Article 10 provides rules for the taxation of dividends paid by a resident of one

Contracting State to a beneficial owner that is a resident of the other Contracting State. The article provides for full residence country taxation of such dividends and a limited source-State right to tax. Article 10 also provides rules for the imposition of a tax on branch profits by the State of source. Finally, the Article prohibits a State from imposing a tax on dividends paid by companies resident in the other Contracting State and from imposing taxes, other than a branch profits tax, on undistributed earnings.

Paragraph 1

The right of a shareholder's country of residence to tax dividends arising in the source country is preserved by paragraph 1, which permits a Contracting State to tax its residents on dividends paid to them by a resident of the other Contracting State. For dividends from any other source paid to a resident, Article 22 (Other Income) grants the residence country exclusive taxing jurisdiction (other than for dividends attributable to a permanent establishment or fixed base in the other State).

Paragraph 2

The State of source may also tax dividends beneficially owned by a resident of the other State, subject to the limitations in paragraph 2. Generally, the source State's tax is limited to 15 percent of the gross amount of the dividend paid. If, however, the beneficial owner of the dividend is a company resident in the other State that has owned at least 25 percent of the voting stock of the company paying the dividend for a 12 month period ending on the date the dividend is declared, then the source State's tax is limited to 5 percent of the gross amount of the dividend. Indirect ownership of voting shares (through tiers of corporations) and direct ownership of nonvoting shares are not taken into account for purposes of determining eligibility for the 5 percent direct dividend rate. Shares are considered voting shares if they provide the power to elect, appoint or replace any person vested with the powers ordinarily exercised by the board of directors of a U.S. corporation.

The benefits of paragraph 2 may be granted at the time of payment by means of reduced withholding at source. It also is consistent with the paragraph for tax to be withheld at the time of payment at full statutory rates, and the treaty benefit to be granted by means of a subsequent refund so long as such procedures are applied in a reasonable manner. See Article 5 of the Protocol, discussed below, regarding Italy’s existing practice for implementing these benefits.

Paragraph 2 does not affect the taxation of the profits out of which the dividends are paid. The taxation by a Contracting State of the income of its resident companies is governed by the internal law of the Contracting State, subject to the provisions of paragraph 4 of Article 24 (NonDiscrimination).

The term "beneficial owner" 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 that is a resident of one of the States (as determined under Article 4 (Resident)) is received by a nominee or agent that is a resident of the other State on behalf of a person that is not a resident of that other State, the dividend is not entitled to the benefits of this Article. However, a dividend received by a nominee on behalf of a resident of that other State would be entitled to benefits. These limitations are confirmed by paragraph 12 of the OECD Commentaries to Article 10. See also, paragraph 24 of the OECD Commentaries to Article 1 (Personal Scope).

Companies holding shares through fiscally transparent entities such as partnerships are considered for purposes of this paragraph to hold their proportionate interest in the shares held by the intermediate entity. As a result, companies holding shares through such entities may be able to claim the benefits of subparagraph (a) under certain circumstances. The lower rate applies when the company's proportionate share of the shares held by the intermediate entity meets the 10 percent voting stock threshold. Whether this ownership threshold is satisfied may be difficult to determine and often will require an analysis of the partnership or trust agreement.

The provisions of paragraphs 3 and 4 of Article 10 of the U.S. Model, which modify the paragraph 2 maximum rates of tax at source in certain cases, appear in revised form in paragraphs 9 and 8, respectively, of Article 10 of the Convention, discussed below.

Paragraph 3

Paragraph 3 defines the term dividends broadly and flexibly. The definition is intended to cover all arrangements that yield a return on an equity investment in a corporation as determined under the tax law of the state of source, as well as arrangements that might be developed in the future.

The term dividends includes income from shares, or other corporate rights that are not treated as debt under the law of the source State, that participate in the profits of the company. The term also includes income that is subjected to the same tax treatment as income from shares

by the law of the State of source. Thus, a constructive dividend that results from a non-arm's length transaction between a corporation and a related party is a dividend. In the case of the United States the term dividend includes amounts treated as a dividend under U.S. law upon the sale or redemption of shares or upon a transfer of shares in a reorganization. See, e.g., Rev. Rul. 92-85, 1992-2 C.B. 69 (sale of foreign subsidiary’s stock to U.S. sister company is a deemed dividend to extent of subsidiary's and sister's earnings and profits). Further, a distribution from a U.S. publicly traded limited partnership, which is taxed as a corporation under U.S. law, is a dividend for purposes of Article 10. However, a distribution by a limited liability company is not characterized by the United States as a dividend and, therefore, is not a dividend for purposes of Article 10, provided the limited liability company is not characterized as an association taxable as a corporation under U.S. law. Finally, a payment denominated as interest that is made by a thinly capitalized corporation may be treated as a dividend to the extent that the debt is recharacterized as equity under the laws of the source State.

