Article 10(3) contains a specific — U.S. Income Tax Treaty

joint ventures, not just wholly-owned subsidiaries, can qualify for benefits. For example, assume that the United States were to enter into a treaty with Country X, a member of the European Union, that includes a provision identical to Article 10(3). USCo is 100 percent owned by SCo, a Swedish company, which in turn is owned 49 percent by PCo, a Swedish publicly-traded company, and 51 percent by XCo, a publicly-traded company that is resident in Country X. In the absence of a special rule for interpreting the derivative benefits provision, each of the shareholders would be treated as owning only their proportionate share of the shares held by SCo. If that rule were applied in this situation, neither shareholder would be an equivalent beneficiary, because neither would meet the 80 percent ownership test with respect to USCo. However, since both PCo and XCo are residents of countries that have treaties with the United States that provide for elimination of withholding tax on inter-company dividends, it is appropriate to provide benefits to SCo in this case.

Consequently, Article 10(3) provides that, when determining whether a person is an equivalent beneficiary, each of the shareholders is treated as owning shares with the same percentage of voting power as the shares held by SCo for purposes of determining whether it would be entitled to an equivalent rate of withholding tax. This rule is necessary because of the high ownership threshold for qualification for the elimination of withholding tax on inter-company dividends.

If a company does not qualify for the elimination of withholding tax under any of the foregoing objective tests, it may request a determination from the relevant competent authority pursuant to paragraph 6 of Article 17. Benefits will be granted with respect to an item of income if the competent authority of the Contracting State in which the income arises determines that the establishment, acquisition or maintenance of such resident and the conduct of its operations did not have as one of its principal purposes the obtaining of benefits under the Convention.

In making its determination under Article 17(6) with respect to income arising in the United States, the U.S. competent authority will consider the obligations imposed upon Sweden by its membership in the European Union. In particular, the United States will have regard for any legal requirements for the facilitation of the free movement of capital among member states of the European Union. The competent authority will also consider the differing internal tax systems, tax incentive regimes and tax treaty practices of the relevant member states.

For example, in the case above where SCo was denied the zero rate of withholding tax because it was wholly owned by ThirdCo, the competent authority would consider whether ThirdCo was a resident of a member state of the European Union or European Economic Area. If it were, that would be a factor in favor of a determination that SCo is entitled to the benefits of the zero rate of withholding tax on dividends. However, that positive factor could be outweighed by negative factors. One negative factor could be a determination by the U.S. competent authority that ThirdCo benefited from a tax incentive regime that eliminated any domestic taxation. The competent

authority would also consider facts that might indicate that ThirdCo acquired SCo not "under ordinary business conditions" but instead to interpose SCo between ThirdCo and USCo, creating a Sweden-U.S. "bridge." These might include the fact that existing U.S. operations were restructured in an attempt to benefit from the elimination of withholding tax on dividends; or the fact that ThirdCo was owned by residents of a country that is not a member state of the European Communities. Finally, another significant negative factor would be if the U.S. competent authority faced difficulties in learning the identity of ThirdCo's owners, such as an uncooperative taxpayer or legal barriers such as "economic espionage" or other limitations on the effective exchange of information in the country of which ThirdCo is a resident.

Subparagraph (b) of paragraph 3 of Article 10 of the Convention provides for exclusive taxation by the Contracting State of residence ( i.e ., the elimination of sourcecountry withholding tax) for dividends beneficially owned by a pension fund (as defined in paragraph 11 of this Article) provided that such dividends are not derived from the carrying on of a business, directly or indirectly, by the pension fund or through an associated enterprise and such fund does not sell or make a contract to sell the holdings from which such dividend is derived within two months of the date the pension fund acquired the holding.

Paragraph 4

Paragraph 4 provides rules for the treatment of dividends paid by RIC or a REIT that are consistent with U.S. treaty policy.

The first sentence of subparagraph 4(a) provides that dividends paid by a RIC or REIT are not eligible for the 5 percent rate of withholding tax of subparagraph 2(a) or the elimination of source-country withholding tax of subparagraph 3(a).

The second sentence of subparagraph 4(a) provides that the 15 percent maximum rate of withholding tax of subparagraph 2(b) applies to dividends paid by RICs and that the elimination of source-country withholding tax of subparagraph 3(b) applies to dividends paid by RICs and beneficially owned by a pension fund.

