ARTICLE 23 (RELIEF FROM DOUBLE — U.S. Income Tax Treaty

This Article describes the manner in which each Contracting State undertakes to relieve double taxation. The United States uses the foreign tax credit method under its internal law, and by treaty.

Paragraph 1

Paragraph 1 provides that the other Contracting State will provide relief from double taxation through [the credit method/the exemption method/a mixture of the credit and exemption methods.]

2006 U.S. Model Technical Explanation

Paragraph 2

The United States agrees, in paragraph 2, to allow to its citizens and residents a credit against U.S. tax for income taxes paid or accrued to the other Contracting State. Paragraph 2 also provides that the other Contracting State=s covered taxes are income taxes for U.S. purposes. This provision is based on the Department of the Treasury=s review of the other Contracting State=s laws.

Subparagraph (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 corporation resident in the other Contracting State of which the U.S. corporation owns at least 10 percent of the voting stock. This credit is for the tax paid by the corporation to the other Contracting State on the profits out of which the dividends are considered paid.

The credits allowed under paragraph 2 are 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 the Article, that is, 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.

Therefore, the U.S. credit under the Convention is subject to the various limitations of U.S. law (see, e.g ., Code sections 901-908). For example, the credit against U.S. tax generally is limited 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) and (d)), and the dollar amount of the credit is determined in accordance with U.S. currency translation rules (see, e.g., Code section 986). Similarly, U.S. law applies to determine carryover periods for excess credits and other inter-year adjustments.

Paragraph 3

Paragraph 3 provides a re-sourcing rule for gross income covered by paragraph 2. Paragraph 3 is intended to ensure that a U.S. resident can obtain an appropriate amount of U.S. foreign tax credit for income taxes paid to the other Contracting State when the Convention assigns to the other Contracting State primary taxing rights over an item of gross income.

Accordingly, if the Convention allows the other Contracting State to tax an item of gross income (as defined under U.S. law) derived by a resident of the United States, the United States will treat that item of gross income as gross income from sources within the other Contracting State for U.S. foreign tax credit purposes. In the case of a U.S.-owned foreign corporation, however, section 904(g)(10) may apply for purposes of determining the U.S. foreign tax credit with respect to income subject to this re-sourcing rule. Section 904(g)(10) generally applies the foreign tax credit limitation separately to re-sourced income. Furthermore, the paragraph 2 resourcing rule applies to gross income, not net income. Accordingly, U.S. expense allocation and apportionment rules, see, e.g., Treas. Reg. section 1.861-9, continue to apply to income resourced under paragraph 2.

2006 U.S. Model Technical Explanation

Paragraph 4

Paragraph 4 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 residents of the other Contracting State. Since U.S. citizens, regardless of residence, 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 other Contracting State 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 other Contracting State who is not a U.S. citizen. The provisions of paragraph 4 ensure that the other Contracting State does not bear the cost of U.S. taxation of its citizens who are residents of the other Contracting State.

Subparagraph (a) provides, with respect to items of income from sources within the United States, special credit rules for the other Contracting State. These rules apply to items of U.S.-source income that would be either exempt from U.S. tax or subject to reduced rates of U.S. tax under the provisions of the Convention if they had been received by a resident of the other Contracting State who is not a U.S. citizen. The tax credit allowed under paragraph 4 with respect to such items need not exceed the U.S. tax that may be imposed under 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 4 of Article 1 (General Scope).

For example, if a U.S. citizen resident in the other Contracting State receives portfolio dividends from sources within the United States, the foreign tax credit granted by the other Contracting State would be limited to 15 percent of the dividend – the U.S. tax that may be imposed under subparagraph (b) of paragraph 2 of Article 10 (Dividends) – even if the shareholder is subject to U.S. net income tax because of his U.S. citizenship. With respect to royalty or interest income, the other Contracting State would allow no foreign tax credit, because its residents are exempt from U.S. tax on these classes of income under the provisions of Articles 11 (Interest) and 12 (Royalties).

Paragraph 4(b) eliminates the potential for double taxation that can arise because subparagraph 4(a) provides that the other Contracting State need not provide full relief for the U.S. tax imposed on its citizens resident in the other Contracting State. The subparagraph provides that the United States will credit the income tax paid or accrued to the other Contracting State, after the application of subparagraph 4(a). It further provides that in allowing the credit, the United States will not reduce its tax below the amount that is taken into account in the other Contracting State in applying subparagraph 4(a).

Since the income described in paragraph 4(a) generally will be U.S. source income, special rules are required to re-source some of the income to the other Contracting State in order for the United States to be able to credit the tax paid to the other Contracting State. This resourcing is provided for in subparagraph 4(c), which deems the items of income referred to in subparagraph 4(a) to be from foreign sources to the extent necessary to avoid double taxation under paragraph 4(b). Subparagraph 3(c)(iii) of Article 25 (Mutual Agreement Procedure)

2006 U.S. Model Technical Explanation

provides a mechanism by which the competent authorities can resolve any disputes regarding whether income is from sources within the United States.

