this test, more than 50 percent of the vote and value of all of the company's shares, not merely its principal class of shares, must be held by Dutch or U.S. publicly-traded companies. For this purpose, "value" is fair market value. Authorized but unissued shares are not considered for purposes of this test. Subject to the limitations imposed by subparagraph 8(k), ownership may be indirect. Thus, ownership may be traced through intermediate companies to an ultimate owner that is a publicly-traded Netherlands or United States corporation, as long as the intermediate companies are residents of the United States or a member state of the European Communities. Share ownership will be determined under the principles of section 883(c)(4) of the Code. The following examples illustrate the application of this subparagraph. Example l. NL-l is a corporation resident in the Netherlands. It has one class of shares. All of the outstanding shares of NL-l are owned by NL-2, a corporation resident in the Netherlands. The principal class of the shares of NL-2 is listed and traded as described in subparagraph 1(c)(i). NL-l is not a conduit company. NL-l is entitled to the benefits of the Convention under subparagraph 1(c)(ii) because more then 50 percent of the vote and value of its shares are owned by a company resident in the Netherlands, and the principal class of the shares of that company is listed and traded as described in subparagraph 1(c)(i). Example 2. The facts are the same as in Example 1, except that NL-l is a conduit company as defined in subparagraph 8(m). NL-1 is not entitled to the benefits of the Convention under subparagraph l(c)(ii), because clause (B) of that subparagraph provides that subparagraph 1(c)(ii) does riot apply to conduit companies NL-l may, however, be entitled to the benefits of the Convention under subparagraph 1(c)(iv). Example 3. The facts are the same as in Example 1, except that the shares of NL-l are held by USCo, a corporation resident in the United States. The principal class of the shares of USCo is listed and traded as described in subparagraph l(c)(i). Since subparagraph 1(c) (ii) provides that the ultimate owner of the shares of the company seeking the benefits of the Convention may be a company that is a resident of either State, NL-1 is entitled to the benefits of the Convention under subparagraph 1(c)(ii). Example 4. US-1 is a corporation resident in the United States. It has one class of shares. 50 percent of the shares of US-1 are owned by an individual who is a resident of the United States, and 50 percent are owned by US-2, a corporation resident in the United States. The principal class of the shares of US-2 is listed and traded as described in subparagraph 1(c)(i). US-1 is not a conduit company. US-1 is not entitled to the benefits of the Convention under subparagraph 1(c)(ii) (although it may be entitled to the benefits of the Convention under subparagraph 1(d)). Subparagraph 1(c)(ii) requires that more than 50 percent of the shares of the company seeking the benefits of the Convention be owned by publicly-traded companies resident in either State. Since 50 percent of the shares of US-1 are owned by an individual, the test of this subparagraph is not satisfied, despite the fact that the individual is a resident of the United States. Example 5. NLSub is a corporation resident in the Netherlands. It has one class of shares. All of the outstanding shares of NLSub are owned by NLHolding, also a corporation resident in the Netherlands. NLHolding has one class of shares. 40 percent of the shares of NLHolding are owned by NLParent, a corporation resident in the Netherlands. The principal class of the shares of NLParent is listed and traded as described in subparagraph 1(c)(i). Sixty percent of the shares of NLHolding are owned by UKCo, a corporation resident in the United Kingdom. UKCo is entitled to the benefits of the Convention between the United States and the United Kingdom. Forty percent of the shares of UKCo are owned by UKCo, a corporation resident in Hong Kong, and 60 percent are owned by USCo, a corporation resident in the United States. The principal class of the shares of USCo is listed and traded as described in subparagraph 1(c)(i). Because more than 50 percent of its shares are owned by USCo, a resident of one of the States, and the principal class of USCo's shares is listed and traded as described in subparagraph 1(c)(i), USCo would be entitled to the benefits of the convention under subparagraph 1(c) (ii), applied as if the United Kingdom were the Netherlands Neither NISub, NLHolding nor UKCo is a conduit company as defined in subparagraph 8(m). The ownership of NLSub’s shares for purposes of subparagraph l(c)(ii) is analyzed as follows. The immediate shareholder of NLSub is NLHolding. The shares of NLHolding are not publicly traded, so its ownership of NLSub does not entitle NLSub, to the benefits of the Convention under subparagraph l(c)(ii). Forty percent of the shares of NLHolding are owned by NLParent. Since NLParent meets the requirements of subparagraph l(c)(i), and NLHolding is a resident of a member state of the European Communities (as required by subparagraph 1(k)), the NLSub shares attributable to NLParent’s shares in NLHolding are counted for purposes of meeting the 50 percent ownership requirement in subparagraph 1(c)(ii). Since NLParent owns 40 percent of the shares of NLHolding, 40 percent of the shares of NLSub are attributable to NLParent. The remaining shares of NLHolding (60 percent) are owned by UKCo. UKCo is not a resident of one of the States and it is not publicly-traded. UKCo therefore is not a qualified shareholder for purposes of subparagraph 1(c)(ii). Subparagraph 8(k) provides that indirect ownership through residents of member states of the European Communities may be taken into account under subparagraph 1(c)(ii). Subparagraph 8(i) provides that a company will be considered a resident of a member state of the European Communities if it is a resident of its state of residence within the meaning of Article 4, it would be entitled to the benefits of the Convention under paragraph 1 if its state of residence were the Netherlands, and it is otherwise entitled to the benefits of the Convention between its state of residence and the United States. Since all of these conditions are satisfied, UKCo is considered to be a resident of a member state of the European Communities, and indirect ownership of NLHolding shares through UKCo will be considered for purposes of the analysis under subparagraph 1(c)(ii). Since HKCo is not a resident of a member state of the European Communities nor a resident of one of the states, the NLHolding shares that are attributable to HKCo's shares in UKCo are disregarded for purposes of the analysis under subparagraph 1(c)(ii). USCo, however, is a resident of one of the States and its principal class of shares is listed and traded as described in subparagraph 1(c)(i). Consequently, the NLSub shares that are attributable to USCo's shares in UKCo are considered for purposes of this analysis. Since USCo owns 60 percent of the shares of UKCo, UKCo owns 60 percent of the shares of NLHolding, and NLHolding owns 100 percent of the shares of NISub, 36 percent of the shares of NISub are attributed to USCo for purposes of subparagraph 1(c)(ii) (i.e., 60% X 60% X 100%), in accordance with the principles of Code section 883(c)(4). The shares of NISub that are attributable to USCo (34 percent) and the shares of NISub that are attributable to NLParent (40 percent) are combined for purposes of subparagraph l(c)(ii). Accordingly, 76 percent of the shares of NISub are considered to be owned indirectly by two companies that are resident of either State, and the principal classes of the shares of those companies are listed and traded as described in subparagraph 1(c)(i). Furthermore, NLSub is not a conduit company. Therefore, under subparagraph l(c)(ii), NLSub is entitled to the benefits of the Convention. Example 6. USSub is a corporation resident in the United States. USSub has two classes of shares: Common and Preferred. The Preferred shares do not have voting rights. The total fair market value of the Common shares is equal to the fair market value of the Preferred shares. USSub is not a conduit company. Sixty percent of the Common shares and 40 percent of the Preferred shares are owned by USParent, a corporation resident in the United States. The principal class of the shares of USParent is listed and traded as described in subparagraph 1(c)(i). The remaining USSub shares (60 percent of the Preferred shares and 40 percent of the Common shares) are owned by CaymanCo, a corporation resident in the Cayman Islands. Since CaymanCo is not a resident of either State and is not a resident of a member state of the European Communities, only the shares owned by USParent are considered for purposes of subparagraph l(c)(ii). Since USParent owns 60 percent of the Common shares, and the Preferred shares do not have voting rights, USParent is considered to control 60 percent of the voting power with respect to the shares of USSub. USParent, however, only owns 50 percent of the value of such shares, since it owns only 40 percent of the Preferred shares and the Preferred and Common classes of shares have equal value. Since subparagraph 1(c)(ii) requires that more than 50 percent of the vote and value of all the shares of the company seeking the benefits of the Convention be owned by companies that are resident of either State and the principal classes of the shares of which are listed and traded as described in subparagraph 1(c)(i), USSub is not entitled to the benefits of the Convention under subparagraph l(c)(ii).30/70 Netherlands/EC ownership - subparagraph 1(c)(iii). 30/70 Netherlands/EC Ownership - Subparagraph 1(c)(iii) Subparagraph 1(c)(iii) sets forth a special test for certain corporations resident in the Netherlands. Under this test, a Netherlands corporation will be entitled to the benefits of the Convention if at least 30 percent of the aggregate vote and value of all of its shares is owned, directly or indirectly, by five or fever companies that are resident of the Netherlands, the principal classes of the shares of which are listed and traded as described in subparagraph 1(c)(i), and at least 70 percent of the aggregate vote and value of all of its shares is owned, directly or indirectly, by five or fever companies that are resident of the United States or of member states of the European Communities, the principal classes of the shares of which are substantially and regularly traded on one or more recognized stock exchanges. In addition, the company may not be a conduit company (as defined in subparagraph 8(m)). This test is similar to the test under subparagraph 1(c)(ii) in that it entitles corporations to the benefits of the Convention if they are subsidiaries of publicly-traded companies. The principal differences from the test under subparagraph 1(c)(ii) are that this test applies only to Netherlands companies, and that it looks to ownership in the prescribed percentages by Netherlands owners and European Community owners. In addition, unlike the subparagraph 1(c)(i) test that is applied to a 30 percent Netherlands owner, the shares of a 70 percent EC owner only must be listed and traded on a recognized stock exchange rather than a recognized stock exchange located in either State. This departure from the general subparagraph l(c)(i) publicly-traded test for EC companies recognizes the fact that many such companies only will be listed and traded in exchanges in their horn countries. In other respects this test generally tracks the test set forth in subparagraph l(c)(ii). The following examples illustrate the application of this subparagraph. Example l. NISub is a corporation resident in the Netherlands. NLSub has one class of shares. NISub is not a conduit company. Thirty-two percent of the shares are owned by NLParent, a corporation resident in the Netherlands. The principal class of shares of NLParent is listed and traded as described in subparagraph 1(c)(i). Forty-three percent of the shares of NLSub are owned by UKParent, a corporation resident in the United Kingdom. The principal class of the shares of UKParent is listed on the London Stock Exchange and substantially and regularly traded as defined in subparagraph 8(f). UKParent is entitled to the benefits of the income tax convention between the United States and the United Kingdom, and would be entitled to the benefits of the Convention under subparagraph l(c)(i), applied as if the United Kingdom were the Netherlands. The remaining 25 percent of the shares of NISub are owned by X, an individual. NISub is not entitled to the benefits of the Convention under subparagraph 1(c) (ii) because only 32 percent of its shares are owned directly or indirectly by publicly-traded corporations resident of either State. NLSub is, however entitled to the benefits of the Convention under subparagraph l(c)(iii). Since NLParent owns 32 percent of the shares of NISub, the 30 percent Netherlands ownership requirement under clause (A) of subparagraph 1(c)(iii) is satisfied. In addition, the 70 percent EC ownership requirement under clause (B) of subparagraph 1(c)(iii) also is satisfied, because NLParent's 30 percent ownership is aggregated with UKParent's 43 percent ownership. Consequently, 75 percent of the shares of NISub are owned by residents of member states of the European Communities. Example 2. The facts are the same as in Example 1, except that the shares of UKParent are not publicly-traded. Rather, 75 percent of the shares of UKParent are owned by UKHolding, a corporation resident in the United Kingdom. UKParent is not a conduit company as defined in subparagraph 8(m). The principal class of shares of NLHolding is listed on the London Stock Exchange and substantially and regularly traded as defined in subparagraph 8(f). UKHolding would be entitled to the benefits of the Convention under subparagraph l(c)(i), applied as if the United Kingdom were the Netherlands. The remaining 25 percent of the shares of UKParent are owned by NLHolding, a corporation resident in the Netherlands. The principal class of the shares of NLHolding is listed on the Amsterdam Stock Exchange and substantially and regularly traded as defined in subparagraph 8(f). NLHolding is entitled to the benefits of the Convention under subparagraph 1(c)(i). As in Example 1, NISub is not entitled to the benefits of the Convention under subparagraph 1(c) (ii) because less than 50 percent of its shares are owned directly or indirectly by publicly-traded corporations resident in either State. NLSub will, however, be entitled to the benefits of the Convention under subparagraph 1(c)(iii), if UKParent is considered to be a resident of a member state of the European Communities within the meaning of subparagraph 8(i). If UKParent is considered to be a resident of a member state of the European Communities, 43 percent of the shares of NISub will be considered to Le owned directly and indirectly by Netherlands corporations (applying the principles of Code section 883(c) (4)) that meet the requirements of subparagraph l(c)(i), thereby satisfying the 30 percent Netherlands ownership requirement of clause (A) of subparagraph 1(c)(iii) (i.e., NLParent's 32 percent direct interest plus NLHolding's 11 percent indirect interest). In addition, if UKParent is considered to be a resident of a member state of the European Communities, 32 percent of the shares of NLSub will be considered to be owned indirectly by a corporation (UKHolding) the principal class of the shares of which is listed on a recognized stock exchange and is substantially and regularly traded. Combined with the 43 percent interest held by the two Netherlands corporations, 75 percent of the shares of NISub would be considered to be held directly or indirectly by companies described in clause (B) of subparagraph 1(c)(iii), satisfying the 70 percent threshold described in that subparagraph. In order to be considered a resident of a member state of the European Communities, UKParent must meet the three requirements under subparagraph 8(i). Since it is assumed that UKParent is a resident of its state of residence within the meaning of Article 4 (Resident) of the Convention, and that UKParent would otherwise be entitled to the benefits of the convention between the United States and the United Kingdom, two of these requirements are clearly satisfied. The remaining requirement is that UKParent must be entitled to the benefits of the Convention under the principles of paragraph 1, applied as if the United Kingdom were the Netherlands. Therefore it is necessary to apply paragraph 1 to UKParent, treating the United Kingdom as if it were the Netherlands. Under this analysis, UKParent would not be entitled to the benefits of the Convention under subparagraph l(c)(i), as its shares are not publicly-traded. It would be entitled to the benefits of the Convention under subparagraph l(c)(ii), however, because more than 50 percent of its shares are held by a corporation (UKHolding) whose shares are listed and traded as described in subparagraph l(c)(i). Since the United Kingdom is treated as if it were the Netherlands for purposes of this analysis, UKHolding is treated as if it were a Netherlands corporation, and the stock exchange on which its shares are listed (London) is treated as if it were a recognized stock exchange located in the Netherlands. In addition, the shares held by NLHolding also would be included, because the shares of NLHolding also are listed and traded as described in subparagraph l(c)(i). While the United Kingdom is treated as if it were the Netherlands for purposes of this analysis, the Netherlands is not treated as if it were a state other than the Netherlands. Thus, solely for purposes of subparagraph 8(i), 100 percent of UKParent's shares are treated as if they were owned by residents of the Netherlands, the principal class of the shares of which are listed and traded as described in subparagraph l(c)(i). Therefore, for purposes of subparagraph 8(i), UKParent is treated as if it were entitled to the benefits of the Convention under subparagraph l(c)(ii). Accordingly, UKParent satisfies all three requirements of subparagraph 8(i) and is considered to be a resident of a member state of the European Communities. The NISub shares held indirectly by the shareholder of UKParent therefore are included in the shares meeting the requirements of clause (B) of subparagraph l(c)(iii), and NLSub is entitled to the benefits of the Convention under subparagraph l(c)(iii). Example 3. The facts are the same as is Example 2, except that UKHolding is a corporation resident in Italy (ItaliaCo). ItaliaCo has one class of shares that is listed on the Milan Stock Exchange and is substantially and regularly traded. ItaliaCo is entitled to the benefits of the income tax convention between the United States and Italy. As in Example 2, NISub is not entitled to the benefits of the Convention under subparagraph 1(c)(ii) because less than 50 percent of its shares are owned directly or indirectly by publicly-traded corporations resident of either State. It would be entitled to the benefits of the Convention, however, if the indirect ownership of its shares by NLHolding and ItaliaCo were included in the shares meeting the requirements of clause (B) of subparagraph l(c)(iii). In order for this indirect ownership through UKParent to be considered in the analysis, UKHolding must be considered to be a resident of a member state of the European Communities under subparagraph 8(i). In order to be considered a resident of a member state of the European Communities, UKParent must, inter alia, be entitled to the benefits of the Convention under paragraph 1, applied as if the United Kingdom were the Netherlands. Under this assumption, UKParent would not be entitled to the benefits of the Convention under subparagraph l(c)(i), as its shares are not publicly-traded Unlike Example 2, subparagraph 1(c)(ii) also would not apply, as only 25 percent of UKParent's shares would be held by corporations resident in the Netherlands or the United Kingdom (i.e., the shares held by NLHolding). It would not qualify under subparagraph 1(c)(iii), because clause (A) of that subparagraph requires that at least 30 percent of the shares of the company be owned by a publicly-traded Netherlands corporation. Finally, subparagraph 1(d) would not apply because, inter alia, more than 50 percent of its shares must be held by qualified persons (i.e., residents of either State) in order for that provision to apply. Therefore UKParent is not considered to be a resident of a member state of the European Communities, and pursuant to subparagraph 8(k) the shares of NISub that are attributable to ItaliaCo and NLHolding are not Considered for purposes of determining whether NISub is entitled to the benefits of the Convention under subparagraph l(c)(iii). Accordingly, only 32 percent of NISub's shares are treated as being owned by residents of member states of the European Communities (i.e., the shares owned by NLParent), and NISub does not satisfy the 70 percent EC ownership requirement under clause (B) of subparagraph l(c)(iii). NISub is not entitled to the benefits of the Convention under subparagraph 1(c)(iii). However, as described in Example 3 under the explanation of paragraph 4, NISub may be entitled under paragraph 4 to the benefits of the Convention with respect to certain items of income. Further, as with any resident of one of the States that does not satisfy one of the tests under Article 26, NISub may be entitled to the benefits of the Convention under paragraph 7. Example 4. The facts are the same as in Example 1, except that NLParent is a closely held corporation and its shares are listed and traded on the parallel market of the Amsterdam Stock Exchange. NISub is not entitled to the benefits of the Convention under subparagraph l(c)(iii) because it does not meet the 30 percent Netherlands ownership requirement under clause (A) of that subparagraph. Clause (A) requires that the principal class of the shares of the Netherlands owner be listed and traded as described in subparagraph l(c)(i). Subparagraph l(c)(i) requires, inter alia, that the principal class of shares of such corporation be listed on a recognized stock exchange located in either of the States. While subparagraph 8(d)(iii) provides that the parallel market of the Amsterdam Stock Exchange generally will be considered to be a recognized stock exchange, that provision also states that the exchanges listed in subparagraph 8(d)(iii) shall not be considered recognized stock exchanges with respect to closely held companies. Accordingly, the principal class of the shares of NLParent is not considered to be listed and traded as described in subparagraph 1(c)(i), and NLParent's ownership of NISub shares does not satisfy the 30 percent Netherlands ownership requirement under clause (A) of subparagraph 1(c)(iii). Conduit Companies - Subparagraph 1(c) (iv) Subparagraph l(c)(iv) provides that corporations that otherwise would be entitled to the benefits of the Convention under subparagraphs 1(c) (ii) or (iii) but that are conduit companies (as defined in subparagraph 8(m)) only may be entitled to the benefits of the Convention under paragraph 1(c) if they also satisfy the conduit base erosion test set forth in subparagraph 5(d). This test is described in the discussion below regarding paragraph 5 of Article 26. 