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. Rules for the imposition of a tax on branch profits by the State of source are found in Article 11A (Branch Tax). Finally, the article prohibits a State from imposing a tax on dividends

paid by companies resident in the other Contracting State except if such dividends are paid to a resident of the first-mentioned State or are attributable to a permanent establishment or fixed based situated in the first-mentioned State.

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, except when the dividends arise in the other State or are attributable to a permanent establishment or fixed base in that other State. In those cases, that other State may also tax the dividend.

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 dividends is a company resident in the other State that holds at least 10 percent of the voting shares of the company paying the dividend, 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 non-voting 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.

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 5 of Article 25 (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 (Residence)) 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 (General 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.

Paragraph 3

Paragraph 3 provides rules that modify the maximum rates of tax at source provided in paragraph 2 in particular cases. The first sentence of paragraph 3 denies the lower direct investment withholding rate of paragraph 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 percent 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 the other State who owns not more than 10 percent interest in the REIT. Second, the dividend may qualify for the 15 percent 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 percent 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 unjustified source taxation benefits for certain shareholders resident in Venezuela. For example, a corporation resident in the other Contracting State 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 a 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 3, 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 Venezuela 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 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 4

Exemption from tax in the State of source is provided for dividends paid to a beneficial owner that is the other Contracting State, one of its political subdivisions or local authorities. In addition, exemption from tax in the State of source is provided for dividends paid to a beneficial owner that is a governmental entity resident in that other Contracting State constituted and operated exclusively to administer or provide pension benefits. This would include, in the case of the United States, state pension funds organized to provide benefits to retired state employees. In both cases, the exemption shall not apply if the dividends are derived directly or indirectly from the carrying on of a trade or business or from an associated enterprise.

Paragraph 8 of the Protocol provides that the reference in paragraph 4 of Article 10 of the Convention to a “governmental entity constituted and operated exclusively to administer or provide pension benefits” shall include certain public or mixed public and private entities that provide pension benefits. In the case of Venezuela, in order to qualify, such entity must operate under or pursuant to the Ley del Subsistema de Pensiones (Law of the Pension System) enacted under the Ley Orgánica del Sistema de Seguridad Social Integral (Organic Law of the Integrated Social Security System). The details of that law are described more fully below.

Venezuela is currently considering ways of reforming its government-run social security system. The Ley del Subsistema de Pensiones, under or pursuant to which a Venezuelan entity must operate in order to qualify under paragraph 8 of the Protocol, currently is proposed legislation that would replace Venezuela’s existing regime with a system of privatized funds, known under the proposed legislation as “individual capitalization funds” which would be permitted to invest in equities. Individuals would open “individual capitalization accounts” that could invest in the individual capitalization fund of the individual’s choice. Participation in these accounts would cover all workers. Under the proposed legislation, both the worker and the worker’s employer would be required to make contributions to the individual’s account. Upon retirement, the worker would receive distributions from his account in amounts based on the account’s investment performance. Further, the proposed legislation would establish “intergenerational solidarity funds,” for the purpose of providing a guaranteed minimum level of benefits in event of inadequate investment performance of a worker’s individual capitalization

fund of choice.

The stated objectives of the proposed legislation are to replace the current social security system with a system that retains the fundamental principles of the current system, grant benefits to citizens in general, and avoid inequities that exist between beneficiaries. The proposed legislation contemplates only the “individual capitalization funds” and “intergenerational solidarity funds.” Because the system under the proposed legislation is similar, both in its purpose and scope of application to all working Venezuelans and their dependents, to a government-run social security system, the inclusion of the proposed funds within the exemption for dividend payments to certain governmental entities providing pension benefits was judged warranted.

The exemption and the explicit inclusion of the proposed Venezuelan funds is consistent with the policy underlying section 892 of the Code, which provides a general tax exemption for the investment income of foreign governments. Also consistent with that policy, paragraph 4 states that the exemption will not apply if the dividend is derived from the carrying on of commercial activity or if the dividend is paid by an associated enterprise.

Any equivalent U.S. entities would also be eligible to receive the withholding exemption given to such governmental entities. Although the United States currently does not have any such funds, the provision was made reciprocal to ensure that, if the United States were ever to adopt a similar regime, the constituent entities would qualify for benefits.

There is no provision in the OECD Model analogous to paragraph 4 of the Convention.

Because the Ley del Subsistema de Pensiones has not been enacted, additional general requirements are listed in paragraph 8 of the Protocol to ensure that the exemption for dividend payments to certain governmental entities providing pension benefits will apply only to entities that operate under or pursuant to a final version of the law that includes the significant features of the proposed law. To satisfy these requirements, the final Venezuelan law must:

(1) provide universal coverage; (2) require mandatory contributions by both employers and employees; (3) limit the discretion of the employers and employees to direct investment; (4) restrict distributions or borrowing, directly or indirectly, except upon or until death, retirement or disability; and

(5) require that accounts be maintained at only one such qualifying entity at a time.

In addition, the entity must be operated, and its investment parameters established, pursuant to governmental oversight and regulation.

Paragraph 5

Paragraph 5 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 participate in the profits of the company and are treated as dividends under the laws of the source State. 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 6

Paragraph 6 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. 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 6 also apply, by virtue of paragraph 8 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 of accrual. See the Technical Explanation of paragraph 8 of Article 7.

Paragraph 7

A State's right to tax dividends paid by a company that is a resident of the other State is restricted by paragraph 7 to cases in which the dividends are paid to a resident of that State or are attributable to 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 7, 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).

Relation to Other Articles

Notwithstanding the foregoing limitations on source country taxation of dividends, the saving clause of paragraph 4 of Article 1 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 the other Contracting State 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 17 in order to receive the benefits of this Article.