The third sentence of subparagraph 4(a) provides that the 15 percent rate of withholding tax also applies to dividends paid by a REIT and that the elimination of source-country withholding tax of subparagraph 3(b) applies to dividends paid by REITs and beneficially owned by a pension fund, provided that one of the three following conditions is met. First, the beneficial owner of the dividend is an individual or a pension fund, in either case holding an interest of not more than 10 percent in the REIT. Second, the dividend is paid with respect to a class of stock that is publicly traded and the beneficial owner of the dividend is a person holding an interest of not more than 5 percent of any class of the REIT’s shares. Third, the beneficial owner of the dividend holds an interest in the REIT of not more than 10 percent and the REIT is “diversified.” A REIT is diversified if the gross value of no single interest in real property held by the REIT exceeds 10 percent of the gross value of the REIT’s total interest in real property.

Foreclosure property is not considered an interest in real property, and a REIT holding a partnership interest is treated as owning its proportionate share of any interest in real property held by the partnership.

The restrictions set out above are intended to prevent the use of these entities to gain inappropriate U.S. tax benefits. For example, a company resident in Sweden that wishes to hold a diversified portfolio of U.S. corporate shares could hold the portfolio directly and would bear a U.S. withholding tax of 15 percent on all of the dividends that it receives. Alternatively, it could hold the same diversified portfolio by purchasing 10 percent or more of the interests in a RIC. If the RIC is a pure conduit, there may be no U.S. tax cost to interposing the RIC in the chain of ownership. Absent the special rule in paragraph 4, such use of the RIC could transform portfolio dividends, taxable in the United States under the Convention at a 15 percent maximum rate of withholding tax, into direct investment dividends taxable at a 5 percent maximum rate of withholding tax or eligible for the elimination of source-country withholding tax.

Similarly, a resident of Sweden directly holding U.S. real property would pay U.S. tax upon the sale of the property either at a 30 percent rate of withholding tax 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, absent a special rule, transform income from the sale of real estate into dividend income from the REIT, taxable at the rates provided in Article 10, significantly reducing the U.S. tax that otherwise would be imposed. Paragraph 4 prevents this result and thereby avoids a disparity between the taxation of direct real estate investments and real estate investments made through REIT conduits. In the cases in which paragraph 4 allows a dividend from a REIT to be eligible for the 15 percent rate of withholding tax, the holding in the REIT is not considered the equivalent of a direct holding in the underlying real property.

Paragraph 5

Paragraph 5 provides a broad and flexible definition of the term “dividends.” 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, including types of 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 residence of the dividend paying company. Thus, a constructive dividend that results from a non-arm's length transaction between a corporation and a related party is a dividend under paragraph 5.

In the case of the United States, the term dividends 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 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. In the case, of the United States, these rules include section 163(j) of the Code.

The term dividends also includes income from arrangements, including debt obligations, carrying the right to participate in profits. In the case of the United States, this includes contingent interest that is not portfolio interest.

Paragraph 6

Paragraph 6 provides that the general source country limitations under paragraph 2 and 3 on dividends do not apply if the beneficial owner of the dividends is a permanent establishment situated in the source country, or performs in that other State independent personal services from a fixed base situated therein, and the dividends are attributable to such permanent establish or fixed base. In such case, the rules of Article 7 (Business Profits) or Article 14 (Independent Personal Service) shall apply, as the case may be. Accordingly, such dividends will be taxed on a net basis using the rates and rules of taxation generally applicable to residents of the Contracting State in which the permanent establishment or fixed base is located, as modified by the Convention. An example of dividends paid with respect to the business property of a permanent establishment would be dividends derived by a dealer in stock or securities from stock or securities that the dealer held for sale to customers.

Paragraph 7

The right of a Contracting State to tax dividends paid by a company that is a resident of the other Contracting State is restricted by paragraph 7 to cases in which the dividends are paid to a resident of that Contracting State or are attributable to a permanent establishment or fixed base in that Contracting State. Thus, a Contracting State may not impose a “secondary” withholding tax on dividends paid by a nonresident company out of earnings and profits from that Contracting State. In the case of the United States, the secondary withholding tax was eliminated for payments made after December 31, 2004 in the American Jobs Creation Act of 2004.