50% Qualified Ownership/Base Erosion - Subparagraph 1(d) Subparagraph 1(d) sets forth a test under which companies and other persons may be entitled to the benefits of the Convention. This test consists of two parts. First, more than 50 percent of the beneficial ownership of the person must be owned, directly or indirectly, by "qualified persons," as defined in subparagraph 8(g). In the case of a company, more than 50 percent of the aggregate vote and value of all the company's shares, and more than 50 percent of any "disproportionate class of shares" (as defined in subparagraph 8(c)), must be owned by qualified persons. Second, the company must meet the base reduction test described in paragraph 5. The beneficial ownership test of this subparagraph is discussed below. The base reduction test is described in the discussion below regarding paragraph 5. Indirect ownership by qualified persons is considered for purposes of this test. For purposes of determining share ownership, the rules of Code section 883(c)(4) shell be applied. Subparagraph 8(k), which requires that all the members of a corporate chain of ownership be residents of one of the States or residents of a member state of the European Communities, does not apply to subparagraph 1(d). Consequently, intermediate owners may be residents of countries that are not described in subparagraph 8(k), as long as more than 50 percent of ultimate ownership resides in qualified persons (i.e., a person entitled to the benefits of the Convention pursuant to paragraph 1 or a U.S. citizen), and the person seeking treaty benefits satisfies the base reduction test. The following examples illustrate the application of subparagraph 1(d) (i). Example l. NLSub is a corporation resident in the Netherlands. NISub satisfies the base reduction test of paragraph 5(d). NISub has one class of shares. Thirty percent of its shares are owned by an individual resident in the Netherlands, 40 percent are owned by NLHolding, a corporation resident in the Netherlands the principal class of the shares of which is listed and traded as described in subparagraph 1(c)(i), and 30 percent are owned by NLHQ, a corporation resident in the Netherlands that is not entitled to the benefits of the Convention under paragraph 1 but that is entitled to the benefits of the Convention under paragraph 3 of Article 26 as a headquarter company. NLSub's entitlement to the benefits of the Convention under subparagraph 1(d) is analyzed as follows. The shares owned by NLHolding are considered because NLHolding is entitled to the benefits of the Convention under subparagraph 1(c)(i). The shares owned by NLHQ are not considered because NLHQ is not entitled to the benefits of the Convention under paragraph 1. The shares owned by the individual are considered because an individual resident in the Netherlands is entitled to the benefits of the Convention under subparagraph 1(a). Therefore, NLSub is entitled to the benefits of the Convention under subparagraph 1(d) because 70 percent of its shares are owned by qualified persons (i.e., the individual's 30 percent and NLHolding’s 40 percent). Example 2. USSub is a corporation resident in the United States. USSub satisfies the base reduction test under subparagraph 5(d). All of the shares of USSub are owned by HKCo, a corporation resident in 'long Kong. All of the shares of HKCo are owned by NLParent, a corporation resident in the Netherlands, the principal class of the shares of which is listed and traded as described in subparagraph 1(c)(i). USSub is entitled to the benefits of the Convention under subparagraph 1(d). Although HKCo is not a qualified person, the ownership test of subparagraph 1(d) merely requires that more than 50 percent of the ultimate beneficial ownership of the person seeking the benefits of the Convention reside in persons entitled to the benefits of the Convention under paragraph 1. Since the indirect owner of USSub (NLParent) is a person entitled to the benefits of the Convention under subparagraph 1(c)(i), this requirement is satisfied. Paragraph XI. of the Memorandum of Understanding sets forth the understanding of the negotiators that a Dutch investment company ("beleggingsinstelling") may satisfy the 50 percent qualified person ownership requirement under this subparagraph by relying on the so-called "global method" of determining ownership that is used for purposes of obtaining a refund with respect to foreign withholding taxes on dividend and interest income received from abroad. Domestic shareholders would, if the income accrued directly to them, be entitled to a credit for those taxes, but foreign shareholders would not, as they are not subject: to Netherlands tax. Since foreign tax is initially withheld on the entire amount of the beleggingsinstelling’s interest and dividend income, and under Dutch law the foreign tax cannot be credited at the level of the beleggingsinstelling, the beleggingsinstelling may apply for a refund of that portion of the withheld taxes that is attributable to domestic owners, and therefore the company must demonstrate the extent of its domestic ownership to the satisfaction of the Dutch tax authority. Since it is in the interest of the beleggingsinstelling to identify its domestic shareholders to the Dutch tax authority, the negotiators felt it generally appropriate for the U.S. competent authority to rely on such evidence as was relied upon by the Dutch tax authority. Not-For-Profit Organizations - Subparagraph 1(e) Subparagraph 1(e) provides that a not-for-profit organization that is a resident of a Contracting State will be entitled to the benefits of the Convention if it satisfies two conditions: (1) It must be generally exempt from tax in its State of residence by virtue of its not-for-profit status, and (2) sore than half of the beneficiaries, members or participants, if any, in the organization must be "qualified persons" as defined in subparagraph 8(g). Subparagraph 8(j) provides that the not-for-profit organizations dealt within subparagraph 1(e) include pension funds, pension trusts, private foundations, trade unions, trade associations and similar organizations. A pension fund or trust or similar entity created for the purpose of providing retirement, disability or other employment benefits is entitled to the benefits of the Convention if the organization sponsoring the fund, trust or entity is entitled to the Convention’s benefits under Article 26. Thus, one need not determine that more than half of the beneficiaries of a Netherlands pension plan are residents of the Netherlands in deciding whether the plan is entitled to the benefits of the Convention in respect of its income as long as the Netherlands corporation sponsoring the fund is entitled to benefits under Article 26, because, for example, its principal class of shares is listed on the Amsterdam Stock Exchange and is substantially and regularly traded, thereby entitling it to the benefits of the Convention under subparagraph 1(c)(i). If, however, the sponsoring organization is not entitled to the benefits of the Convention, the tests of subparagraph 1(e) must be met. Substantial Trade or Business Test - Paragraph 2 Paragraph 2 provides that a person resident in one of the States may be entitled to the benefits of the Convention with respect to income derived from the other State if it is considered to be engaged in the active conduct of a trade or business in its State of residence. Subparagraph 2(a) provides that such a person will be entitled to the benefits of the Convention with respect to an item of income derived from the other State if the income is derived in connection with the trade or business conducted in the State of residents and the trade or business is substantial in relation to the income producing activity, or the income derived in the other State is incidental to the trade or business conducted in the State of residence. This determination is made separately for each item of income derived from the other State. It therefore is possible that a person would be entitled to the benefits of the Convention with respect to one item of income but not with respect to another. For instance, dividends received from a subsidiary in the other State might be entitled to the benefits of the Convention, but interest received from an unrelated party might not be so entitled. Trade at Business The term "trade or business" is not defined in the Convention. Pursuant to paragraph 2 of Article 3 (General Definitions), when determining whether a Netherlands resident is entitled to the benefits of the Convention under paragraph 2 with respect to income derived from U.S. sources, the United States will ascribe to this term the meaning that it has under the law of the United States. Accordingly, the United States competent authority will refer to the regulations issued under section 367 (a) for the definition of the term "trade or business." In general, therefore, a trade or business will be considered to be a specific unified group of activities that constitute or could constitute an independent economic enterprise carried on for profit. Furthermore, a corporation will generally be considered to carry on a trade or business only if the officers and employees of the corporation conduct substantial managerial and operational activities. See, Code section 367(a)(3) and the regulations thereunder. Notwithstanding this general definition of trade or business, subparagraph 2(a) provides that the business of making or managing investments, when part of banking or insurance activities conducted by a bank or insurance company, respectively, viii be considered to be a trade or business. Conversely, such activities conducted by an entity other than a bank or insurance company will not be considered to be the conduct of an active trade or business. Paragraph XIII. of the Memorandum of Understanding sets forth the understanding of the negotiators that a bank only viii be considered to be engaged in the active conduct of a banking business if it regularly accepts deposits from the public or makes loans to the public, and an insurance company only viii be considered to be engaged im the active conduct of an insurance business if its gross income consists primarily of insurance or reinsurance premiums, and investment income attributable to such premiums. Paragraph III. of the Agreed Minutes to the Protocol clarifies the understanding of the negotiators that group financing or portfolio investments will be considered to be part of a business of making or managing investments. Accordingly, such activities will not be considered to be a trade or business, unless they fall within the banking or insurance exception described in subparagraph 2 (a). Because a headquarters operation is in the business of managing investments, a company that functions solely as a headquarter company will not be considered to be engaged in an active trade or business for purposes of paragraph 2. Such companies may, however, be entitled to the benefits of the Convention under paragraph 3. In order for a person to be entitled under subparagraph 2 to the benefits of the Convention with respect to an item of income, that income must be derived in connection with the trade or business conducted in the State of residence or be incidental to such trade or business. An item of income say be derived partly in connection with a trade or business conducted in the State of residence and partly not in connection with such trade or business. Furthermore, subparagraph 2(a)(i) provides that income derived in connection with a trade or business must also be "substantial" in relation to the income-producing activity conducted in the other State. Derived in Connection With Requirement - Subparagraph 2(b) Subparagraph 2(b) provides that income is derived in connection with a trade or business if the income-producing activity in the other State is a line of business that forms a part of or is complementary to the trade or business conducted in the State of residence by the income recipient. Although no definition of the terms "forms a part of" or "complementary" is set forth in the Convention, it is intended that a business activity generally will be considered to "form a part of" a business activity conducted in the other State if the two activities involve the design, manufacture or sale of the same products or type of products, or the provision of similar services. In order for two activities to be considered to be "complementary" the activities need not relate to the same types of products or services, but they should be part of the same overall industry and he related in the sense that the success or failure of one activity will tend to result in success or failure for the other. In cases in which more than one trade or business is conducted in the other State and only one of the trades or businesses forms a part of or is complementary to a trade or business conducted in the State of residence, it is necessary to identify the trade or business to which an item of income is attributable. Royalties generally will he considered to be derived in connection with the trade or business to which the underlying intangible property is attributable. Dividends will he deemed to be derived first out of earnings and profits of the treaty-benefitted trade or business, and then out of other earnings and profits. Interest income may be allocated under any reasonable method consistently applied. A method that conforms to U.S. principles for expense allocation will he considered a reasonable method. The following examples illustrate the application of subparagraph 2(b). Example1. NLCo is a corporation resident in the Netherlands. NLCo is engaged in an active manufacturing business in the Netherlands. NLCo owns 100 percent of the shares of USCO, a corporation resident in the United States. USCo is the United States distributor for NLCo products. Since the business activities conducted by the two corporations involve the same products, USCo’s distribution business is considered to form a part of NLCo 's manufacturing business within the meaning of subparagraph 2(b). Example 2. The facts are the same as in Example 1, except that NLCo does not manufacture. Rather, NLCo operates a large research and development facility in the Netherlands that licenses intellectual property to affiliates worldwide, including USCo. USCo and other NLCo affiliate then manufacture and market the NLCo-designed products in their respective markets. Since the activities conducted by NLCo and USCo involve the same product lines, these activities are considered to form a part of the same trade or business. Example 3. NLAir is a corporation resident in the Netherlands. NLAir operates an international airline. USSub is a wholly-owned U.S. subsidiary of NLAir. USSub operates a chain of hotels in the United States that are located near airports served by NLAir flights. NLAir frequently sells tour packages that include air travel to the United States and lodging at USSub hotels. Although both companies are engaged in the active conduct of a trade or business, the businesses of operating a chain of hotels and operating am airline are distinct trades or businesses. Therefore USSub’s business does not form a part of NLAir' s business. However, USSub's business is considered to he complementary to NLAir's business because they are part of the same overall industry (travel) and the links between their operations tend to make them interdependent. Example 4. The facts are the same as in Example 3, except that USSub owns am office building in the United States instead of a hotel chain. No part of NLAir's business is conducted through the office building. USSub's business is not considered to form a part of or to he complementary to NLAir's business. They are engaged in distinct trades or businesses in separate industries, and there is no economic dependence between the two operations. Example 5. NLBulb is a corporation resident in the Netherlands. NLBulb produces and sells tulip bulbs in the Netherlands and other countries. NLBulb owns all the shares of USHolding, a corporation resident in the United States. USHolding is a holding company that is not engaged in a trade or business. USHolding owns all the shares of three corporations that are resident in the United States: USBuIb, USLawn, and USHolding. USBulb distributes NLBulb tulip bulbs under the NLBulb trademark in the United States. USLawn markets a line of lawn care products in the United States under the NLBulb trademark. In addition to being sold under the same trademark, USLawn and USBuIb products are sold in the same stores and sales of each company's products tend to generate increased sales of the other's products. USHerring imports herring from the Netherlands and distributes it to United States fish wholesalers. For purposes of paragraph 2, the business of USBulb forms a part of the business of NLBulb, the business of USLawn is complementary to the business of NLBulb, and the business of USHerring is neither part of nor complementary to that of NLBulb. USBuIb and USLawn pay an annual royalty to NLBulb for the use of the NLBulb trademark. Because these royalties are attributable to USBulb's and USLawn's businesses, they are considered to be derived in connection or complementary with the trade or business of NLBulb for purposes of subparagraph 2(a). NLBulb made a loan to USHolding. USHolding used these funds to finance the initial establishment of its U.S. subsidiaries. For purposes of determining the portion of its annual interest payments that is derived in connection with the business of USBulb and USLawn, NLBulb allocates the interest expense between the businesses of USBulb and USLawn on the one hand and USHerring on the other in proportion to the book values of the assets held by the three subsidiaries of USHolding. USHolding pays annual dividends to NLBulb. These dividends are less than the combined earnings and profits of USBulb and USLawn. For purposes of paragraph 2, the dividends are considered to be distributed out of the earnings and profits of USBuIb and US Lawn. Finally, subparagraph 2(a)(ii) provides that a corporation resident in one of the States also will he entitled to the benefits of the Convention with respect to income derived from the other State if the income is "incidental" to the trade or business conducted in the recipient's State of residence. Subparagraph 2(d) provides that income derived from a State will be incidental to a trade or business conducted in the other State if the income is not described in subparagraph 2(b) (i.e., it is not derived in connection with a trade or business conducted in the other State) and the production of such income facilitates the conduct of the trade or business in the other State. An example of incidental income is the temporary investment of working capital derived from a trade or business. Finally, subparagraph 2(d) provides that in the case of a person electing to apply the EC attribution rule under subparagraph 2(h), the income considered to be incidental to a trade or business shall not be greater than four times the amount of income that would have been considered to be incidental to the trade or business actually conducted in the Netherlands. In general, the Netherlands company will be allowed to derive incidental income attributable to amounts in excess of that produced by its own incidental investments to the extent of any uninvested working capital in the other EC companies whose activities are attributed to the Netherlands, up to a maximum of three times the Netherlands company's own incidental income. The following example illustrates the application of subparagraphs 2(a)(ii) and (d). Example. NLCo is a corporation resident in the Netherlands. NLCo is engaged in the manufacture of machine tools in the Netherlands. UKCo is a sister corporation of NLCo that is a resident of the United Kingdom. USCo is a wholly-owned subsidiary of NLCo that is resident in the United States. USCo is engaged in the manufacture and sale of machine tools in the United States. UKCo manufactures machine tools in the United Kingdom. Ten dollars of income derived from NLCo's business that is retained as working capital is invested in U.S. Government securities and other U.S. debt instruments until needed for use in NLCo’ s business. For purposes of satisfying the substantiality test under subparagraph 2(a)(i) with respect to dividend income received from USCo, NLCo elects to attribute to the Netherlands the business of UKCo. UKCo has $20 in uninvested working capital. The amount of U.S. debt instruments that may be considered to generate income incidental to NLCo's business is increased to $30. The maximum amount that may be invested is four times NLCo's own working capital, but not in excess of the uninvested working capital in the EC businesses whose activities are attributed to NLCo under subparagraph 2(h). Since UKCo has only $20 in uninvested working capital, the amount of NLCo's incidental investment is limited to this additional amount rather than the additional $30 otherwise permitted. Substantiality As indicated above, subparagraph 2(a)(i) provides that income that a resident of a State derives from the other State will he entitled to the benefits of the Convention under paragraph 2 only if the income is derived in connection with a trade or business conducted in the recipient's State of residence and that trade or business is "substantial" in relation to the income-producing activity in the other State (unless the income is incidental to the recipient's trade or business). Subparagraph 2(c) provides that whether the trade or business of the income recipient is substantial generally will he determined by reference to the relative sizes of the activities conducted in the two States and the relative contributions made to the conduct of the trade or businesses in the two States. Substantiality Safe Harbor - Subparagraph 2(c) In addition to this subjective rule, subparagraph 2(c) provides a safe harbor under which the trade or business of the income recipient will be deemed to be substantial based on three ratios that compare the size of the recipient's activities to those conducted in the other State. The three ratios compare: (i) the value of the assets in the recipient's State to the assets used in the other State; (ii) the gross income derived in the recipient's State to the gross income derived in the other State; and (iii) the payroll expense in the recipient's State to the payroll expense in the other State. The average of the three ratios with respect to the preceding taxable year must exceed 10 percent, and each individual ratio must exceed 7.5 percent. If any individual ratio does not exceed 7. 