Paragraph 4

Paragraph 4, in combination with paragraph 10 of Article 1 of the Protocol, is substantially the same as paragraph 6 of Article 10 of the U.S. Model. It excludes from the general source country limitations under paragraph 2 dividends paid with respect to holdings that form part of the business property of a permanent establishment or a fixed base. 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 the Convention. Paragraph 10 of Article 1 of the Protocol clarifies that the provisions of Article 7 (Business Profits) or Article 14 (Independent Personal Services), as the case may be, apply to such dividends. An example of dividends paid with respect to the business property of a permanent establishment would be dividends derived by a dealer in stock or securities from stock or securities that the dealer held for sale to customers.

In the case of a permanent establishment or fixed base that once existed in the State but that no longer exists, the provisions of paragraph 4 also apply, by virtue of paragraph 6 of Article 7 (Business Profits), to dividends that would be attributable to such a permanent establishment or fixed base if it did exist in the year of payment or accrual. See the Technical Explanation of paragraph 6 of Article 7.

Paragraph 5

A State's right to tax dividends paid by a company that is a resident of the other State is restricted by paragraph 5 to cases in which the dividends are paid to a resident of that State or the holding in respect of which the dividends are paid is effectively connected with a permanent establishment or fixed base in that State. Thus, a State may not impose a "secondary" withholding tax on dividends paid by a nonresident company out of earnings and profits from that State. In the case of the United States, paragraph 5, therefore, overrides the ability to impose taxes under sections 871 and 882(a) on dividends paid by foreign corporations that have a U.S. source under section 861(a)(2)(B).

The paragraph also restricts a State's right to impose corporate level taxes on

undistributed profits, other than a branch profits tax. The accumulated earnings tax and the personal holding company taxes are taxes covered in Article 2. Accordingly, under the provisions of Article 7 (Business Profits), the United States may not impose those taxes on the income of a resident of Italy except to the extent that income is attributable to a permanent establishment in the United States. Paragraph 5 also confirms the denial of the U.S. authority to impose those taxes. The paragraph does not restrict a State's right to tax its resident shareholders on undistributed earnings of a corporation resident in the other State. Thus, the U.S. authority to impose the foreign personal holding company tax, its taxes on subpart F income and on an increase in earnings invested in U.S. property, and its tax on income of a passive foreign investment company that is a qualified electing fund is in no way restricted by this provision.

Paragraph 6

Paragraph 6 permits a State to impose a branch profits tax on a corporation resident in the other State. The tax is in addition to other taxes permitted by the Convention. Since the term “corporation” is not defined in the Convention, it will be defined for this purpose under the law of the first-mentioned (i.e., source) State.

A State may impose a branch profits tax on a corporation if the corporation has income attributable to a permanent establishment in that State, derives income from real property in that State that is taxed on a net basis under Article 6, or realizes gains taxable in that State under paragraph 1 of Article 13. The tax is limited, however, to the aforementioned items of income that are included in the "dividend equivalent amount."

Paragraph 6 permits the United States generally to impose its branch profits tax on a corporation resident in Italy to the extent of the corporation's

(i) business profits that are attributable to a permanent establishment in the United States

(ii) income that is subject to taxation on a net basis because the corporation has elected under section 882(d) of the Code to treat income from real property not otherwise taxed on a net basis as effectively connected income and

(iii) gain from the disposition of a United States Real Property Interest, other than an interest in a United States Real Property Holding Corporation.

The United States may not impose its branch profits tax on the business profits of a corporation resident in Italy that are effectively connected with a U.S. trade or business but that are not attributable to a permanent establishment and are not otherwise subject to U.S. taxation under Article 6 or paragraph 1 of Article 13.