Paragraph 8

Paragraph 8 provides an exemption from U.S. excise taxes on private foundations in the case of a religious, scientific, literary, educational, or charitable organization which

is resident in Sweden, but only if such organization has received substantially all of its support from persons other than citizens or residents of the United States. This provision is designed to ensure that the Nobel Foundation, a Swedish charitable organization, will not be subject to U.S. excise taxes.

Paragraphs 9 and 10

Paragraph 9 permits a Contracting State to impose a branch profits tax on a company resident in the other Contracting State. The tax is in addition to other taxes permitted by the Convention. The term “company” is defined in subparagraph 1(b) of Article 3 (General Definitions).

A Contracting State may impose a branch profits tax on a company if the company has income attributable to a permanent establishment in that Contracting State, derives income from real property in that Contracting State that is taxed on a net basis under Article 6 (Income from Real Property), or realizes gains taxable in that State under paragraph 1 of Article 13 (Gains). In the case of the United States, the imposition of such tax is limited, however, to the portion of the aforementioned items of income that represents the amount of such income that is the “dividend equivalent amount.” This is consistent with the relevant rules under the U.S. branch profits tax, and the term dividend equivalent amount is defined under U.S. law. Section 884 defines the dividend equivalent amount as an amount for a particular year that is equivalent to the income described above that is included in the corporation's effectively connected earnings and profits for that year, after payment of the corporate tax under Articles 6 (Income from Real Property), 7 (Business Profits) or 13 (Gains), 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.

Sweden currently does not impose a branch profits tax. If Sweden were to impose such a tax, the base is limited to the portion of the income described in subparagraph 9(a) that is comparable to the amount that would be distributed as a dividend by a locally incorporated subsidiary.

Paragraph 10 limits the rate of the branch profits tax allowed under paragraph 9 to 5 percent. Paragraph 10 also provides that the branch profits tax will not be imposed, however, if certain requirements are met. In general, these requirements provide rules for a branch that parallel the rules for when a dividend paid by a subsidiary will be subject to exclusive residence-country taxation (i.e., the elimination of source-country withholding tax). Accordingly, the branch profits tax may not be imposed in the case of a company that: (1) meets the “publicly traded” test of subparagraph 2(c) of Article 17 (Limitation of Benefits), (2) meets the “ownership base erosion” and “active trade or business” test described subparagraph 2(e) and subparagraph 4 of Article 17, (3) meets the “derivative benefits” test of paragraph 3 of Article 17, or (4) is granted the benefits of subparagraph 3(a) of Article 10 by the competent authority pursuant to paragraph 6 of Article 17.

Thus, for example, if a Swedish company would be subject to the branch profits tax with respect to profits attributable to a U.S. branch and not reinvested in that branch, paragraph 10 may apply to eliminate the branch profits tax if the company either met the “publicly traded” test, met both the “ownership-base erosion” and “active trade or business” tests, or the derivative benefits test. If, by contrast, a Swedish company did not meet those tests, then the branch profits tax would apply at a rate of 5 percent, unless the Swedish company is granted benefits with respect to the elimination of the branch profits tax by the competent authority pursuant to paragraph 6 of Article 17.

Paragraph 11

Paragraph 11 defines a pension fund to mean a person (as defined in Article 3 (General Definitions)) that is organized under the laws of a Contracting State who is established and maintained in that State primarily to administer or provide pensions or other similar remuneration, including social security payments, and is exempt from tax in that Contracting State with respect to such activities.

Relation to Other Articles

Notwithstanding the foregoing limitations on source country taxation of dividends, the saving clause of paragraph 4 of Article 1 (Personal Scope) permits the United States to tax dividends received by its residents and citizens as if the Convention had not come into effect.

The benefits of this Article are also subject to the provisions of Article 17 (Limitation on Benefits). Thus, if a resident of Sweden is the beneficial owner of dividends paid by a U.S. company, the shareholder must qualify for treaty benefits under at least one of the tests of Article 17 in order to receive the benefits of this Article.

Paragraph 2 of Article III of the Protocol makes a conforming change to the crossreference in paragraph 5 of Article 24 (Non-Discrimination) of the Convention.