5 percent for the preceding taxable year, the average for the three preceding taxable years may be used instead. (Thus, if the taxable year is 1998, the preceding year is 1997. If one of the ratios for 1997 is not greater than 7.5 percent, the average ratio for 1995, 1996, and 1997 with respect to that item may be used.) Finally, if a Netherlands person elects to attribute activities conducted in the EC to the Netherlands under subparagraph 2(h), the average of the three ratios for the preceding taxable year must exceed 60 percent, and each individual ratio must exceed 50 percent (and if any ratio does not exceed 50 percent for the preceding taxable year, the average for the preceding three taxable years may be used instead). In each case, only those items are included that are connected to the trade or business: assets, income and expenses unrelated to the trade or business are excluded from the calculation of the ratios. The term "gross income" is not defined is the Convention. Thus, is accordance with paragraph 2 of Article 3 (General Definitions), in determining whether a person deriving income from United States sources is entitle' to the benefits of the Convention, the United States will ascribe the meaning to the term that it has in the United States. In such case "gross income" will be defined as gross receipts lose cost of goods sold. The term "value" also is not define' in the Convention. Therefore, this term also will be defined under U.S. law for purposes of determining whether a person deriving income from United States sources is entitled to the benefits of the Convention. In such cases, "value" generally will be defined using the method used be the taxpayer in keeping its books for purposes of financial reporting in its country of residence. See, Treas. Reg. §l.884-5(e)(3)(ii)(A). Unless the election under subparagraph 3(h) is made, only items actually located or incurred in the Netherlands are included in the computation of the ratios. If the person from whom the income in the other State is derived is not wholly controlled by the recipient (or by persons related to the recipient by operation of the attribution rules under subparagraph 2(e)) then the items included is the computation with respect to such person must be reduced by a percentage equal to the percentage control held by persons not related to the recipient within the meaning of subparagraph 2(e). For instance' as described in Example 2 of paragraph XXX. of the Memorandum of Understanding, if a Netherlands corporation derives income from a U.S. corporation in which it holds 80 percent of the shares, and unrelated parties hold the remaining shares, for purposes of subparagraph 2(c) only 80 percent of the assets, payroll and gross income of the U.S. company would be taken into account. Consequently, if neither the recipient nor a person related to the recipient within the meaning of subparagraph 2(e) has an ownership interest in the person from whom the income is derived, the substantiality test always will be satisfied (the denominator in the computation of each ratio will be zero and the numerator will be a positive number). Paragraph II. of the Agreed Minutes to the Protocol confirms this result. Paragraphs XXI. and XV. of the Memorandum of Understanding set forth three examples illustrating the application of subparagraph 2(c). Attribution Rules - Subparagraph 2(e) Subparagraph 2(e) sets forth attribution rules under which activities conducted by certain parties related to the income recipient will be attributed to the income recipient for purposes of paragraph 2. A person that is a resident of one of the States will be considered to be engaged in the active conduct of a trade or business in that State if it meets one of seven conditions. A person to which an active trade or business in attributed under subparagraphs 2(e)(ii) through (vii) will be considered to carry on that business in addition to any active business in which such person may be engaged. First, subparagraph 2(e)(i) clarifies that a person will be considered to be engaged in a trade or business in its State of residence if it directly conducts such trade or business. Second, subparagraph 2(e)(ii) provides that e person will be considered to be engaged in a trade or business in its State of residence if such a trade or business is conducted by a partnership in which the person is a partner. Third, subparagraph 2(e)(iii) provides that a person will be considered to be engaged in a trade or business in its State of residence if another person that is engaged in such a trade or business holds a "controlling beneficial interest" in the first person. The term "controlling beneficial interest" is defined in subparagraph 2(f) and is discussed below. Fourth, subparagraph 2(e)(iv) provides that a person will be considered to be engaged in a trade ow business in its State of residence if a controlling beneficial interest in the person is held by a group of five or fewer persons and each member of the group is engaged in activity in the person's State of residence that is a component part or is directly related to a trade or business conducted in that State. Fifth, subparagraph 2(e)(v) provides that a person will be considered to be engaged in a trade or business in its State of residence if the person is a company that is member of a group of companies that form or could fore (without regard to the residence of the companies) a consolidated group for tax purposes according to the law of that State, and the group is engaged in the active conduct of a trade or business in that State. It is not necessary that each member of the consolidated group be engaged in a trade or business for this purpose. Sixth, subparagraph 2(e) (vi) provides that a person will be considered to be engaged in a trade or business in its State of residence if it owns, either alone or as a member of a group of five or fewer persons that are qualified persons, residents of member states of the European Communities, or residents of an identified state, a controlling beneficial interest in a person that is engaged in the active conduct of a trade or business in the State in which the first person is resident. The term "identified state" is described below. Seventh, subparagraph 2(e)(vii) provides that a person will be considered to be engaged in the conduct of a trade or business in its State of residence if it is, together with another person that is so engaged, under the common control of a person (or a group of five or fewer persons) that is a qualified person, a resident of a member state of the European Communities or a resident of an identified state. If the person is under the control of a group, each member of the group must be a qualified person, resident of a member state of the European Communities or a resident of an identified state. The terms "common control" and "identified state" are described below. For purposes of subparagraphs 2(e)(vi) and (vii), an identified state includes any country identified by agreement of the competent authorities, and that has effective provisions for the exchange of information with the State of which the person being tested is a resident. Lists of identified states as of the date of signature of the Convention with respect to the United States and the Netherlands are set forth in paragraph IV, of the Memorandum of Understanding. In addition, paragraph XV. of the Agreed Minutes to the Protocol provides that with respect to the Netherlands, Portugal and Japan shall be considered to be identified states. Subparagraph 2(f) defines "controlling beneficial interest"as a direct or indirect beneficial ownership interest that represents more than 50 percent of the value and voting power in a person. Although indirect ownership generally is taken into account for purposes of determining a controlling beneficial interest, subparagraph 2(f)(i) provides that an interest consisting of 50 percent or less of the value and voting power of any third person shall not be considered in determining the percentage of ownership held in a corporation. In addition, subparagraph 2(f) (ii) provides that no person shall be considered to be a part of a group owning a controlling beneficial interest in an entity unless such person holds directly a beneficial interest that represents at least 10 percent of the value and voting power of the entity. The following examples illustrate the application of this subparagraph. Example 1. NLCo is a corporation resident in the Netherlands. NLCo is engaged in the active conduct of a trade or business in the Netherlands. NLCo owns 40 percent of the shares of XCo, a corporation. XCo owns 80 percent of the shares of NLSub, a corporation resident in the Netherlands. NLCo owns the remaining 20 percent of the shares of NLSub. NLSub derives income from the United States. Although NLCo directly holds 20 percent of the shares of NISub and indirectly holds 32 percent of the shares of NLSub (i.e., the product of its 40 percent interest in XCo and XCo's 80 percent interest in NLSub), NLCo is not considered to own a controlling beneficial interest in NLSub. Under subparagraph 2(f)(i), NLCo's 40 percent interest in XCo may not be considered for purposes of determining the percentage of indirect ownership that NLCo holds in NISub. Therefore, NLCo’s active trade or business is not attributed to NLSub under subparagraph 2(e)(iii). Example 2. USSub is a corporation resident in the United States. USSub is engaged in the active conduct of a trade or business in the United States. Thirty percent of the shares of USSub are held by UKCo, a corporation resident in the United Kingdom, 20 percent are held by USParent, a corporation resident in the United States, 5 percent are held by FCo, a corporation resident in France, and the remaining shares of USSub are held by individuals resident in Hong Kong. Although FCo, UKCo and USParent collectively own 55 percent of the shares of USSub, this group of corporations is not considered to own a controlling beneficial interest in USSub. subparagraph 2(f) (ii) provides that no person shall be considered to be part of a group owning a controlling beneficial interest in an entity unless such person holds directly at least 10 percent of the value and voting power of such entity. Since FCo owns only 5 percent of the shares of USSub, its interest is not considered for purposes of determining whether there is a group that owns a controlling beneficial interest in USSub. The only persons with the requisite level of ownership in USSub are USParent (20 percent) and UKCo (30 percent). Since these two corporations collectively do not own more than 50 percent of the value and voting power of USSub, USParent is not considered to be a part of a group that owns a controlling beneficial interest in USSub. Therefore, USSub's active trade or business is not attributed to USParent under subparagraph 2(e)(vi). Subparagraph 2 (g) provides that for purposes of subparagraph 2(e) a person or group shall be deemed to have "common control" of two persons if it holds a controlling beneficial interest in each such person. Paragraphs XII. and XV. of the Memorandum of Understanding set forth three examples illustrating the application of subparagraph 2(e) and related provisions of paragraph 2. The following examples further illustrate the application of subparagraph 2(e). Example 1. NLCo is a corporation resident in the Netherlands. NLCo is not engaged in the active conduct of a trade or business in the Netherlands. All the shares of NLCo are owned by NLParent, a corporation resident in the Netherlands that is engaged in an active trade or business there. Subparagraph 2(e)(iii) provides that a resident of one of the States will be considered to conduct a trade or business in that State if a person that is so engaged holds a controlling beneficial interest in the first person. Since NLParent is engaged in the conduct of a trade or business in the Netherlands and it owns a controlling beneficial interest in NLCo, NLCo is considered to conduct the trade or business conducted by NLParent. Example 2. NLJV is a corporation resident in the Netherlands. The shares of NLJV are owned equally by NLSC, NLConv and NLTech, all of which are corporations resident in the Netherlands. NLSC operates a factory in the Netherlands that manufactures superchargers for automobile engines. NLConv operates a factory in the Netherlands that manufactures convertible tops for automobiles. NLTech is the licensee of automotive manufacturing technology from a related party engaged in the manufacture of automobiles in a third state. NLJV was formed by its three owners as a joint venture to design and manufacture for distribution in the United States a new automobile with a supercharged engine and a convertible top. All the design and manufacturing activities related to the new automobile are conducted by NLSC, NLConv and NLTech's shareholder. NLTech's sole function is to sublicense manufacturing technology to the venture. NLJV is not directly engaged in the conduct of a trade or business in the Netherlands, and the activities of NLTech do not constitute an active trade or business. However, the activities of NLTech are a component part of the overall business of designing and manufacturing a new automobile. Taken together, the activities of NLTech, NLConv and NLSC constitute an active trade or business. Under subparagraph 2(e)(iv), these activities are considered to be conducted by NLJV. Example 3. USParent is a corporation resident in the United States. USParent owns all the shares of UKCo, a corporation resident in the United Kingdom. USCo owns all the shares of USSub, a corporation resident in the United States. USSub is not engaged in the conduct of a trade or business. USParent is engaged in the active conduct of a trade or business in the United States. For purposes of subparagraph 2, USSub will be considered to conduct the trade or business conducted by USParent. Subparagraph 2 (e)(v) provides that a company that is a resident of one of the States viii be considered to conduct a trade or business in that State that is conducted by another member of a group of corporations that form or could form a consolidated group for tax purposes under the law of that State. In determining whether the law of that State would permit a group to from a consolidated group for tax purposes, such law is to be applied without regard to the residence of any of the Bember5 of the group. Thus, despite the fact that UKCo is not a U.S. corporation, subparagraph 2(e)(v) will attribute the trade or business of USParent to USSub because if UKCo were a U.S. corporation, USParent, UKCo and USSub could form a consolidated group for U.S. tax purposes. Example 4. USCo is a corporation resident in the United States. USCo is not engaged in the conduct of a trade or business. USTB is a corporation resident in the United States. USTB is engaged in the active conduct of a trade or business in thee United States. Twenty percent of the shares of USTB and of USCo are owned by FCo, a corporation resident in France that is a resident of a member state of the European Communities within the meaning of subparagraph 8(i). Twenty percent of the shares of USTB and USCo are owned by NLHolding, a corporation resident in the Netherlands. Twenty percent of the shares of USTB and USCo are owned by EgyptCo, a corporation resident in Egypt. The remaining shares of USTB and USCo are held by individuals resident in Hong Kong. Pursuant to subparagraph 2(e)(vii), USCo is considered to conduct the trade or business conducted by USTB in the United States. That subparagraph provides that a trade or business will be attributed from one person to another if both persons are under the common control of a person or group if each such person is a qualified person, a resident of a member state of the European Communities, or a resident of an identified state. Since FCo, NLHolding and EgyptCo collectively own 60 percent of the shares of both USTB and USCo, USTB and USCo are under the common control of these three companies within the meaning of subparagraph 2(g). FCo's ownership is counted for this purpose because FCO is a resident of a member state of European Communities. NLHolding's ownership is counted because it is a qualified resident. EgyptCo's ownership is counted because Egypt is included in the list of identified states that have effective provisions for the exchange of information with the United States in paragraph XVI. of the Memorandum of Understanding. EC Attribution - Subparagraph 2(h) Subparagraph 2(h) provides rules under which, for purposes of the Substantiality test under subparagraph 2(c), certain activities conducted by persons in member states of the European Communities may be attributed to related persons engaged in the conduct of an active trade or business in the Netherlands. Subparagraph 2(h) provides that if a person is a resident of the Netherlands and is considered to be engaged in the active conduct of a trade or business in the Netherlands under the principles of subparagraph 2(e), and activity that is a component part of, or directly related to the trade or business conducted in the Netherlands is conducted in other member states of the European Communities, the person may elect to treat its proportionate share of such activity as if it were conducted in the Netherlands, consistent with the rules of subparagraph 2(e). This attribution only will be made, however, if each of the following three ratios exceeds 15 percent: (i) The ratio of the value of the assets actually used or held for use in the active conduct of the trade or business in the Netherlands to the proportionate share of such assets used or held for use within all such member states; (ii) The ratio of gross income actually derived from the active conduct of the trade or business in the Netherlands to the proportionate share of the gross income so derived within all such member states; and (iii) The ratio of payroll expenses of the trade or business for services actually performed in the Netherlands to the proportionate share of the payroll expenses of the trade or business for services performed within all such member states. The computation of these ratios follows the rules set forth with respect to the computation of the ratios under subparagraph 2(c). In addition, activities only will be attributed from a resident of an EC state to the Netherlands person if the two persons bear a relationship described in subparagraph 2(e). The following example illustrates the application of subparagraph 3(h) and its interaction with subparagraphs 2(c) and 2(e). Example. USCo is a corporation resident in the United States. USCo is engaged in the active conduct of a trade or business in the United States. NLHolding is a corporation resident in the Netherlands. NLHolding owns 50 percent of the shares of USCo. NLHolding is not engaged in a trade or business. NLHolding owns 80 percent of the shares of NLCo, a corporation resident in the Netherlands. NLCo is engaged in the active conduct of a trade or business in the Netherlands. NLHolding also owns 100 percent of the shares of UKCo, a corporation resident in the United Kingdom. UKCo is engaged in the active conduct of a trade or business in the United Kingdom. UKCo, NLCo and USCo are engaged in the same trade or business. NLHolding receives dividend and royalty income from USCo in the l998 taxable year. Set forth below are the asset values, gross income and payroll expenses of USCo, NLCo and UKCo for the l997 taxable year that are related to this trade or business. Assets Gross Income Payroll USCo $520 $100 $50 NLCo 23.75 7.5 5 UKCo 125 25 15 These items are the same for the 1994, 1995, and 1996 taxable years. Under subparagraph 2(e)(vi), the trade or business conducted by NLCo is considered to be conducted by NLHolding. However, for purposes of subparagraph 2(c), the assets, gross income and payroll attributed from NLCo to NLHolding must be reduced by the percentage of shares that are not owned by NLHolding (20%). Similarly, the assets, gross income and payroll taken into account for purposes of subparagraph 2(c) must be reduced by the percentage of shares of USCo that are not owned by NLHolding (50%). Therefore the amounts of these items for NLCo and USCo are recomputed for purposes of subparagraph 2(c) as follows: Assets Gross Income Payroll USCo $260 $50 $25 NLCo 19 6 4 In order for the trade or business that NLHolding is considered to conduct in the Netherlands to be considered substantial in relation to the trade or business conducted by USCo, the average of the ratios of their relative assets, gross income and payroll must be greater than 10 percent and each ratio must be greater than 7.5 percent. The three ratios are 7.3%, 12% and 16%, respectively. Although the average of these three ratios is greater than 10 percent (11.8%), the Netherlands trade or business is not considered to be substantial because the assets ratio is not greater than 7.5 percent. However, applying the principles of subparagraph 2(e) (vi), the activities of UKCo that are related to the trade or business conducted in the United States may be considered to be conducted by NLHolding under subparagraph 2(h), as long as the ratios of the Netherlands assets, gross income and payroll to the UK assets, gross income and payroll exceed 15 percent. Since NLHolding owns all the shares of UKCo, the full amounts of the assets, gross income and payroll of UKCo are compared to the corresponding amounts for NLHolding. These ratios are 15.2%, 24%, and 26.7%, respectively. Since all the ratios are above 15 percent, they may be attributed to NLHolding for purposes of subparagraph 2(c). Therefore, the NLHolding amounts are added to the UKCo amounts and compared to the USCo amounts. These values are