The following two examples illustrate the application of paragraph 4 in the case of a U.S.-source portfolio dividend received by a U.S. citizen resident in the other Contracting State. In both examples, the U.S. rate of tax on residents of the other Contracting State, under subparagraph (b) of paragraph 2 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 35 percent. In example 1, the rate of income tax imposed in the other Contracting State on its resident (the U.S. citizen) is 25 percent (below the U.S. rate), and in example 2, the rate imposed on its resident is 40 percent (above the U.S. rate).

Example 1 Example 2 Subparagraph (a)

U.S. dividend declared $100.00 $100.00 Notional U.S. withholding tax (Article 10(2)(b)) 15.00 15.00 Taxable income in other Contracting State 100.00 100.00 Other Contracting State tax before credit 25.00 40.00 Less: tax credit for notional U.S. withholding tax 15.00 15.00 Net post-credit tax paid to other Contracting State 10.00 25.00

Subparagraphs (b) and (c)

U.S. pre-tax income $100.00 $100.00 U.S. pre-credit citizenship tax 35.00 35.00 Notional U.S. withholding tax 15.00 15.00 U.S. tax eligible to be offset by credit 20.00 20.00 Tax paid to other Contracting State 10.00 25.00 Income re-sourced from U.S. to foreign source (see below) 28.57 57.14 U.S. pre-credit tax on re-sourced income 10.00 20.00 U.S. credit for tax paid to the other Contracting State 10.00 20.00 Net post-credit U.S. tax 10.00 0.00 Total U.S. tax 25.00 15.00

In both examples, in the application of subparagraph (a), the other Contracting State credits a 15 percent U.S. tax against its residence tax on the U.S. citizen. In the first example, the net tax paid to the other Contracting State after the foreign tax credit is $10.00; in the second example, it is $25.00. In the application of subparagraphs (b) and (c), from the U.S. tax due before credit of $35.00, the United States subtracts the amount of the U.S. source tax of $15.00, against which no U.S. foreign tax credit is allowed. This subtraction ensures that the United States collects the tax that it is due under the Convention as the State of source.

In both examples, given the 35 percent U.S. tax rate, the maximum amount of U.S. tax against which credit for the tax paid to the other Contracting State may be claimed is $20 ($35

2006 U.S. Model Technical Explanation

U.S. tax minus $15 U.S. withholding tax). Initially, all of the income in both examples was from sources within the United States. For a U.S. foreign tax credit to be allowed for the full amount of the tax paid to the other Contracting State, an appropriate amount of the income must be resourced to the other Contracting State under subparagraph (c).

The amount that must be re-sourced depends on the amount of tax for which the U.S. citizen is claiming a U.S. foreign tax credit. In example 1, the tax paid to the other Contracting State was $10. For this amount to be creditable against U.S. tax, $28.57 ($10 tax divided by 35 percent U.S. tax rate) must be resourced to the other Contracting State. When the tax is credited against the $10 of U.S. tax on this resourced income, there is a net U.S. tax of $10 due after credit ($20 U.S. tax eligible to be offset by credit, minus $10 tax paid to the other Contracting State). Thus, in example 1, there is a total of $25 in U.S. tax ($15 U.S. withholding tax plus $10 residual U.S. tax).

In example 2, the tax paid to the other Contracting State was $25, but, because the United States subtracts the U.S. withholding tax of $15 from the total U.S. tax of $35, only $20 of U.S. taxes may be offset by taxes paid to the other Contracting State. Accordingly, the amount that must be resourced to the other Contracting State is limited to the amount necessary to ensure a U.S. foreign tax credit for $20 of tax paid to the other Contracting State, or $57.14 ($20 tax paid to the other Contracting State divided by 35 percent U.S. tax rate). When the tax paid to the other Contracting State is credited against the U.S. tax on this re-sourced income, there is no residual U.S. tax ($20 U.S. tax minus $25 tax paid to the other Contracting State, subject to the U.S. limit of $20). Thus, in example 2, there is a total of $15 in U.S. tax ($15 U.S. withholding tax plus $0 residual U.S. tax). Because the tax paid to the other Contracting State was $25 and the U.S. tax eligible to be offset by credit was $20, there is $5 of excess foreign tax credit available for carryover.

Relationship to other Articles

By virtue of subparagraph (a) of paragraph 5 of Article 1 (General Scope), Article 23 is not subject to the saving clause of paragraph 4 of Article 1. 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 (such as the re-sourcing provided by paragraph 3 and subparagraph 4(c)).