Article 10 provides rules for the taxation of dividends and

similar amounts paid by a company resident in one Contracting State to a resident of the other Contracting State. Article 10

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also provides rules for the imposition by the United States of a

tax on branch profits. Although paragraph 1 establishes that dividends "may be taxed" in the residence country, as noted in the MOU, this rule does not prevent the source State from also taxing such dividends. Generally, the article limits the source State's right to tax dividends and amounts treated as dividends

or dividend equivalents.

   Under paragraph 1, dividends paid by a company that is a

resident of one Contracting State to a shareholder resident in the other Contracting State may be taxed in the State of resi­ dence of the recipient. Thus, paragraph 1 preserves the right of each Contracting State to tax dividends derived by its residentsfrom companies resident in the other Contracting State. In the case of the United States, this provision is consistent with the saving clause of paragraph 5 of Article 1 (Personal Scope).

   Under Austrian law, Austria generally exempts certain direct

investment dividends. Dividends received by a resident company from its nonresident subsidiary are exempt from corporate income tax in the hands of the former, subject to the condition that the

recipient company owned 25% or more of the share capital of the

distributing company directly and continuously for at least 12

months prior to the end of the taxable year in which the profit

distribution was received (KStG 1988. Sec. 10). Dividends which

do not qualify for exemption under this participation exemption
are normally included in taxable income.

   Paragraph 2 limits the right of the source State to tax

dividends paid by a company resident in that State if the benefi­

cial owner of the dividends is a resident of the other Contract­

ing State. Under subparagraph 2(a), the source State tax is

generally limited to 5 percent of the gross amount of the divi­

dends if the beneficial owner is a company (other than a partner­ ship) that holds directly at least 10 percent of the voting stock of the company paying the dividend. Under subparagraph 2(b), the

source State tax is limited to 15 percent of the gross amount of

the dividends in all other cases. Indirect ownership of voting shares (e g., through tiers of corporations) and direct ownership

of nonvoting shares are not included 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 the person, or a majority of the board of
persons, exercising the powers ordinarily exercised by the board

of directors of a U.S. corporation., The Convention does not

require that the 10-percent voting interest be held for a minimum
period prior to the dividend payment date.

Under the 1956 Convention, direct investment dividends are
also taxable by the source State at a maximum rate of 5 percent
of the statutory rate of tax otherwise imposed on such dividends,

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but the 1956 Convention requires an ownership threshold of 95

percent for the 5 percent rate to apply. Portfolio dividends are subject to source State tax under the 1956 Convention at a rate that is one-half of the rate otherwise applicable. In the base of the United States, this rule results in the application of a 15 percent rate.

Paragraph 2 imposes special limits on the rate of source State taxation for dividends paid by U.S. Regulated Investment Companies and Real Estate Investment Trusts ("RICs" and "REITs"). Because RICs and REITs are generally not liable to corporate tax with respect to distributed amounts, the rate reduction from 15

to 5 percent cannot be justified as a means of relieving multiple

levels of corporate tax when the dividend recipient holds a

substantial interest in the payer. Dividends paid by RICs are denied the 5-percent direct dividend rate and are subject to the

15-percent portfolio dividend rate (which generally would be applicable to a direct investment in the underlying corporate stock), regardless of the percentage of voting shares held directly by an Austrian corporate recipient of the dividend. Dividends paid by a REIT are generally taxed at source at full statutory rates (reflecting the source State taxation of real property income under Article 6). The fact that notwithstanding paragraphs 1 and 2, the United States may tax most REIT dividends at its statutory 30-percent rate is made clear in the Memorandum of Understanding. However, dividends paid by REITs are taxed at

source at the 15-percent portfolio dividend rate if the benefi­

cial,owner of the dividend is an Austrian individual who owns

less than a 10-percent interest in the REIT.

   The denial of the 5-percent withholding rate at source to

all RIC and REIT shareholders, and the denial of the 15 percent

ratd to most shareholders of REITs, is intended to prevent the

use of these conduit entities to gain unjustifiable benefits for certain shareholders. For example, an Austrian corporation 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. Alterna­

tively, it may place the portfolio of U.S. stocks in a RIC in

which the Austrian corporation owns more than 10 percent 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 Austrian corporation

of interposing the RIC as an intermediary in the chain of owner­

ship. In the absence of the special rules in paragraph 2,

however, the interposition would transform portfolio dividends into direct investment dividends, which are taxable at source by

the United States at only 5 percent.