as follows: Assets Gross Income Payroll USCo $260 $50 $25 NLHolding + UKCo 144 31 19 Since NLHolding has elected to apply the EC attribution rule of subparagraph 2(h), each ratio must be greater than 50 percent and the average of the three ratios must be greater than 60 percent. The ratios of the assets, gross income and payroll are 55.4%, 62% and 76 percent, respectively. The average of the three ratios is 64.5%. Since all the ratios are greater than 50 percent and the average of the three ratios is greater than 60 percent, the Netherlands trade or business, after attribution from the EC, is considered to be substantial under subparagraph 2(c). Headquarter Companies - Paragraph 3 Paragraph 3 provides that a resident of one of the States shall be entitled to all the benefits of the Convention if that person functions as a headquarter company for a multinational corporate group. All corporations that the headquarter company supervises are included in the group. The headquarter company does not have to own shares in the companies that it supervises. In order to be considered a headquarter company, the person must meet several requirements that are enumerated in paragraph 3. These requirements are discussed below. Overall Supervision and Administration - Subparagraph 3(a) Subparagraph 3(a) provides that the person must provide a substantial portion of the overall supervision and administration of the group. This activity may include group financing, but group financing may not be the principal activity of the person functioning as the headquarter company. Paragraph V. of the Agreed Minutes to the Protocol clarifies that it is understood that the activities described in this subparagraph must be performed in the State of residence of the headquarter company. Paragraph XVIII. of the Memorandum of Understanding sets forth several understandings of the negotiators regarding this subparagraph. First, it provides that a person only will be considered to engage in supervision and administration if It engages in a number of the following activities: group financing, pricing, marketing, internal auditing, internal communications, and management. Other activities also could be part of the function of supervision and administration. In determining whether group financing constitutes the person’s principal activity, paragraph XVIII. provides that a simple comparison of gross income from the company’s various activities cannot be used alone. Other indicia also would be relevant. For instance, the payroll expense attributable to each of the headquarter functions could also be a useful indicator of whether group financing constitutes a company's principal activity. Paragraph XVIII. also provides that in determining whether a "substantial portion" of the overall supervision and administration of the group is provided by the headquarter company, its headquarter-related activities must be substantial in relation to the same activities for the same group performed by other entities. An example is provided under which it is determined that a Netherlands headquarter company provides a substantial portion of the overall supervision and administration for a group of North American and European companies despite the fact that the Netherlands company's Japanese parent also participates in this activity. The determination turns principally on the fact that the Netherlands company is responsible for implementation of overall policies that the Japanese company sets for the worldwide group, which includes companies not under the purview of the Netherlands company, and that the capital and payroll devoted to these activities by the Netherlands company is large in comparison to the capital and payroll devoted to these activities by the Japanese company. Subparagraph 3(a) does not require that the group that is supervised include persons in the other State. However, it is anticipated that in most cases the group will include such persons, due to the requirement discussed below that the income derived by the headquarter company be derived in connection with or be incidental to an active trade or business supervised by the headquarter company. Active Trade or Business - Subparagraph 3(b) Subparagraph 3(b) provides that the corporate group supervised by the headquarter company must consist of corporations resident in, and engaged in active trade or businesses in, at least five countries. Furthermore, each of these businesses must generate at least 10 percent of the gross income of this group for the taxable year in question. For purposes of the 10 percent gross income requirement, the income from multiple countries may be aggregated, am long as there are at least five individual countries or groupings that satisfy the 10 percent requirement. If the gross income requirement under this subparagraph is not met for a taxable year, the taxpayer may satisfy this requirement by averaging the ratios for the four years preceding the taxable year. The following examples illustrate the application of this subparagraph. Example l. NLHQ is a corporation resident in the Netherlands. NLHQ functions as a headquarter company far a group of companies. These companies are resident in the United States, Canada, Mexico, Brazil, Argentina, Chile, Bolivia, Colombia, Venezuela, New Zealand and Australia. The gross income generated by each of these companies for 1996 and 1997 are as follows: 1996 1997 United States $40 $45 Canada 25 18 Mexico 10 20 Brazil 20 25 Argentina 10 12 Chile 5 6 Bolivia 2 2 Colombia 5 9 Venezuela 10 12 Australia 30 30 New Zealand 5 5 Total $162 $183 For 1996, 10 percent of the gross income of this group is equal to $16.20. Only the United States, Canada, Brazil and Australia satisfy this requirement for that year. The other companies in the group may be aggregated to meet this requirement. Since they have a total gross income of $47, they are treated as the fifth member of the group for purposes of subparagraph 3(b). In the following year, 10 percent of the gross income is $18.30. Only the United States, Mexico, Brazil, and Australia satisfy this requirement. The other companies in the group again may be aggregated to meet the requirement that there be five members with the requisite level of income. Since they have a total gross income of $63, they are treated as the fifth member of the group for purposes of subparagraph 3(b). The fact that Canada has replaced Mexico in the grouping is immaterial. The composition of the grouping may change from year to year. Example 2. USHQ is a corporation resident in the United States. USHQ functions as a headquarter company for a group of companies. These companies are resident in the Netherlands, Belgium, Germany, Sweden, and France. The companies in the Netherlands, Germany, Belgium and France are active exclusively in their states of residence. The Swedish company conducts activities through permanent establishments in Norway, Denmark and Finland, in addition to conducting activities in Sweden. The gross income of each company and the location of the activities generating that income for the 1997 taxable year are set forth below. Company Situs Amount France France $50 Germany Germany 75 Netherlands Netherlands 20 Belgium Belgium 20 Sweden Sweden 10 Sweden Finland 5 Sweden Denmark 5 Sweden Norway 5 $190 Subparagraph 3(b) requires that there be five companies or groupings of companies, each of which accounts for at least 10 percent of the overall group's gross income. The total gross income of Sweden, France, Germany, the Netherlands and Belgium are greater than 10 percent of the total gross income of the group, and the group satisfies subparagraph 3(b). Single Country Limitation - Subparagraph 3(c) Subparagraph 3(c) provides that the business activities carried on in any one country other than the headquarter company's state of residence must generate less than 50 percent of the gross income of the group. If the gross income requirement under this subparagraph is not met for a taxable year, the taxpayer may satisfy this requirement by averaging the ratios for the four years preceding the taxable year. The following example illustrates the application of this subparagraph. Example. NLHQ is a corporation resident in the Netherlands. NLHQ functions as a headquarter company for a group of companies. NLHQ derives dividend income from a United States subsidiary in the 1998 taxable year. The state of residence of each of these companies, the situs of their activities and the amounts of gross income attributable to each for the years 1995 through 1998 are set forth below. Company Situs 1998 1997 1996 1995 1994 United States U.S. $100 $100 $ 95 $ 90 $ 85 United States Mexico 10 8 5 0 0 United States Canada 20 18 16 15 12 Germany Germany 40 42 38 36 35 France France 35 32 30 30 28 Netherlands NL 25 25 24 22 20 United Kingdom U.K. 30 32 30 28 27 $260 $257 $238 $221 $207 Since the United States' total gross income of $130 in 1998 is not less than 50 percent of the gross income of the group, subparagraph 3(c) is not satisfied with respect to the dividends derived in 1998. However, the United States' average gross income for the preceding four years may be used in lieu of the preceding year’s average. The United Statess average gross income for the years 1994-1997 is $111.00 ($444/4). The group's total average gross income for these years is $230.75 ($923/4). Since $111.00 represents 48.1 percent of the group’s average gross income for the years 1994 through 1997, the United States satisfies the requirement under subparagraph 3(c). Other State Gross Income Limitation - Subparagraph 3(d) Subparagraph 3(d) provides that no more than 25 percent of the headquarter company’s gross income may be derived from the other State. Thus, if the headquarter company's gross income for the taxable year is $200, no more than $50 of this amount may be derived from the other State. If the gross income requirement under this subparagraph is not met for a taxable year, the taxpayer may satisfy this requirement by averaging the ratios for the four years preceding the taxable year. Independent Discretionary Authority - Subparagraph i(e) Subparagraph 3(e) requires that the headquarter company have and exercise independent discretionary authority to carry out the functions referred to in subparagraph 3(a). Thus, if the headquarter company was nominally responsible for group financing, pricing, marketing, and other management functions, but merely implemented instructions received from another entity, the headquarter company would not be considered to have and exercise independent discretionary authority with respect to these functions. This determination is made individually for each function. For instance, a headquarter company could be nominally responsible for group financing, pricing, marketing and internal auditing functions, but another entity could be actually directing the headquarter company as to the group financing function. In such a case the headquarter company would not be deemed to have independent discretionary authority for group financing, but it might have such authority for the other functions. Functions for which the headquarter company does not have and exercise independent discretionary authority are considered to be conducted by an entity other than the headquarter company for purposes of subparagraph 3(a). Income Taxation Rules - Subparagraph 3(f) Subparagraph 3(f) requires that the headquarter company be subject to the same income taxation rules in its country of residence as persons described in paragraph 3. The reference to paragraph 2 means that the headquarter company must be subject to the income taxation rules to which a company engaged in the active conduct of a trade or business would be subject. Thus, if one of the States introduced special taxation legislation that would impose a lower rate of income tax on headquarter companies then was imposed on companies engaged in the active conduct of a trade or business, or would provide for an artificially low taxable base for such companies, a headquarter company subject to these rules would not be entitled to the benefits of the Convention under paragraph 3. In Connection With or Incidental to Trade or Business - Subparagraph 3(g) Finally, subparagraph 3(g) requires that the income derived in the other State be derived in connection with or be incidental to the active business activities referred to in subparagraph 3(b). This determination is made under the principles set forth in paragraph 2. For instance, if a Netherlands company acted as a headquarter company for a group that included a United States corporation, the group was engaged in the design and manufacture of computer software, but the U.S. company was also engaged in the design and manufacture of photocopying machines, the income that the Netherlands company derived from the United States would have to be derived in connection with or be incidental to the income generated by the computer business in order to be entitled to the benefits of the Convention under paragraph 3. Similarly, interest income received from the U.S. company also would be entitled to the benefits of the Convention under this paragraph as long as the interest was attributable to a trade or business supervised by the headquarter company. Interest income derived from an unrelated party would normally not, however, satisfy the requirement of this subparagraph. Derivative Benefits - Paragraph 4 Paragraph 4 sets forth a limited derivative benefits test. In general, a derivative benefits test entitles the resident of a state to treaty benefits if the beneficial owner of the resident would have been entitled to the same benefit had the income im question flowed directly to that owner. Paragraph 4 provides a derivative benefits test under which a Netherlands company may be entitled to the benefits of the Convention with respect to Articles 10 (Dividends), 11 (Branch Tax), 12 (Interest) and 13 (Royalties). A Netherlands company may not obtain other benefits of the Convention under paragraph 4. In order to be entitled to the enumerated benefits of the Convention under this paragraph, the Netherlands company must meet an ownership test and a base reduction test. The ownership test is described below. The base reduction test is described in the discussion of paragraph 5. 30/70 Netherlands/EC Ownership - Subparagraph 4(a) Subparagraphs 4(a)(i) and (ii) set forth a 30/70 Netherlands/EC ownership test that is similar, but not identical to that set forth under subparagraph 1(c) (iii). First, subparagraph 4(a)(i) provides that more than 30 percent of the vote and value of all the company's shares must be owned directly or indirectly by qualified persons resident in the Netherlands. Unlike the test under paragraph 1, there is no limit on the number of shareholders. In addition, more then 30 percent of any disproportionate class of shares (as defined in subparagraph 8(c)) also must be owned directly or indirectly by qualified persons resident in the Netherlands. As under subparagraph 1(d), share ownership is to be determined under the principles of Code section 883(c)(4). The restrictions imposed on indirect ownership by subparagraph 8(k) with respect to certain tests under paragraph 1 do not apply under this subparagraph. Second, subparagraph 4(a)(ii) provides that more than 70 percent of all the shares (i.e., 70 percent of any disproportionate shares and 70 percent of the aggregate vote and value of all of the company's shares) must be owned directly or indirectly by any number of qualified persons or persons that are residents of member states of the European Communities (as defined in subparagraph 8(i)). As under subparagraph 4(a)(i), share ownership is to be determined under the principles of Code section 883(c)(4) and the restrictions imposed on indirect ownership by subparagraph 8(k) with respect to certain tests under paragraph 1 do not apply under this subparagraph. For purposes of subparagraph 4(a)(ii), subparagraph 4(b) provides that shares will be considered to be held by residents of the European Communities only if the shareholders are residents of member states of the European communities that have a comprehensive income tax convention with the United States, and the particular payment in respect of which treaty benefits are claimed would be subject to a rate of tax under such comprehensive income tax convention that is equal to or loss than the rate imposed on such payment under the Convention. The following examples illustrate the application of this subparagraph. Paragraph XI. of the Memorandum of Understanding sets forth the understanding of the negotiators that a Dutch investment company ("beleggingsinstelling") may satisfy the qualified person ownership requirement under this paragraph by relying on the so-called "global method" of determining ownership that is used for purposes of obtaining a refund for Netherlands shareholders with respect to foreign dividend and interest withholding taxes. This method is discussed above under subparagraph 1(d). Example l. NLCo is a corporation resident in the Netherlands. Sixty percent of the shares of NLCo are owned by UKCo, a corporation resident in the United Kingdom. The remaining 40 percent of the shares of NLCo are owned by NLParent, a corporation resident in the Netherlands that is entitled to the benefits of the convention under subparagraph l(c)(i). NLParent therefore is a qualified person resident in the Nether1ands. All the shares of UKCo are owned by NZCo, a corporation resident in New Zealand. The shares of NZCo are publicly-traded on a stock exchange in New Zealand. NLCo derives portfolio dividends from the United States for the 1998 taxable year. NLCo satisfies the ownership requirement of subparagraph 4(a)(i) because AG percent of its shares are owned by NLParent. NLCo does not satisfy the ownership requirements of subparagraph 4(a)(ii) despite the fact that the other 60 percent of its shares are owned by UKCo. The application of paragraph 4 turns on the identity of the ultimate, indirect owners of the company seeking the benefits of the Convention. In this case the ultimate indirect owner of NLCo is NZCo. Although NZCo would satisfy the derivative benefit test under subparagraph 4(b) because the income tax convention between the United States and New Zealand would impose the same rate of taxation on portfolio dividends that is imposed under the Convention (15 percent), NZCo is not a qualified person nor a resident of a member state of the European Communities. Consequently the requirement of subparagraph 4(a)(ii) is not satisfied. Example 2. The facts are the sale as in Example 1, except that 60 percent of the shares of NLCo are owned directly by NZCo and the shares of NZCo are owned by UKCo. The principal class of the shares of UKCo is listed on the London Stock Exchange and substantially and regularly traded. UKCo is entitled to all the benefits of the income tax convention between the United States and the United Kingdom. UKCo would be entitled to the benefits of the Convention under subparagraph 1(c)(i), applied as if the United Kingdom were the Netherlands. UKCo therefore is a resident of a member state of the European Communities as defined in subparagraph 8(i). NLCo satisfies the base reduction test under paragraph 5. The 30 percent Netherlands ownership requirement under subparagraph 4(a)(i) is satisfied because NLParent owns 40 percent of the shares of NLCo and NLParent is a qualified person resident in the Netherlands. Since the remaining shares of NLCo are indirectly owned by UKCo, a resident of a member state of the European Communities the 70 percent EC ownership requirement under subparagraph 4(a)(ii) also is satisfied, because portfolio dividends are subject to the same rate of taxation under the income tax convention between the United State and the United Kingdom that is imposed under the Convention (15 percent). Since subparagraph 8(k) does not apply for purposes of paragraph 4, the fact that the intermediate owner of NLCo (NZCo) is not a resident of a member state of the European Communities is not relevant. Since it is assumed that the base reduction test under paragraph 5 is satisfied, NLCo is entitled under paragraph 4 to the benefits of the Convention with respect to the portfolio dividends. Example 3. NLSub is a corporation resident in the Netherlands. NLSub has one class of shares. Thirty-two percent of the Shares of NLSub are owned by NLParent, a corporation resident in the Netherlands. The principal class of shares of NLParent is listed and traded as described in subparagraph 1(c)(i). NLParent therefore is a qualified person. Forty-three percent of the shares of NLSub are owned by UKParent, a corporation resident in the United Kingdom. Seventy-five percent of the shares of UKParent are owned by ItaliaCo, a corporation resident in Italy. The principal class of shares of ItaliaCo is listed on the Milan Stock Exchange and substantially and regularly traded as defined in subparagraph 8(f). ItaliaCo is entitled to all the benefits of the income tax convention between the United States and Italy. The remaining 25 percent of the shares of UKParent are owned by NLHolding, a corporation resident in the Netherlands. The principal class of shares of NLHolding is listed on the Amsterdam Stock Exchange and substantially and regularly traded as defined in subparagraph 8(f). The remaining 25 percent of the shares of NLSub are owned by X, an individual. NLSub satisfies the base reduction test under paragraph 5. In the 1998 taxable year, NLSub receives portfolio dividends from a corporation in the United States. NLSub satisfies the 30 percent Dutch ownership requirement under subparagraph 4(a)(i) because 32 percent of its shares are owned directly by NLParent, a qualified person resident in the Netherlands, and under the principles of Code section 883(c)(4) 11 percent of its shares are owned indirectly by NLHolding, also a qualified person resident in the Netherlands. NLSub also satisfies the 70 percent EC ownership requirement under subparagraph 4(a)(ii) because, in addition to the 43 percent of its shares that are owned directly or indirectly by qualified persons resident in the Netherlands, 32 percent of its shares are owned indirectly by ItaliaCo, a resident of a member state of the European Communities. The ownership attributable to ItaliaCo is considered for purposes of subparagraph 4(a)(ii) because the rate of tax that the United States may impose on portfolio dividends paid by a United States corporation under the United States - Italy income tax convention is the same as the rate that say be imposed under the Convention with respect to such payments (15 percent). Therefore 