The term "dividend equivalent amount" used in paragraph 6 has the same meaning that it has under section 884 of the Code, as amended from time to time, provided the amendments are consistent with the purpose of the branch profits tax. Generally, the dividend equivalent amount for a particular year is the income described above that is included in the corporation's effectively connected earnings and profits for that year, after payment of the corporate tax under Articles 6, 7 or 13, reduced for any increase in the branch's U.S. net equity during the year or increased for any reduction in its U.S. net equity during the year. U.S. net equity is U.S. assets

less U.S. liabilities. See Treas. Reg. section 1.884-1. The dividend equivalent amount for any year approximates the dividend that a U.S. branch office would have paid during the year if the branch had been operated as a separate U.S. subsidiary company. In the case that Italy also enacts a branch profits tax, the base of its tax is limited to an amount that is analogous to the dividend equivalent amount.

Paragraph 7

Paragraph 7 provides that the branch profits tax permitted by paragraph 6 shall not be imposed at a rate exceeding the direct investment dividend-withholding rate of five percent.

Paragraph 8

Exemption from tax in the state of source is provided for dividends paid to qualified governmental entities in paragraph 8. Although there is no analogous provision in the OECD Model, the exemption of paragraph 8 is analogous to that provided to foreign governments under section 892 of the Code. Paragraph 8 makes that exemption reciprocal. A qualified governmental entity is defined in paragraph 1(i) of Article 3 (General Definitions), and it includes a government pension plan. The definition does not include a governmental entity that carries on commercial activity. As in the U.S. Model, the exemption at source does not apply if the qualified governmental entity’s ownership of the payer exceeds a certain level. Paragraph 8 does not allow the exemption at source if the qualified governmental entity holds, directly or indirectly, 25 percent or more of the voting stock of the company paying the dividend, whereas the U.S. Model does not allow the exemption at source if the qualified governmental entity controls (within the meaning of Treas. Reg. Section 1.892-5T) the company paying the dividend. Paragraph 9

Paragraph 9 provides rules that modify the maximum rates of tax at source provided in paragraph 2 in particular cases. The first sentence of paragraph 9 denies the lower direct investment withholding rate of subparagraph 2(a) for dividends paid by a U.S. Regulated Investment Company (RIC) or a U.S. Real Estate Investment Trust (REIT). The second sentence states that dividends paid by a RIC will qualify for the 15% rate provided by subparagraph 2(b).

The third sentence denies the benefits of both subparagraphs (a) and (b) of paragraph 2 to dividends paid by REITs in certain circumstances, allowing them to be taxed at the U.S. statutory rate (30 percent). The United States limits the source tax on dividends paid by a REIT to the 15 percent rate only when the beneficial owner of the dividend satisfies one or more of three criteria. First, the dividend may qualify if the beneficial owner is an individual resident of Italy who holds an interest of not more than 10 percent in the REIT. Second, the dividend may qualify for the 15% rate if it is paid with respect to a class of stock that is publicly traded and the beneficial owner of the dividends is a person holding an interest of not more than 5 percent of any class of the REIT's stock. Finally, the dividend may qualify for the 15% rate if the beneficial owner of the dividend is a person holding an interest of not more than 10 percent of the REIT and the REIT is diversified.

For this purpose, a REIT will be considered diversified if the value of no single interest in

the REIT's real property exceeds 10 percent of the REIT’s total interests in real property. For purposes of this rule, foreclosure property and mortgages will not be considered an interest in real property unless, in the case of a mortgage, it has substantial equity components. With respect to partnership interests held by a REIT, the REIT will be treated as owning directly the interests in real property held by the partnership.

The denial of the 5 percent withholding rate at source to all RIC and REIT shareholders, and the denial of the 15 percent rate to REIT shareholders that do not meet one of the 3 tests described above, is intended to prevent the use of these entities to gain unjustifiable source taxation benefits for certain shareholders resident in Italy. For example, a corporation resident in Italy that wishes to hold a diversified portfolio of U.S. corporate shares may 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 acquire a diversified portfolio by purchasing 10 percent or more of the interests in a RIC. Since the RIC may be a pure conduit, there may be no U.S. tax costs to interposing the RIC in the chain of ownership. Absent the special rule in paragraph 9, such use of the RIC could transform portfolio dividends, taxable in the United States under the Convention at 15 percent, into direct investment dividends taxable only at 5 percent.

Similarly, a resident of Italy directly holding U.S. real property would pay U.S. tax either at a 30 percent rate on the gross income or at graduated rates on the net income. As in the preceding example, by placing the real property in a REIT, the investor could transform real estate income into dividend income, taxable at the rates provided in Article 10, significantly reducing the U.S. tax burden that otherwise would be imposed. This policy avoids a disparity between the taxation of direct real estate investments and real estate investments made through REIT conduits. In the cases covered by the exceptions, the holding in the REIT is not considered the equivalent of a direct holding in the underlying real property.