Similarly, a resident of Austria may hold U.S. real property

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directly and pay U.S. tax either at a 30-percent rate on the
gross income or at the ordinary income tax rates specified in
Code sections 1 or 11 on net income. As in the preceding exam­
ple, by placing the real estate holding in a REIT, the Austrian

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 an
Austrian 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 excep­
tion, 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 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 10-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 (._e, the source
country). The beneficial owner of a U.S. source 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 U.S. corporation is re­
ceived by a nominee or an agent that is a resident of Austria on
behalf of a person that is not a resident of Austria the dividend
is not entitled to the benefits of this Article. However, a
dividend received by the nominee on behalf of a resident of
Austria would be entitled to the U.S. benefits.
   Paragraph 2 does not affect the taxation of the profits of
the corporation out of which the dividends are paid.

   Paragraph 3 defines the term dividends as used in Article 10
to mean income from shares or other rights, not being debt
claims, participating in profits, as well as other income derived

from other rights that is subjected to the same taxation treat­
ment as income from shares by the laws of the Contracting State

of which the company making the distribution is a resident. The
definition of dividends also includes income from arrangements,
including debt obligations, that carry the right to participate
in profits, or that are determined by reference to profits, to
the extent that such income is characterized as a dividend under
the tax law of the source State. 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.

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Rul. 92-85, 1992-2 CB 69 (sale of foreign subsidiary 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. Under Austrian law, the income from Austrian bonds participating in profits is not characterized as a dividend but rather as interest.

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. Further, if a shareholder lends shares to a third party, the payments by the borrower to the lender in

substitution for dividends the lender otherwise would have received also would be treated as dividends.

Paragraph 4 excludes from the rules of paragraphs 1 and 2 dividends effectively connected with a permanent establishment or

fixed base of the recipient in the source State. Such dividends

will be included in the taxable income of the permanent
establishment and taxed on a net basis under the rules of Article
7 (Business Profits) or Article 14 (Independent Personal

Services). This rule conforms to the OECD Model. The rule in

paragraph 9 of Article 7 (Business Profits) applies to this

paragraph as well, so that dividends attributable to a permanent establishment or fixed base, but received after the permanent establishment or fixed base no longer exists, will, nevertheless,

be taxable in the Contracting State in which the permanent
establishment or fixed base existed.

Paragraph 5 generally bars one Contracting State from impos­ ing any tax on dividends paid by a company resident in the other Contracting State or on the undistributed profits of such compa­ ny, even if the dividends or profits consist wholly or partly of profits or income arising in that first State. However, excep­

tions to this rule apply if such dividends are paid to a resident
of the first-mentioned Contracting State, or if the holding in
respect of which the dividends are paid is effectively connected

with a permanent establishment or fixed base situated in the

first-mentioned State.

   Paragraph 6 provides for the imposition of a branch profits

tax by the United States. The paragraph permits the United

States to impose an additional tax (i e., its branch profits tax

imposed by section 884(a) of the Code) on a company that is resident in Austria and that has a permanent establishment in the United States, or that is subject to net basis taxation in the United States under Article 6 (Income from Real Property) because the Austrian corporation has elected under Code section 882(d) to treat income from real property not otherwise taxed on a net

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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. Such additional tax may be imposed only on the portion of the business profits of the Austria company that is attributable to the permanent establishment and the portion of net income that is subject to tax under Article 6 or paragraph 1 of Article 13 that represents the dividend equivalent amount. For this purpose, "dividend equivalent amount" has the same meaning it has under U.S. law, as amended from time to time without changing the general principle thereof. It is understood that the concept of

dividend equivalent amount is intended to approximate the portion
of the income referred to above that would be distributed as a
dividend if such income were earned by a U.S. subsidiary of the

Austrian company. The United States may not impose its branch tax on the business profits of an Austrian corporation that are effectively connected with a U.S. trade or business but that are not attributable to a permanent establishment and are not other­ wise subject to U.S. taxation under Article 6 or paragraph 1 of

Article 13.

Austria does not impose a branch tax under its law, and,

therefore, saw no need to preserve an Austrian right to impose
such a tax under the treaty.

   Paragraph 7 provides that the branch profits tax permitted
by paragraph 6 shall not be imposed at a rate exceeding the

direct dividend withholding rate specified in subparagraph 2(a),

which is five percent.

   Notwithstanding the foregoing limitations on source State
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, subject to the

special foreign tax credit rules of paragraph 2 of Article 22
(Relief from Double Taxation), as if the Convention had not come

into effect. The benefits of this Article are available to a resident of a Contracting State only if that resident qualifies

for benefits under the provisions of Article 16 (Limitation on
Benefits).