75 percent of the shares of NLSub are considered to be owned directly or indirectly by qualified persons and residents of member states of the European Communities. Since it is assumed that the base reduction test of paragraph 5 is satisfied, NLSub is entitled to the benefits of the Convention with respect to the dividend income received from the United States. Example 4. NLCo is a corporation resident in the Netherlands. Sixty percent of the shares of NLCo are owned by ItaliaCo, a corporation resident in Italy. Forty percent of the shares of NLCo are owned by an individual resident is the Netherlands. All the shares of ItaliaCo are owned by an individual resident in Italy. NLCo derives interest income from the United States. NLCo satisfies the 30 percent Netherlands ownership requirement under subparagraph 4(a)(i) because the individual shareholder with 40 percent of the shares of NLCo is a qualified person with more then 30 percent of the shares of NLCo. Although the indirect owner of the remaining shares of NLCo is a resident of a member state of the European Communities, NLCo does not satisfy the 70 percent EC ownership test under subparagraph 4(a)(ii). The indirect owner of the shares is an individual resident of Italy. The rate of tax imposed on interest income under the income tax convention between the United States and Italy (15 percent) is higher than the rate imposed on such income under the Convention (zero). Therefore under subparagraph 4(b) ItaliaCo is not treated as a resident of a member state of the European Communities for purposes of paragraph 4, and NLCo is not entitled to the benefits of the Convention with respect to the interest income. Base Reduction - Paragraph 5 Paragraph 5 sets forth two base reduction tests that are applied in determining whether a parson is entitled to benefits under other provisions of Article 26. The general base reduction test under subparagraph 5(a) is applied under subparagraph 1(d) and paragraph 4. The conduit base reduction test under subparagraph 5(d) is applied to certain conduit companies under subparagraph 1(c)(iv). General Base Reduction Test - Subparagraph 5(a)(i) Subparagraph 5(a)(i) sets forth the general base reduction test that is applicable to residents of either State who seek entitlement to the benefits of the Convention under subparagraph 1(d) or paragraph 4. In order to be entitled to the benefits of the Convention under either of those tests a person must meet the requirements under those tests as well as the base reduction test under subparagraph 5(a). The base reduction test under subparagraph 5(a) includes a test that is applicable to residents of either State and an alternative test that residents of the Netherlands may apply in lieu of the generally applicable test. The generally applicable test is described under subparagraph 5(a)(i). It provides that a person will meet the base reduction test of paragraph 5 if less than 50 percent of the person's gross income is used directly or indirectly, to make "deductible payments" in the current taxable year to parsons that are not qualified persons. The term qualified persons is defined under subparagraph 8(g). As discussed previously, gross income generally is equal to the current year's gross receipts less cost of goods sold. For purposes of paragraph 5, this definition is modified by subparagraph 5(b). For purposes of paragraph 5, gross income is the greater of gross income (determined under the general definition) for the preceding taxable year, or the average of the annual amounts of gross income for the four taxable years preceding the current taxable year. The following example illustrates the application of subparagraph 5(b). Example. The taxable year is 1997. The taxpayer's gross income for the preceding four taxable years is as follows: Year Amount 1996 $100 1995 95 1994 110 1993 105 The taxpayer’s gross income for the 1997 taxable year for purposes of paragraph 5 is the greater of the gross income for 1996 or the average gross income for the years 1993 through 1996. The average gross income for the years 1993 through 1996 is $102.50. Since this amount is greater than the $100 in gross income for 1996, the taxpayer’s gross income for the 1997 taxable year for purposes of paragraph 5 is deemed to be $102.50. The term "deductible payments" is defined in subparagraph 5(c). In general, deductible payments includes all payments that are deductible for tax purposes, such as payments for interest and royalties. The term does not, however, include payments at arm’s length for the purchase, use of, or right to use tangible property in the ordinary course of business, or remuneration at arm’s length for services performed in the country of residence of the person making the payment. These exceptions may be modified by mutual agreement of the competent authorities. The base reduction test applies to indirect as well as direct payments to persons that are not qualified persons. Thus, if a person makes payments of items included in the definition of deductible payments to a qualified person, and the qualified parson transfers all or a portion of this amount to persons that are not qualified persons, the portion of the payment that was transferred to the non-qualified persons would not be treated as a payment to a qualified person. In identifying indirect payments to non-qualified persons, it is not intended that a payment automatically be treated as an indirect payment to a non-qualified person solely because the qualified person made similar payments to a non-qualified person. It is only intended that a payment to a qualified person be treated as an indirect payment to a non-qualified person when the facts indicate that there is a relationship between the two payments such that the obligation on the part of the qualified person to make the payment to the non-qualified person would not have been incurred absent the obligation of the initial payor to make a payment to the qualified parson, or that the non-qualified person in substance was the recipient of the payment under a conduit arrangement. The following example illustrates the application of this subparagraph. Example. NLCo is a corporation resident in the Netherlands. For the 1997 tamable year, NLCo makes deductible payments to two persons: $10 is paid to a corporation resident in the Netherlands that is a qualified parson and $60 is paid to a corporation resident in Hong Kong. NLCo's gross income for the four taxable years preceding 1997 is as follows: Year Amount 1996 $110 1995 110 1994 120 1993 125 For purposes of subparagraph 5(a)(i), the deductible payments to the qualified person are disregarded. Only the $60 paid to the Hong Kong corporation is considered. NLCo's gross income for the taxable year is considered to be $116.25 (the average for the taxable years 1993-96, which is greater than the amount for 1996). Fifty percent of this amount is $58.13. Since the deductible payments to non-qualified persons for 1997 were $60, the base reduction test under subparagraph 5(a)(i) is not satisfied. 30/70 Base Reduction Test - Subparagraph 5(a)(ii) Subparagraph 5(a)(ii) sets forth an additional base reduction test that is available to residents of the Netherlands. This subparagraph provides that the base reduction test will be satisfied if a two-part test is met. First, under clause (A) of the subparagraph, less than 70 percent of the parson' a gross income for the taxable year is used, directly or indirectly, to make deductible payments to persons that are not qualified persons. Second, under clause (B), less then 30 percent of the person's gross income for the taxable year is used, directly or indirectly, to make deductible payments to persons that are neither qualified persons nor residents of member states of the European Communities. The definitions of gross income and deductible payments are the sane as those discussed above with respect to the general base reduction test under subparagraph 5(a)(i). The term residents of member states of the European Communities is defined under subparagraph 8(i). The following examples illustrate the application of subparagraph 5(a)(ii). Example 1. The facts are the same as those described in the example set forth under the discussion of subparagraph 5(a)(i), above. Thus, NLCo's gross income for the taxable year is considered to be $116.25, and NLCo made deductible payments of $10 to a qualified person and $60 to a non-qualified person. NLCo satisfies the test set forth under clause (A) of subparagraph 5(a)(ii) because its $60 in deductible payments to a non-qualified person is less than 70 percent of its gross income (70% of its gross income is $81.38, or the product of .70 and $116.25). NLCo does not, however, satisfy the test set forth under clause (B) of subparagraph 5(a)(ii) because more than 30 percent of its gross income was used to make deductible payments to a parson (the Hong Kong corporation) that is neither a qualified person nor a resident of a member state of the European Communities. Example 2. The facts are the same as in Example 1, except that instead of making $60 in deductible payments to a Hong Kong corporation, NLCo pays $60 in deductible payments to an individual resident in Germany. The individual satisfies the definition of a resident of a member state of the European Communities set forth under subparagraph 8(i). As in Example 1, NLCo satisfies the test set forth under clause (A) of subparagraph 5(a)(ii) because its $60 in deductible payments to a non-qualified person (the individual resident in Germany) is less than 70 percent of its grass income. Unlike Example 1, however, NLCo also satisfies the test set forth under clause (B) of subparagraph 5(a)(ii) because it made no deductible payments to persons that are neither qualified person nor residents of member states of the European Communities. NLCo satisfies the base reduction test under paragraph 5. Conduit Base Reduction Test - Subparagraph 5(d) Subparagraph 5(d) sets forth a special conduit base reduction test that applies solely for purposes of subparagraph l(c)(iv). Under this test, a company that would qualify for the benefits of the Convention under subparagraph 1(c)(ii) or (c)(iii) but for the fact that it is a conduit company as defined under subparagraph 8(m) will be entitled to the benefits of the Convention if it satisfies the conduit base reduction test. The conduit base reduction test is the same as the general base reduction test set forth under subparagraph 5(a), except that the definition of the term "deductible payments" under subparagraph 5(c) is modified for purposes of this test to include only those deductible payments that (i) are made to an associated enterprise (as described in Article 9 (Associated Enterprises) (determined without regard to the residence of the payor and the payee), and (ii) are subject to an aggregate rate of tax (including withholding taxes) in the hands of the recipient that is less then 50 percent of the rate that would have been applicable had the payment been received by a person subject to the normal taxing regime in the State of residence of the payor. In determining whether a person is entitled to the benefits of the Convention with respect to income derived from the United States, the aggregate rate of tax borne by an item of income will be determined under the principles set forth under Code section 954(b)(4). The following example illustrates the application of this subparagraph. Example. NL-1 is a corporation resident in the Netherlands. All of the shares of NL-1 are owned by NL-2, a corporation resident in the Netherlands that is entitled to the benefits of the Convention under subparagraph 1(c)(i). NL-1's gross income (determined under the rules of subparagraph 5(b)) for the 1996 taxable year was $100. NL-1 receives $100 of interest income during its 1996 taxable year. It does not receive any royalties or other deductible payments during the year. It pays $90 in interest during the same year. The interest was paid to the following persons. Thirty dollars was paid to an unrelated bank resident in Switzerland; $30 was paid to a sister corporation resident in Bermuda; and $30 was paid to an unrelated corporation resident in the Isle of Man. The income received by the Bermuda affiliate was not subject to tax in the hands of the recipient. NL-l is a conduit company because it made payments of items classified as deductible payments equal to at least 90 percent of its receipts of such items. If it were not a conduit company, NL-l would be entitled to the benefits of the Convention under subparagraph 1(c)(ii). Since it is a conduit company it also must satisfy the conduit base reduction test in order to be entitled to the benefits of the Convention under subparagraph 1(c). For purposes of the conduit base reduction test, NL-l 's deductible payments consist solely of the payments made to the related party in Bermuda. The payments to the unrelated Swiss bank and the Isle of Man corporation are not considered to be deductible payments because the recipients of these payments are not associated enterprises. The payment to the related Bermuda corporation is considered to be a deductible payment because the recipient is an associated enterprise and the recipient was subject to an aggregate rate of tax less that is less than 50 percent of the rate that would have applied had the income been taxed in the hands of NL-l. Thus, for purposes of the base reduction test, NL-l is considered to have made deductible payments of $30. Since $30 is less than 50 percent of NL-l's gross income of $100 for 1996, NL-l satisfies the base reduction test under subparagraph 5(d), and is entitled to the benefits of the Convention under subparagraph 1(c)(iv). Shipping and Air Transport - Paragraph 6 Paragraph 6 provides that a resident of one of the States that derives income from the other State described in Article 8 (Shipping and Air Transport) and that is not entitled to the benefits of the Convention under paragraphs 1 through 5 of Article 26, shall nonetheless be entitled to the benefits of the Convention with respect to income described in Article 8 if it meets one of two tests. These tests in substance duplicate the rules set forth under Code section 883 and therefore afford little additional benefits beyond those already afforded by the Code. These tests are described below. First, a resident of one of the States will be entitled to the benefits of the Convention with respect to income described in Article 8 if more then 50 percent of the beneficial interest in the person (in the case of a company, more than 50 percent of the value of the stock of the company) is owned, directly or indirectly by qualified persons or individuals who are residents of a third state that grants by law, common agreement, or convention an exemption under similar terms for profits as mentioned in Article 8 to citizens and corporations of the other State. This provision is analogous to the relief provided under Code section 883(c)(1). Alternatively, a resident of one of the States will be entitled to the benefits of the Convention with respect to income described in Article 8 if the person is a company, the stock of which is primarily and regularly traded on an established securities market in a third state, provided that the third state grants by law, common agreement, or convention an exemption under similar terms for profits as mentioned in Article 8 to citizens and corporations of the other State. This provision is analogous to the relief provided under Code section 883(c)(3). The term "primarily and regularly traded on an established securities market" is not defined in the Convention. In determining whether a resident of the Netherlands is entitled to benefits of the Convention under this paragraph, the United States will refer to the principles of Code section 883(c)(3)(A) for guidance as to the definition of this term. Competent Authority - Paragraph 7 Paragraph 7 of Article 26 provides that a resident of one of the States that is not entitled to the benefits of the Convention with respect to income derived from the other State under any of the other provisions of Article 26 may, nevertheless, be granted benefits under the Convention at the discretion of the competent authority of the State in which the income arises. In making determinations under paragraph 7 the competent authority of the State in which the income arises will take into account as its guideline whether the establishment, acquisition, or maintenance of the person seeking benefits under the Convention, or the conduct of such person's operations, has or had as one of its principal purposes the obtaining of benefits under the Convention. Thus, persons that establish operations in one of the States with a principal purpose of obtaining the benefits of the Convention ordinarily will not be granted relief under paragraph 7. Before denying benefits, however, a competent authority is required by paragraph 7 to consult the other competent authority. In making this determination with respect to a corporation, paragraph XIX. of the Memorandum of Understanding provides that the following factors (and others) may be relevant: (1) The date of incorporation of the corporation seeking benefits in relation to the date that the Convention entered into force: (2) the continuity of the historical business and ownership of the corporation; (3) the business reasons for the corporation residing in its State of residence; (4) the extent to which the corporation is claiming special tax benefits in its country of residence: (5) the extent to which the corporation's business activity in the other State is dependent an the capital, assets or personnel of the corporation in its State of residence; and (6) the extent to which the corporation would be entitled to treaty benefits comparable to those afforded by the Convention if it had been incorporated in the country of residence of the majority of its shareholders. An additional factor that might be accorded weight by the United States competent authority with respect to a Netherlands corporation include obtaining the benefit of various European Community directives for operations conducted in the EC. Further, the fact that a Netherlands corporation failed to satisfy one of the tests under the substantive rules of Article 26, but failed to do so by a narrow margin, would generally be a factor that, in combination with one or more of the factors described above, would weigh in favor of favorable consideration by the United States competent authority. Paragraph XXI. of the Memorandum of Understanding provides an additional factor weighing in favor of favorable determinations by the competent authority in cases in which a corporation that was entitled to the benefits of the Convention under paragraphs 1 or 2 of Article 26 is no longer entitled to benefits as the result of "changed circumstances". This paragraph recognizes the legal requirements for the free flow of capital and persons within the European Communities. Changed circumstances that the competent authority may consider as a favorable factor include a change in the state of residence of a major shareholder of the company, the sale of part of the stock of a Netherlands company to a person resident in another member state of the European Communities, or an expansion of a company's activities in other member states of the European Communities, all under ordinary business conditions. If these changed circumstances affect only the distribution of a company's activities or ownership within the European Communities, and are not attributable to tax avoidance motives, the U.S. competent authority will view these changed circumstances as a factor weighing in favor of continued entitlement to benefits under paragraph 7. In addition, paragraph XX. of the Memorandum of Understanding sets forth the understanding of the negotiators that certain mutual funds, although not entitled to the benefits of the Convention under Article 26, will be granted the benefits of the Convention if they hold stock and securities the income from which is not predominantly from sources in the other State, have widely dispersed ownership, and employ in their State of residence a substantial staff actively engaged in trades of stacks and securities owned by the company. Moreover, if any of these factors is absent it is understood that relief under paragraph 7 will not be granted to an entity seeking to qualify as a mutual fund. This paragraph is not relevant for applying paragraph 7 to entities that are not mutual funds. It is assumed that, for purposes of implementing paragraph 7, a taxpayer will be permitted to present his case to his competent authority for an advance determination based on the facts, and will not be required to wait until the tax authorities of one of the States have determined that benefits are denied. In these circumstances, it is also expected that if the competent authority determines that benefits are to be allowed, they will be allowed retroactively to the time of entry into force of the relevant treaty provision or the establishment of the structure in question, whichever is later. It is not necessary, however, for a taxpayer to obtain an advance determination under paragraph 7 in order to obtain the benefits of the Convention under this paragraph. A taxpayer confident of its ability to present a convincing case under paragraph 7 could refrain from obtaining an advance determination from the competent authority and wait to present a case to the competent authority until requested to do so by the competent authority. A person pursuing this strategy will have no assurance (apart from its confidence in its position) that the competent authority will determine that benefits of the Convention should be granted, unless that position is based on further guidance provided by the competent authorities with respect to the application of paragraph 7. ARTICLE 27 Offshore Activities This Article deals exclusively with the taxation of activities carried on by a resident of one of the States on the continental shelf of the other State in connection with the exploration or exploitation of the natural resources of the shelf, principally activities connected with exploration for oil by offshore drilling rigs. In the U.S. and OECD Models, the income from these activities is subject to the standard rules found in the other Articles of the Convention (e.g., the business profits and personal services articles). Other U.S. treaties with countries bordering on the North Sea (e.g., Norway and the U.K.), however, have articles dealing with offshore activities. Netherlands treaties with its North Sea