Paragraph 10

Paragraph 10 provides that the benefits of this Article will be denied in cases in which the main purpose, or one of the main purposes, for the creation or assignment of shares or other rights in respect of which dividends are paid is to take advantage of this Article.

This provision addresses abusive transactions that would not be caught by the Limitation on Benefits provision of Article 2 of the Protocol because the purported recipient of the income qualifies under that Article. For example, an abuse that would not be caught by the Limitation on Benefits provisions involves “dividend washing”. A bank that is a resident of Italy and that easily can meet any of the tests under a limitation on benefits provision may decide to “sell” its treaty qualification to a customer that does not so qualify because it is a resident of a third country. One way that it could do so would be for the bank to purchase shares in a U.S. company that are owned by the customer immediately before the record date for dividends to be paid on the shares. At the same time, the bank would enter into a “repurchase” agreement under which it agreed with the customer to “resell” the shares to the customer on a certain date at a certain price. The main purpose of the agreement would be to qualify for reduced withholding tax under the Convention, without the bank incurring any actual market risk.

Similarly, taxpayers that qualify for Convention benefits could enter into transactions that are intended to increase the benefits that they otherwise would receive under the Convention. For example, an Italian government pension fund would qualify for an exemption from U.S. withholding tax with respect to a dividend if it owns less than 25 percent of the company paying the dividend. If the pension fund held more than 25 percent of a company paying the dividend, it could enter into a transaction to decrease temporarily its holding mainly for the purpose of securing the dividend withholding exemption under the Convention. Because the Italian pension fund would qualify for benefits as a qualified governmental entity, the Limitation on Benefits provision would not address this transaction.

The Commentary to Article 1 of the OECD Model and the OECD Report on Harmful Tax Competition make clear that countries can impose their internal anti-abuse rules to deny claims for treaty benefits. The United States has a number of such rules and doctrines and they may reach the above cases. Because some have argued that these internal rules and doctrines do not apply in the above cases, paragraph 10 clarifies that anti-abuse rules can be applied to deny treaty benefits to transactions entered into with a main purpose of taking advantage of the Article. The provision has been added because of a proliferation of such schemes in recent years, but the lack of the provision in other treaties does not imply that internal anti-abuse rules do not apply. Although the provision uses the term “main purpose”, which has gained international acceptance, it is intended to have the same meaning as the term “principal purpose”, and the United States will interpret it that way.

The provision has gained international currency because other countries may not have as many domestic tools to prevent abuse as the United States. For them, the explicit inclusion of a main purpose standard in a treaty may be necessary to prevent abuses of the treaty. Even in the United States, taxpayers frequently have argued that a transaction qualifies for treaty benefits unless there is specific guidance to the contrary.

The provision is narrower, and provides a more definitive standard to taxpayers, than anti-abuse provisions that are included in certain of Italy’s other bilateral treaties. In the broadest of those provisions, the competent authorities have unfettered discretion to deny the benefits of the treaty with respect to any transaction if, in their opinion, the receipt of those benefits, under the circumstances, would constitute an abuse of the Convention according to its purposes.

The provisions of paragraph 10 are self-executing and will apply even if guidance addressing a particular transaction has not yet been issued. Taxpayers therefore will be expected to determine whether one of the principal purposes of a particular transaction was to take advantage of the provision. The tax authorities of one of the Contracting States may, on review, however, deny the benefits of this Article. Moreover, the competent authorities of both Contracting States may together agree that this standard has been met in a particular case or with respect to a specific transaction entered into by a number of taxpayers. See Technical Explanation to paragraph 19 of Article 1 of the Protocol, relating to Article 25 (Mutual Agreement Procedure) of the Convention. Such agreements, along with U.S. statutory, regulatory, and common law, will provide guidance to taxpayers regarding the scope of the provision.

Relation to Other Articles

Notwithstanding the foregoing limitations on source country taxation of dividends, the saving clause of paragraph 2 of Article 1 permits the United States to tax dividends received by its residents and citizens, subject to the special foreign tax credit rules of paragraph 4 of Article 23 (Relief from Double Taxation), as if the Convention had not come into effect.

The benefits of this Article are also subject to the provisions of Article 2 of the Protocol, regarding limitation on benefits. Thus, if a resident of Italy is the beneficial owner of dividends paid by a U.S. corporation, the shareholder must qualify for treaty benefits under at least one of the tests of Article 2 of the Protocol in order to receive the benefits of this Article.