partners also contain such provisions. The prior Convention had no similar provision. The normal business profits and personal services provisions, therefore, applied under the prior Convention to offshore income. Paragraph 1 states that the provisions of Article 27 apply notwithstanding any other provision of the Convention. Although there are no explicit cross references to other articles, the implicit references are principally to Articles 5 (Permanent Establishment), 7 (Business Profits), 15 (Independent Personal Services) and 16 (Dependent Personal Services). For example, if a drilling rig of a U.S. enterprise is present on the continental shelf of the Netherlands for 10 months, and would, therefore, not constitute a permanent establishment because of the 12-month construction site rule of paragraph 3 of Article 5, the rig would, nevertheless, be deemed to be a permanent establishment under paragraph 3 of this Article. Paragraph 1 further provides, however, that if activities constitute a permanent establishment or fixed base under Articles 5 or 15, Article 27 will not apply, and the income of the permanent establishment or fixed base will be taxed in accordance with the other Articles of the Convention. Because of this rule, an activity of a U.S. enterprise on the continental shelf of the Netherlands that constitutes a permanent establishment or a fixed base under Articles 5 or 15 will be taxed as provided in the Convention without reference to Article 27. Although it is unlikely that this rule would have a substantive effect with respect to the presence of a permanent establishment, since any case that would constitute a permanent establishment under Article 5 also would be a deemed permanent establishment under Article 27, it is possible for income to be taxable under Article 15 and not under Article 27. Article 27 requires a 30-day physical presence in a calendar year for income to be deemed to be attributable to a fixed base. Article 15 merely requires that a fixed base be regularly available to the performer of the services and that the income from the services be attributable to the fixed base. Thus, a work place on a rig could be deemed to be a fixed base regularly available to an individual who performs services at that work place for less than 30 days during the year. The individual's remuneration for the services performed at that work place would be taxable under Article 15, but not under Article 27. Paragraph 2 defines the term "offshore activities" for purposes of the Article as activities that are conducted offshore in connection with the exploration or exploitation of the sea bed and its subsoil and their natural resources, situated in one of the States. Paragraph 3 provides the basic rule for determining when a permanent establishment is deemed to exist and when income from offshore activities is deemed to be attributable to the permanent establishment. An enterprise of one State carrying on offshore activities (subject to exceptions described in paragraph 4) in the other State will be deemed to be carrying on business through a permanent establishment situated there if the activities are carried on there for a period or periods aggregating more than 30 days in a calendar year. Paragraph 3 also provides that if the enterprise carrying on the offshore activities is associated with another enterprise, and that associated enterprise is also carrying on offshore activities that are part of the same project, their periods of presence are aggregated to determine whether the 30 day threshold has been met. If the threshold is passed, both enterprises are deemed to have a permanent establishment under this Article. For purposes of this rule, association is defined as direct or indirect ownership of at least one-third of the capital in the other, or where one person holds, directly or indirectly, at least a one-third of the capital of both enterprises. Paragraph 4 identifies three classes of activities that are not to be treated as "offshore activities" for purposes of taxation under paragraph 3. Subparagraph (a) excludes the activities mentioned in paragraph 4 of Article 5 that do not give rise to a permanent establishment under that Article even if they are carried on through a fixed place of business. Subparagraph (b) excludes towing or anchor handling by ships primarily designed for that purpose, and other activities performed by such ships. Subparagraph (c) excludes any transport by ships or aircraft in international traffic. The activities described in subparagraphs (a) and (c) will be exempt from tax by the host country under Articles 7 (Business Profits) and 8 (Shipping and Air Transport), respectively, whether or not the income is attributable to a permanent establishment. Activities under group (b) are subject to the normal rules of Articles 5 and 7, (i.e., if the income is not attributable to a permanent establishment there will be no host country tax). Paragraph XXVI. of the Memorandum of Understanding clarifies that when supplies or personnel are transported from one of the States to an offshore location in that State, or between two offshore locations in that State, or between an onshore location and an offshore rig on that State 's continental shelf, or between two offshore rigs located on the shelf, such transport will be considered to be between two places within that State, and is not, therefore, in international traffic. Paragraph 5 sets a threshold of 30 consecutive days for the deemed existence of a fixed base and for the attribution of income from offshore activities of a professional or independent character to that fixed base. Thus, if an individual who is a resident of the United States performs independent personal services on a drilling rig on the continental shelf of the Netherlands for 30 consecutive days, his income from such services will be taxable by the Netherlands, whether or not his income was attributable to a fixed base regularly available to the individual in the Netherlands and otherwise taxable under Article 15 (Independent Personal Services). Paragraph 6 contains a rule for the taxation of employment income connected with offshore activities. It provides for a broader beet-country taxing right than does Article 16 (Dependent Personal Services). Under paragraph 6, salaries, etc., of a resident of one State derived from an employment in connection with offshore activities carried on through a permanent establishment (whether as a result of Article 5 or paragraph 3) in the other may be taxed by the other State. Paragraph 6 contains no special rule regarding the taxation of persons employed on ships, etc., in connection with offshore activities. Under Article 16, the presence of a permanent establishment is not sufficient to subject the employee to host country tax. Under paragraph 6 of Article 27, however, an employee merely needs to be engaged in offshore activities carried on in connection with a Netherlands permanent establishment engaged in offshore activities in the Netherlands to be subject to tax, regardless of who pays his salary and whether it is deductible in the Netherlands, and regardless of the amount of time he has spent in, or off the shore of, the Netherlands. Paragraph 7 provides for an exemption by the Netherlands, in conformity with the rules of paragraph 2 of Article 25 (Methods of Elimination of Double Taxation), for income that is taxable in the United States under paragraphs 3, 5 or 6 of this Article. These are all classes of income that are exempt from Netherlands tax under Article 25. Paragraph 7, however, requires documentary evidence that the U.S. tax has actually been paid. As with any benefit of the Convention, an enterprise claiming a benefit under this Article must be entitled to the benefit under the provisions of Article 26 (Limitation on Benefits). ARTICLE 28 Non-Discrimination This Article assures that nationals of a State, in the case of paragraph 1, and residents of a State1 in the case of paragraphs 2 through 5, will not be subject to discriminatory taxation in the other State. For this purpose, non-discrimination means providing national treatment. Paragraph 1 provides that a national of one of the States may not be subject to taxation or connected requirements in the other State that are other or more burdensome than the taxes and connected requirements imposed upon a national of that other State in the same circumstances. A national of one of the States is afforded protection under this paragraph even if the national is not a resident of either State. Thus, a U.S. citizen who is resident in a third country is entitled, under this paragraph, to the same treatment in the Netherlands as a Dutch national who is in similar circumstances (i.e., who is resident in that third country). The term "national" is defined for each State in subparagraph 1(g) of Article 3 (General Definitions). Paragraph 1 clarifies that this paragraph does not obligate the United States to apply the same taxing regime to a Netherlands national who is not resident in the United States and a U.S. national who is not resident in the United States. Paragraph 1 applies only when the nationals of the two States are in the same circumstances. United States citizens who are not residents of the United States but who are, nevertheless, subject to United States tax on their worldwide income, are not in the same circumstances with respect to United States taxation as nationals of the Netherlands who are not United States residents. Therefore, Article 28 would not entitle a Netherlands national not resident in the United States to the net basis taxation of U.S. source dividends or other investment income that applies to a U.S. citizen not resident in the United States. Paragraph 2 provides that a permanent establishment in one of the States of an enterprise of the other State may not be less favorably taxed in the first-mentioned State than an enterprise of that first-mentioned State that is carrying on the same activities in the first-mentioned State. This provision, however, does not obligate a State to grant to a resident of the other any tax allowances, reliefs, etc., that it grants to its own residents on account of their civil status or family responsibilities. Thus, if an individual resident in the Netherlands owns a Netherlands enterprise that has a permanent establishment in the United States, in assessing income tax on the profits attributable to the permanent establishment, the United States is not obligated to allow to the Netherlands resident the personal allowances for himself and his family that would be permitted if the permanent establishment were a sole proprietorship owned and operated by a U.S. resident. Section l446 of the Code imposes on any partnership with income that is effectively connected with a U.S. trade or business the obligation to withhold tax on amounts allocable to a foreign partner. In the context of the Convention, this obligation applies with respect to a Netherlands resident partner's share of the partnership income attributable to a U.S. permanent establishment. There is no similar obligation with respect to the distributive shares of U.S. resident partners. It is understood, however, that this distinction is not a form of discrimination within the meaning of paragraph 2. No distinction is made between U.S. and Netherlands partnerships, since the law requires that partnerships of both domiciles withhold tax in respect of the partnership shares of non-U.S. partners. In distinguishing between U.S. and Netherlands partners, the requirement to withhold on the Netherlands but not the U.S. partner's share is not discriminatory taxation, but, like other withholding on nonresident aliens, is merely a reasonable method for the collection of tax from persons who are not continually present in the United States, and as to whom it otherwise say be difficult for the United States to enforce its tax jurisdiction. If tax has been over-withheld, the partner can, as in other cases of over-withholding, file for a refund. (The relationship between paragraph 2 and the imposition of the branch tax is dealt with below in the discussion of paragraph 6.) Paragraph 3 prohibits discrimination in the allowance of deductions. When an enterprise of one of the States pays interest, royalties or other disbursements to a resident of the other State, the first-mentioned State must allow a deduction for those payments in computing the taxable profits of the enterprise under the same conditions as if the payment had been made to a resident of the first-mentioned State. An exception to this rule is provided for cases where the provisions of paragraph 1 of Article 9 (Associated Enterprises), paragraph 5 of Article 12 (Interest) or paragraph 4 of Article 13 (Royalties) apply, because these provisions permit the denial of deductions in certain circumstances in respect of transactions between related persons. The term "other disbursements" is understood to include a reasonable allocation of executive and general administrative expenses, research and development expenses and other expenses incurred for the benefit of a group of related persons which includes the person incurring the expense. The rules under section 163(j) of the Code relating to earnings-stripping are not discriminatory within the meaning of paragraph 3. First, section 163(j) applies equally to interest paid to domestic or foreign related parties, as interest paid to all domestic tax-exempt entities related to the payor corporation (under a greater than 50% ownership test) is subject to the provision. Second, as noted above, paragraph 3 does not apply to payments falling under Article 9(1) or 12(5), relating to transactions not conducted in accordance with the arm's length standard. Paragraph IV. of the Memorandum of Understanding reflects the negotiators' understanding that Article 9 applies to issues relating to thin capitalization, and that adjustments to amount of a deduction for interest must be consistent with the arm's length principles of paragraph 1 of Article 9 as those principles are examined and explained in OECD publications regarding thin capitalization. The paragraph also provides the understanding that the appropriate amount of interest deduction of an enterprise may be determined not only by reference to the amount of interest deduction of the enterprise but also by reference to the overall amount of debt capital of the enterprise. The approach taken by section 163(j) is consistent with this description. Paragraph 4 requires that a State not impose other or more burdensome taxation or connected requirements on an enterprise of that State which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other State, than the taxation or connected requirements which it imposes on other similar enterprises of that first-mentioned State. The Tax Reform Act of 1986 ("TRA") introduced section 367(e)(2) of the Code which changed the rules for taxing corporations on certain distributions they make in liquidation. Prior to the TRA, corporations were not taxed on distributions of appreciated property in complete liquidation, although non-liquidating distributions of the same property, with several exceptions, resulted in corporate-level tax. In part to eliminate this disparity, the law now generally taxes corporations on the liquidating distribution of appreciated property. The Code provides an exception in the case of distributions by 80 percent or more controlled subsidiaries to their parent corporations, on the theory that the built-in gain in the asset will be recognized when the parent sells or distributes the asset. This exception does not apply to distributions to parent corporations that are tax-exempt organizations or, except to the extent provided in regulations, foreign corporations. The policy of the legislation is to collect one corporate-level tax on the liquidating distribution of appreciated property; if and only if that tax can be collected on a subsequent sale or distribution does the legislation defer the tax. It is understood that the inapplicability of the exception to the tax on distributions to foreign parent corporations does not conflict with paragraph 4 of the Article. While a liquidating distribution to a U.S. parent will not be taxed, and, except to the extent provided in regulations, a liquidating distribution to a foreign parent will, paragraph 4 of the Article merely prohibits discrimination among corporate taxpayers on the basis of U.S. or foreign stock ownership. Eligibility for the exception to the tax on liquidating distributions for distributions to non-exempt, U.S. corporate parents is not based upon the nationality of the owners of the distributing corporation, but is based upon whether such owners would be subject to corporate tax if they subsequently sold or distributed the same property. Thus, the exception does not apply to distributions to persons Which would not be so subject -- not only foreign corporations, but also tax-exempt organizations. For the reasons given above in connection with the discussion of paragraph 2 of the Article, it is also understood that the provision in section 1446 of the Code for withholding of tax on non-U.S. partners does not violate paragraph 4 of the Article. It is further understood that the ineligibility of a U.S. corporation with nonresident alien shareholders to make an election to be an "S" corporation does not violate paragraph 4 of the Article. If a corporation elects to be an S corporation (requiring 35 or fewer shareholders), it is generally not subject to income tax and the shareholders take into account their pro-rata shares of the corporation's items of income, loss, deduction or credit. (The purpose of the provision is to allow an individual or small group of individuals to conduct business in corporate form while paying taxes at individual rates as if the business were conducted directly.) A nonresident alien does not pay U.S. tax on a net basis, and, thus, does not generally take into account items of loss, deduction or credit. Thus, the S corporation provisions do not exclude corporation with nonresident alien shareholders because such shareholders are foreign, but only because they are not net basis taxpayers. The provisions also exclude corporations with other types of shareholders where the purpose of the provisions cannot be fulfilled or their mechanics implemented. For example, corporations with corporate shareholders are excluded because the purpose of the provisions to permit individuals to conduct a business in corporate form at individual tax rates would not be furthered by their inclusion. Paragraph 5 contains a rule not found in the U.S. or OECD Models, though a similar rule appears in several other U.S. treaties. The paragraph concerns the deductibility of contributions to pension plans. It deals with an individual who is an employee and who is either a resident of one of the States or is temporarily present there, and who is not a citizen of that State. Under the paragraph, contributions by, or on behalf of, that individual to a pension plan that is recognized for tax purposes in the other State will be treated in the same manner for tax purposes in the State in which he is resident or temporarily present as a contribution to a plan that is recognized for tax purposes in that first-mentioned State. This rule applies only if (1) the individual was contributing to the plan in the other State before he became resident or temporarily present in the first-mentioned State, and (2) the competent authority of the first-mentioned State agrees that the pension plan in the otter State corresponds to a recognized pension plan in the first-mentioned State. A retirement plan "recognized" for U. S. tax purposes is one that is exempt from U.S. Federal income tax. It includes, for example, a Keough Plan and an Individual Retirement Account. Paragraph 6 of the Article specifies that no provision of the Article will prevent either State from imposing the branch tax described in Article 11 (Branch Tax). Thus, even if the branch tax were judged to violate the provisions of paragraphs 2 or 4 of the Article, neither State would be constrained from imposing the tax. As noted above, notwithstanding the specification of taxes covered by the Convention in Article 2 (Taxes Covered), for purposes of providing nondiscrimination protection this Article applies to taxes of every kind and description imposed by a one of the States or a political subdivision or local authority thereof. Customs duties are not considered to be taxes for this purpose. The saving clause of paragraph 1 of Article 24 (Basis of Taxation) does not apply to this Article, by virtue of the exceptions in subparagraph 2(a). Thus, a U.S. citizen who is resident in the Netherlands may claim benefits in the United States under this Article. ARTICLE 29 Mutual Agreement Procedure This Article provides for cooperation between the competent authorities of the States to resolve disputes that may arise under the Convention and to resolve cases of double taxation not provided for in the Convention. The Article also provides for the possibility of the use of arbitration to resolve disputes that cannot be settled by the competent authorities. The competent authorities of the two States are identified in subparagraph 1(i) of Article 3 (General Definitions). Paragraph 1 provides that when a resident of one of the States considers that the actions of one or both States will result for him in taxation that is not in accordance with the Convention, he may present his case to the competent authority of his State of residence or nationality. It is not necessary for a person first to have exhausted the remedies provided under the national laws of the States before presenting a case to the competent authorities. Paragraph 2 provides that if the competent authority of the State to which the case is presented judges the case to have merit, and cannot reach a unilateral solution, it shall seek agreement with the competent authority of the other State such that taxation not in accordance with the convention will be avoided. If agreement is reached under this provision, it is to be implemented even if implementation is otherwise barred by the statute of limitations or by some other procedural limitation, such as a closing agreement. Since subparagraph 2(a) of Article 1 (General Scope) provides that the Convention cannot operate to increase a taxpayer's liability, time or other procedural limitations can be overridden under this paragraph only for the purpose of making refunds and not to impose additional tax. Paragraph 2, however, specifies that the time limits or other procedural limitations are to be overridden for purposes of implementing an agreement only if the competent authority that has been asked to waive its limits in a particular case, and has received written notification that a case exists within six years from the end of the taxable year in the other State to which the case relates. The notification may be given by the competent authority of that other State, by tile taxpayer who has requested the competent authority to take action, or by a person related to that taxpayer. Although it is preferred U.S. policy to provide no time limit for the presentation of a case to the competent authorities, the limit in paragraph 2 of the Article should not result in any unreasonable denial of protection or assistance to taxpayers. The prior Convention had no such time limits. Paragraph 3 authorizes the competent authorities to seek to resolve difficulties or doubts that may arise as to the application or interpretation of the Convention. The paragraph includes a non-exhaustive list of examples of the kinds of matters about which the competent authorities may reach agreement. They may agree to the same attribution of income, deductions, credits or allowances between an enterprise in one State and its permanent establishment in the other State (subparagraph (a)) or between persons (subparagraph (b)). These allocations are to be made in accordance with the arm's length principles of Article 7 (Business Profits) and Article 9 (Associated Enterprises). Paragraphs IV. and V. of the Memorandum of Understanding deal with these allocations and attributions under Articles 9 (Associated Enterprises) and Article 29. Those paragraphs are described in the explanation to Article 9. The competent authorities also may agree to resolve bilaterally a variety of other possible conflicting applications of the Convention. They may agree to a common characterization of an item of income (subparagraph (c)), to a common application of source rules with respect to a particular item of income (subparagraph (d)) and to a common meaning of a term (subparagraph (e)). Subparagraph (f) authorizes the competent authorities to increase the dollar amounts referred to in the Convention to reflect economic and monetary developments. The dollar amounts referred to are Articles 18 (Artistes and Athletes) and 22 (Students and Trainees). If, for example, after the Convention has been in force for some time, inflation has rendered the $10,000 exemption threshold for entertainers or the $2,000 earned income exemption threshold for students or trainees unrealistically low in terms of the original objectives in setting the thresholds, the competent authorities may agree to a higher threshold without the need for formal amendment to the treaty and ratification by the States. This provision can be applied only to the benefit of taxpayers, (i.e., only to increase thresholds, not to reduce them). Paragraph 3 also provides that the competent authorities may agree to the application, consistent with the objective of avoiding double taxation, of the internal laws of the Contracting States regarding penalties, fines and interest (subparagraph (g)). Agreements reached by the competent authorities under this paragraph need not conform to the internal law provisions of either Contracting State. Finally, paragraph 3 authorizes the competent authorities to consult for the purpose of eliminating double taxation in cases not provided for in the Convention, but with respect to the taxes covered by the Convention. An example of such a case might be double taxation arising from a transfer pricing adjustment between two permanent establishments of a third-country resident, one in the United States and one in the Netherlands. Since no resident of one of the States is involved in the case, the Convention does not, by its terms, apply, but the competent authorities may, nevertheless, use the authority of the Convention to seek to prevent any double taxation. Paragraph 4 provides that the competent authorities may communicate with each other, including, where appropriate, in face-to-face meetings of representatives of the competent authorities, for the purpose of reaching agreement under this Article. Paragraph 5 contains an arbitration procedure found in only one other U.S. tax treaty, that with the Federal Republic of Germany, signed in 1989. Paragraph 5 provides that where the competent authorities have been unable, pursuant to paragraphs 1 through 4 of the Article, to resolve a disagreement regarding the application or interpretation of the Convention, the disagreement may, by mutual consent of the competent authorities, be submitted for arbitration, provided the taxpayer agrees in writing to be bound by the decision of the arbitration board. Nothing in the provision requires that any case be submitted for arbitration. If a case is submitted to an arbitration board, the board's decision in that case will be binding on both Contracting States with respect to that case. The United States was reluctant to implement an arbitration procedure under another tax convention until there had been an opportunity to evaluate the process in practice under the German Convention. It was agreed, therefore, that, as specified in paragraph 5, the provisions of the Convention calling for an arbitration procedure will not take effect until the two States have agreed through an exchange of diplomatic notes to do so. This agreement is elaborated on in subparagraph A of paragraph XXVII. of the Memorandum of Understanding. That paragraph notes the understanding that the two States will exchange diplomatic notes implementing the arbitration procedure at such tine as either the provision under the U.S. - Germany Convention, or the similar provision in the European Communities agreement signed on 23 July, 1990, has proven to the satisfaction of the competent authorities of both the United States and the Netherlands to be satisfactory. It is further agreed that the competent authorities will consult at the conclusion of three years following entry into forms of the Convention to determine whether conditions have been fulfilled for the exchange of diplomatic notes implementing the arbitration procedure. The arbitration procedures are to be made effective by exchanges of notes through diplomatic channels. Subparagraph B of Paragraph XXVII. of the Memorandum of Understanding specifies a set of procedures to be used in the implementation of paragraph 5. It is agreed that, in using the arbitration procedure in a specific case, the following procedures will be applied: 1. If, in applying paragraphs 1 to 4 of Article 29, the competent authorities fail to reach an agreement within two years of the date on which the case was submitted to one of the competent authorities, they may agree to invoke arbitration in a specific case, but only after fully exhausting the procedures available under paragraphs 1 to 4 of Article 29. The competent authorities will not generally accede to arbitration with respect to matters concerning the tax policy or domestic tax law of either State. 2. The competent authorities shall establish an arbitration board for each specific case in the following manner: (a) An arbitration board shall consist of not fever than three members. Each competent authority shall appoint the same number of members, and these members shall agree on the appointment of the other member(s). (b) The other member(s) of the arbitration board shall be from either State or from another OECD member country. The competent authorities may issue further instructions regarding the criteria for selecting the other member(s) of the arbitration board. (c) Arbitration board member(s) (and their staffs) upon their appointment must agree in writing to abide by and be subject to the applicable confidentiality and disclosure provisions of both States and the Convention. In case those provisions conflict, the most restrictive condition will apply. 3. The competent authorities may agree on and instruct the arbitration board regarding specific rules of procedure, such as appointment of a chairman, procedures for reaching a decision, establishment of time limits, etc. Otherwise, the arbitration board shall establish its own rules of procedure consistent with generally accepted principles of equity. 4. Taxpayers and/or their representatives shall be afforded the opportunity to present their views to the arbitration board. These presentations may be either in person or in writing. 5. The arbitration board shall decide each specific case on the basis of the Convention, giving due consideration to the domestic laws of the States and the principles of international law. The arbitration board will provide to the competent authorities an explanation of its decision. The decision of the arbitration board in a particular case shall be binding on both States and the taxpayer(s) with respect to that case. While the decision of the arbitration board shall not have precedential effect, it is expected that such decisions ordinarily will be taken into account in subsequent competent authority cases involving the same taxpayer(s), the same issue(s), and substantially similar facts, and may also be taken into account in other cases where appropriate. 6. Costs for the arbitration procedure will be borne in the following manner. (a) each State shall bear the cost of remuneration for the member(s) appointed by it, as well as for its representation in the proceedings before the arbitration board; (b) the cost of remuneration for all other costs of the arbitration equally between the States: and the other member(s) and board shall be shared (c} the arbitration board may decide on a different allocation of costs. However, if it deems appropriate in a specific case, in view of the nature of the case and the roles of the parties, the Competent Authority of one of the States may require the taxpayer(s) to agree to bear that State's share of the costs as a prerequisite for arbitration. 7. The competent authorities may agree to modify or supplement these procedures: however, they shall continue to be bound by the general principles established in these procedures. Paragraph 6 establishes a procedure to be followed by the competent authorities in the event that one of the States applies or may apply its law in a manner that may impede the full implementation of the Convention. This provision is intended to address the possibility that changes to the law of one of the States may prevent application of the Convention as intended by the States as of the date of signature. In particular, this paragraph would apply in the case of a statutory override of the provisions of the Convention by the United States. It is unlikely to be invoked by the United States, as the Netherlands is constitutionally barred from overriding a treaty by internal legislation. The paragraph requires a competent authority that becomes aware of such application, or potential application, to inform the competent authority of the other State in a timely manner. Either State may request that the competent authorities consult with a view to establishing a basis for the full implementation of the Convention. The paragraph directs that these consultations begin within six months of the time that the competent authority of the first State advises the competent authority of the other State of the impediment to the application of the Convention. The notes exchanged by the Staten at the time of the signing of the Convention dealt with the issue of treaty overrides. In the notes, the two Governments affirm both that the Convention, once in force, is binding on both parties, and their recognition of the need to avoid legislative or interpretive overrides of treaty obligations. They also recognize, however, that changes in tax laws may affect the implementation of the Convention. In such a case, the two Governments will engage in consultations and negotiations to determine whether, and the extent to which, an amendment to the convention is necessary and acceptable. By virtue of the exceptions in paragraph 2(a) of Article 24 (Basis of Taxation), this Article is not subject to the saving clause of paragraph 1 of that Article. Thus, rules, definitions, procedures, etc., that are agreed upon by the competent authorities under this Article, may be applied by the States with respect to their citizens and residents even if they differ from the comparable internal law provisions. Similarly, as indicated above, internal law may be overridden by a State to provide refunds of tax to its citizens or residents under this Article. ARTICLE 30 Exchange of Information and Administrative Assistance This Article provides for the exchange of information between the competent authorities of the States. The information to be exchanged is that which is necessary for carrying out the provisions of the convention or the domestic laws of the United States or the Netherlands concerning the taxes covered by the convention. The taxes covered by the convention are those referred to in Article 2 (Taxes Covered). This provision differs from the U.S. Model, which, for purposes of exchange of information, covers all taxes imposed by the two Contracting States. Although the U.S. Model expresses the preferred U.S. position, many U.S. tax treaties depart from the Model in this respect, often due to the fact that the laws of the other treaty partner do not always permit exchange of information with respect to non-covered taxes. The Netherlands was unable to extend the coverage beyond the taxes specified in Article 2. Exchange of information with respect to domestic law is authorized insofar as the taxation under those domestic laws is not contrary to the Convention. Thus, information may be exchanged with respect to a covered tax, even if the transaction to which the information relates is a purely domestic transaction in the requesting State and, therefore, the exchange is not made for the purpose of carrying out the Convention. It is contemplated that Article 30 will be used to exchange information on a routine basis, on request in relation to a specific case, or spontaneously. Paragraph 1 states that information exchange is not restricted by Article 1 (Personal Scope), meaning that information may be requested and provided under this Article with respect to persons who are not residents of either State. For example, if a third-country resident has a permanent establishment in the Netherlands and that permanent establishment engages in transactions with a U.S. enterprise, the United States may request information with respect to that permanent establishment, even though it is not a resident of either State. Similarly, if a third-country resident maintains a bank account in the Netherlands, and the Internal Revenue Service has reason to believe that funds in that account should have been reported for U.S. tax purposes but have not been so reported, information can be requested from the Netherlands with respect to that person's account. Paragraph 1 also provides assurances that any information exchanged will be treated as secret, subject to the same disclosure constraints as information obtained under the laws of the requesting State. The purposes for which information lay be requested include the assessment, collection, administration, enforcement, prosecution before an administrative authority, initiation of prosecution before a judicial body, or the determination of appeals with respect to the taxes covered by the Convention. The persons authorized to receive information may disclose the information in public court proceedings or in judicial decisions. Information received may be disclosed only to persons or authorities (including courts or administrative bodies) involved in the above functions in relation to the taxes covered by the Convention. The description in the Convention of the uses to which exchanged information may be put differs in one respect from the standard U.S. tax treaty policy. It is U.S. policy to exchange information both for civil and criminal uses. The view of the Netherlands is that it is not appropriate to use a tax treaty to request information for use in a criminal proceeding. Information for such purposes should be exchanged under the U.S. - Netherlands Mutual Legal Assistance Treaty (MLAT). However, information requested at an administrative stage, for enforcement purposes, prior to the initiation of any criminal proceedings, can subsequently be used for criminal prosecution, as long as the competent authority supplying the information has given prior authorization for such use. The competent authorities may agree to waive this prior authorization condition. Paragraph XXIX. of the Memorandum of Understanding clarifies the meaning of the term "administration" as it is used in paragraph 1 of Article 30. The Memorandum of Understanding explains that persons concerned with the administration of taxes, in the United States, include legislative bodies, such as the tax-writing committees of Congress and the General Accounting office. These bodies are subject to the same requirements of confidentiality under the Convention as apply to any information exchanged under the Convention. Information received by these bodies is for use in the performance of their role in overseeing the administration of U.S. tax laws. This role is understood to be limited to ensuring that the administration of the tax laws by the executive branch is honest, efficient and consistent with legislative intent. Paragraph 2 provides that when information is requested by one of the States in accordance with this Article, the other State is obligated to obtain the requested information as if the tax in question were the tax of the requested State even if that State has no direct tax interest in the case to which the request relates. The paragraph further provides that the requesting State may specify the form in which information is to be provided (e.g., depositions of witnesses and authenticated copies of original documents) and that the requested State shall provide the information in the form requested to the same extent that it can obtain information in that form under its own laws and administrative practices with respect to its own taxes. Paragraph 3 relates to the disclosure provisions of Article 30 and to the arbitration provisions of paragraph S of Article 29 (Mutual Agreement Procedure). Then a case is referred to an arbitration board, confidential information necessary for carrying out the arbitration procedure may be released by the states to the board. The members of the board, and any staff, however, are subject to the disclosure rules of paragraph 1 of this Article. The release of information to the arbitration board is subject to the provisions of paragraph 2 of this Article, and to the provisions of Article 32 (Limitation of Articles 30 and 31). Thus, if an arbitration board requests information in a particular form, the requested state should endeavor (as provided in paragraph 2) to provide the information in the form requested. However, the requested State is not required to carry out administrative measures at variance with its own laws in order to provide the information (as provided in Article 32). The limitations on the obligations of a State to provide information, that are found in the information exchange article in the U.S. and OECD Models, are set forth in Article 32 (Limitation on Articles 30 and 31) in the Convention. Paragraph XXVIII. of the Memorandum of Understanding clarifies the relationship between Article 30 and the reporting requirements of Code sections 6038A and 6038C. The paragraph specifies when the Internal Revenue Service will request information under Article 30 of the Convention before seeking the information under those Code rules. The paragraph provides that if a U.S. "reporting corporation" (as defined for purposes of Code section 6038A) that is a U.S. resident, or a U.S. permanent establishment of a U.S. reporting corporation that is not a U.S. resident, has neither possession of nor access to records that may be relevant to the U. S. income tax treatment of any transaction between it and a foreign "related partner" (as defined in Code section 6038A), and such records are under the control of a Netherlands resident and are maintained outside the United States, then the United states shall request such records from the Netherlands through an exchange of information under Article 30 before issuing a summons for such records to the United States reporting corporation, provided that under all the circumstances presented, the records will be obtainable through the request on a timely and efficient basis. For this purpose, records will be considered to be available on a timely and efficient basis if they can be obtained within 180 days of the request or such other period agreed upon in mutual agreement between the competent authorities, except where the statute of limitations may expire in a shorter period. Similar principles apply with respect to requests for information under Code section 6038C. This provision is consistent with the provisions of the regulations under section 6038A (see, Treas. Reg. § l.6038A-6(b)), and the legislative history of the provision, which expressed a concern that the IRS not be required to use treaty information exchange procedures when information was not available on a timely basis or when the statute of limitations was about to expire. Paragraph XXVIII. of the Memorandum of Understanding also provides guidance on another aspect at information exchange. Under the terms of this paragraph, the competent authority of one of the States will, in applying the "conduit base reduction test" of subparagraph 5(d) of Article 26 (Limitation on Benefits), limit its requests for information initially to that information necessary to determine whether the subject of the request is a "conduit company," as defined in subparagraph 8(m) of Article 26. Only if it determines that the company is a conduit company, will it then request additional information necessary to determine whether that company has satisfied the conduit base reduction test. ARTICLE 31 Assistance and Support in Collection This Article is essentially the same as Article XXII of the prior Convention. Under paragraphs 1 through 3, the States agree to lend assistance in collection of the taxes that are the subject of the Convention, along with interest, costs, additions to the taxes and non-penal fines. The taxes to be collected must be finally determined in the requesting State, as established by documents accompanying the request. The requested State will use the procedures that it uses in the collection of its own taxes, but will not be required to enforce executory measures for which there is no provision in the law of the requesting State. Paragraph 4 provides that assistance will not be granted with respect to citizens, corporations or other entities of the requested State, except to the extent necessary to ensure that the benefits of the Convention are enjoyed only by persons entitled to those benefits under the terms of the Convention. Under the paragraph, assistance will be provided in those cases where the competent authorities agree that an exemption or reduced rate of tax at source granted under the Convention by that other State has been enjoyed by persons not entitled to those benefits. Article 32 (Limitations on Articles 30 and 31) makes clear that the State asked to collect the tax is not obligated, in the process, to carry out administrative measures that are different from those used in the collection of its own taxes. Paragraph XXX. of the Memorandum of Understanding specifies the agreed rules for the application of Article 31. It provides as follows: 1. The requested State shall not be obliged to accede to the request of the applicant State: (a) if the applicant State has not pursued all appropriate collection action in its own jurisdiction; (b) in those cases 'where the administrative burden for the requested State is disproportionate to the benefit to be derived by the applicant State. 2. The request for administrative assistance in the recovery of a tax claim shall be accompanied by: (a) an official copy of the instrument permitting enforcement in the applicant State; (b) where appropriate, certified copies of any other document required for recovery; (c) a certification by the competent authority of the applicant State that, under the laws of that State, the revenue claim has been finally determined. For the purposes of this Article, a revenue claim is finally determined when the applicant State has the right under its internal law to collect the revenue claim and all administrative and judicial rights of the taxpayer to restrain collection in the applicant State have lapsed or been exhausted. 3. A revenue claim of the applicant State that has been finally determined may be accepted for collection by the competent authority of the requested State and, subject to the provisions of paragraph 7, if accepted shall be collected by the requested State as though such revenue claim 'were the requested State’s own revenue claim finally determined in accordance with the laws applicable to the collection of the requested State’s own taxes. 4 Where an application for collection of a revenue claim in respect of a taxpayer is accepted: (a) by the United States, the revenue claim shall be treated by the United States as an assessment under United States law against the taxpayer as of the time the application is received; and (b) by the Netherlands, the revenue claim shall be treated by the Netherlands as an amount payable under appropriate Netherlands law, the collection of which is not subject to any restriction. 5. Nothing in this Article shall be construed as creating or providing any rights of administrative or judicial review of the applicable State's finally determined revenue claim by the requested State, based on any such rights that may be available under the laws of either State. If, at any time pending execution of a request for assistance under this Article, the applicant State loses the right under its internal law to collect the revenue claim, the competent authority of the applicant State shall promptly withdraw the request for assistance in collection. 6. Subject to this paragraph, amounts collected by the requested State pursuant to this Article shall be forwarded to the competent authority of the applicant State. Unless the competent authorities of the States otherwise agree, the ordinary costs incurred in providing collection assistance shall be borne by the requested State and any extraordinary costs so incurred shall be borne by the applicant State. 7. The requested State may allow deferral of payment or payment by installments, if its laws or administrative practice permit it to do so in similar circumstances, but it shall first inform the applicant State. Any interest received by the requested State as a result of the allowance of a deferral of payment or payment by installments will be transferred to the competent authority of the applicant State. 8. A revenue claim of an applicant State accepted for collection shall not have in the requested State any priority accorded to the revenue claims of the requested State. 9. The competent authorities may under this Article grant assistance in collecting any tax deferred by operation of paragraph 8 of Article 14 (Capital Gains). 10. The competent authorities of the Contracting States shall agree upon the mode of application of this Article. ARTICLE 32 Limitation of Articles 30 and 31 Article 32 contains certain rules regarding the application of Articles 30 (Exchange of Information and Administrative Assistance) and 31 (Assistance and Support in Collection). The Article explains that the obligations undertaken in the two Articles to exchange information and to lend collection assistance do not require a State to carry out administrative measures that are at variance with the laws or administrative practices of either State. Nor does the Article require a State to supply information not obtainable under the laws or administrative practices of either State, or to disclose trade, business, industrial, commercial or professional secrets, trade processes, or other information, the disclosure of which would be contrary to public policy. Either State may, however, at its discretion, subject to the limitations of Articles 30 and 31 and its internal law, provide information or give collection assistance that it is not obligated to provide under the provisions of this Article. ARTICLE 33 Diplomatic Agents and Consular Officers Paragraph 1 provides that any fiscal privileges to which diplomatic or consular officials are entitled under general provisions of international law or under special agreements will apply notwithstanding any provisions to the contrary in the Convention. Under paragraph 2, an individual who is a member of a diplomatic mission or consular post of one of the States and 'who is a national of that State, whether that mission or consular post is situated in the other Contracting State or in a third State, will be deemed to be a resident of the sending State if the individual is liable in the sending State to the same income tax obligations as are residents of that State. Residence as determined under this paragraph will apply notwithstanding any result to the contrary from the application to such individual of the rules of Article 4 (Resident). Paragraph 3 clarifies that the Convention does not apply to international organizations or to organs or officials of such organizations, or to members of diplomatic missions or consular posts of third States present in a State, if such persons are not liable to the income tax obligations of residents in either State. The saving clause of paragraph 1 of Article 24 (Basis of Taxation) does not, by virtue of the exception in paragraph 2(b) of Article 24, apply to override any benefits of this Article available to an individual who is neither a citizen of one of the States nor, in the case of the United States, has immigrant status there. ARTICLE 34 Regulations Paragraph 1 through 3 of Article 34 specify certain procedures and practices that may be exercised by the competent authorities. Paragraph 1 authorizes the competent authorities, by mutual agreement, to determine the mode of application of Articles 10 (Dividends), 11 (Branch Tax), 12 (Interest), 13 (Royalties) and 26 (Limitation on Benefits). For example, the competent authorities say decide whether reduced rates of tax at source on items dealt within those Articles should be granted by withholding agents at the time payment is made, and, if so, what documentation may be required, or whether full tax may be withheld and treaty benefits granted after the fact by means of refunds. Paragraph 2 authorizes the competent authorities to agree on procedures for exchange of information and assistance in collection. These agreements may relate to such matters as forms for communication both with taxpayers and between competent authorities, currency conversion, transfer of amounts collected between tax authorities and minimum amounts subject to collection. Under paragraph 3, each competent authority may prescribe regulations in accordance with the internal law and practice in its State, for carrying out other provisions of the Convention. These three paragraphs confirm what is implicit in the general grant of authority to the competent authorities in Article 29 (Mutual Agreement Procedure) and other Articles of the Convention. Paragraph 4 provides a rule for the refund of tax when tax has been withheld at source in excess of the amount provided for under the Convention. It specifies that application for refund must be made to the competent authority of the State that has levied the tax within three years after the expiration of the calendar year in which the tax has been levied. ARTICLE 35 Exempt Pension Trusts This Article provides for exemption from tax by the source State of dividend and interest income earned by certain pension trusts resident in the other State. Such rules are not typically found in U.S. tax treaties, although the U.S. - Canada treaty contains essentially the same provision. There is no comparable provision in the prior Convention. Since interest income is generally exempt from source State taxation pursuant to Article 12 (Interest), a pension fund described in Article 35 will be exempt from source State taxation on interest unless such interest is attributable to a permanent establishment or fixed base in the source State. Article 35 may extend U.S. tax benefits to some Netherlands tax-exempt organizations that they could not enjoy if they were organized in the United States, because they would not fulfill all the requirements of U.S. 1aw to be treated as tax-exempt organizations. Similarly, some U.S. tax-exempt organizations may be entitled to Netherlands tax benefits under Article 35 that they could not enjoy if they were organized in the Netherlands because they could not qualify as tax-exempt organizations in the Netherlands. Conversely, some Dutch taxpayers that would qualify as tax-exempt organizations under U.S. law may not be so qualified under Dutch law and therefore will be unable to obtain the benefits of this Article with respect to U.S. - source dividend income. The same is true with respect to United States pension funds investing in the Netherlands. Unlike a unilateral U.S. extension of U.S. tax benefits to Netherlands organizations, this provision extends U.S. benefits in exchange for a quid pro quo in the form of equivalent benefits for similar U.S. organizations This approach is a reasonable way to relieve an administrative burden that otherwise would be imposed if an organization were obligated to qualify as tax-exempt under the laws of both States. Paragraph 1 provides that a trust, company or other organization, resident in one of the States, and constituted and operated exclusively to administer or provide benefits under one or more funds or plans established to provide pension, retirement or other employee benefits, is exempt from tax on its dividend and interest income arising in the other State, if the income of the organization is generally exempt from tax in the State in which it is resident. In determining whether a pension fund satisfies the requirement that it be constituted and operated "exclusively" to administer or provide benefits of the type described, the source of the entity's income will not be relevant. Rather, the use to which the entity's income is put will be dispositive. Thus, a pension fund that carries on investment and administrative activities incidental to its purpose of providing pension and other benefit. shall not be considered to have failed to meet the requirement that it be constituted and operated "exclusively" for such purposes as a result of having performed such activities. In addition, although by operation of paragraph 2 dividends that are attributable to a trade or business are not entitled to the exemption described in paragraph 1, the receipt of such dividends would not result in a pension fund being deemed to have failed to operate "exclusively" to administer or provide benefits. Section 897(h) of the Code provides that distributions by Real Estate Investment Trusts to nonresident alien individuals or foreign corporations are treated as gain recognized by such nonresident alien individual or foreign corporation from the sale or exchange of a United States real property interest. Such distributions consequently are not treated as dividends for purposes of the Convention and are subject instead to Article 14 (Capital Gains). Article 6 of the Protocol confirms this result with respect to capital gains dividends received by exempt pension trusts, providing that Article 35 does not apply to such distributions. Paragraph 2 qualifies the exemption provided in paragraph 1 by providing that it does not apply with respect to income of such an organization that is derived from carrying on a trade or business, or that is received from a related person, other than from another exempt pension trust of the type described in paragraph 1. In the United States, whether an exempt pension trust is carrying on a trade or business generally will be determined under the rules of section 367(a)(3) of the Code. In addition, income will he considered to be derived from carrying on a trade or business for this purpose if the income is unrelated business taxable income as defined in Code section 512. Thus, excess inclusions with respect to a residual interest in a REMIC are treated as income from carrying on a trade or business pursuant to Code section 860E(b) and therefore are included in the income described in paragraph 2. Paragraph VIII. of the Agreed Minutes to the Protocol provides the understanding of the negotiators that for purposes of paragraph 2, a person will he considered to be a "related person" if more than 80 percent of the vote or value of any class of shares is owned by the person deriving the income. The benefits provided by this Article are subject to the provision of Article 26 (Limitation on Benefits). Subparagraph 1(e) of Article 26 provides that a not-for-profit organization that is, by virtue of that status, generally exempt from tax in its State of residence, will be entitled to benefits if more than half of its beneficiaries, members or participants are entitled to the benefits of the Convention under paragraph 1 of the Article or are U.S. citizens. Thus, a Dutch pension plan, more than half of the members of which are individual residents of the Netherlands will be entitled, under Article 26, to the benefits of Article 35. In addition, a pension plan may be entitled to the benefits of the Convention as a result of its sponsorship by an entity that is itself entitled to the benefits of the Convention (as described in subparagraph 8(j) of Article 26). ARTICLE 36 Exempt Organizations Article 36 provides for reciprocal exemption for the income of certain exempt organizations in addition to those dealt within Article 35 (Exempt Pension Trusts). This Article does not reflect standard U.S. treaty policy, although similar provisions are found in several other U.S. tax treaties. There is no comparable provision in the prior Convention. Paragraph 1 provides that a trust, company or other organization resident in one of the States that is operated exclusively for religious, charitable, scientific, educational or public purposes (such as an entity described in Code section 501(c)(3)) will be exempt from tax in the other State in respect of items of income if two conditions are met. The two conditions are (l) that the entity be exempt from tax in its State of residence, and (2) that the entity would be exempt from tax on such items of income in the other State, under its laws, if the company or organization were organized in that other State and carried on all of its activities there. As under Article 35, the source of an entity’s income is not relevant in determining whether an entity is operated exclusively for one of the enumerated purposes. Paragraph 3 qualifies the exemption provided in paragraph 1 by providing that it does not apply with respect to income of such an entity that is derived from carrying on a trade or business, or that is received from a related person, other than from another entity of the type described in paragraph 1. The terms trade or business and related person under this paragraph will be defined consistently with the definitions of those terms under Article 35. Paragraph 3 provides that the competent authorities will develop procedures to implement the Article. The benefits provided by this Article are subject to the provisions of Article 26 (Limitation on Benefits). Subparagraph 1(e) of Article 26 provides rules for determining whether a not-for-profit organization is entitled to the benefits of the Convention. ARTICLE 37 Entry into Force This Article specifies the procedures for bringing the Convention into force and giving effect to its provisions. Paragraph 1 provides that the States each apply their required constitutional ratification procedures and notify the other in writing that those procedures have been complied with. The Convention will enter into force on the thirtieth day after the date of the later of the notifications. With respect to taxes payable at source, the rules of the Convention will have effect for payments made on or after the first day of January of the year following entry into force. For other taxes, the Convention will have effect for taxable years or periods beginning on or after the first day of January of the year following entry into force. Paragraph 2 provides a general exception to the effective date rules of paragraph 1. Under this paragraph, if the prior Convention would have afforded greater relief from tax to a person entitled to its benefits than would be the case under this Convention, that person may elect to remain subject to all of the provisions of the prior Convention for a twelve-month period from the date on which this Convention would have had effect under the provisions of paragraph 1 of this Article. Under the election, all of the provisions of the prior Convention must be applied for that additional year. Although a person ordinarily must be entitled to the benefits of Convention under Article 26 (Limitation on Benefits) in order to claim a benefit under the Convention, a person not so entitled my nonetheless claim the benefits afforded by this paragraph. During the period in which the election is in effect, the provisions of the prior Convention will continue to apply only insofar as they applied prior to the entry into force of the Convention. Paragraph 3 provides that the prior Convention will cease to have effect when the provisions of this Convention take effect in accordance with paragraphs 1 and 2 of the Article. Thus, for a person not taking advantage of the election in paragraph 2, the prior Convention will cease to have effect at the time, on or after January 1 of the year following entry into force of the Convention, when the provisions of the new Convention first have effect. For persons electing the additional year of coverage of the prior Convention, the prior Convention will remain in effect for one additional year beyond the date specified in the preceding sentence. Paragraph 4 makes clear that the entry into force of the new Convention and the termination of the prior Convention will not have any effect on the applicability of any extensions of the prior Convention. Thus, the limited application of the prior Convention, according to Article XVII of that Convention, to interest flows between the United States and the Netherlands Antilles and between the United States and Aruba will continue, notwithstanding the termination of the prior Convention. Article 7 of the Protocol provides that the provisions of the Protocol shall enter into force on the later of the dates on which the respective Governments have notified each other in writing that the formalities constitutionally required in their respective States have been complied with, and its provisions shall have effect for taxable years and periods beginning on or after the first day of January in the year following the date of entry into force of the Convention. Since the Protocol modifies the provisions of the Convention, a taxpayer that makes the election described under paragraph 2 of Article 37 will not be subject to the provisions of the Protocol until subject to the Convention itself. Conversely, a taxpayer that does not make the election described in paragraph 2 would be subject to the Protocol from the same date that the Convention was applicable to such person. Paragraph 2 of Article 7 of the Protocol provides that notwithstanding the provisions of paragraph 1, the Protocol provisions relating to the so-called "triangular case" (Articles 1 and 2 and paragraph 2 of Article 4 of the Protocol) will have effect for payments made on or after the 30th day after the date on which the Protocol has entered into force. As with the other provisions of the Protocol, taxpayers electing the prior Convention will not be subject to these provisions until subject to the Convention itself. ARTICLE 38 Termination The Convention is to remain in effect indefinitely, unless terminated by one of the States in accordance with the provisions of this Article. The Convention may be terminated by either State at any time after 5 years from the date of its entry into force, provided that at least six months’ prior written notice has been given through diplomatic channels. If notice is given on or before June 30 of a calendar year (assuming the 5-year requirement has been met) the termination will have effect for taxable years or periods beginning, or, with respect to withholding taxes, for payments made, on or after January 1 of the calendar year following the year in which notice is given. Nothing in Article 38, which relates to unilateral termination by one of the States of the Convention, should be construed as preventing the Contracting States from entering into a new bilateral agreement that supersedes, amends or terminates provisions of the Convention either prior to the expiration of the five year period or without the six month notification period.
