Article 11 specifies the taxing — U.S. Income Tax Treaty

and residence and defines the terms necessary to apply the article. The Article provides for full residence country taxation of such interest and a limited source country right to tax.

Paragraph 1

Paragraph 1 preserves the residence country’s general right to tax its residents on interest arising in the other State. For interest from any other source paid to a resident, Article 22 (Other Income) grants the residence country exclusive taxing jurisdiction (other than for interest attributable to a permanent establishment or fixed base in the other State).

Paragraph 2

Paragraph 2 allows the State where the interest arises, as defined in paragraph 7, to tax the interest, except as provided in paragraph 3. If, however, the beneficial owner of the interest is a resident of the other Contracting State, the tax may not exceed the maximum rates specified in subparagraphs (a) and (b). 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 interest for purposes of Article 11 is the person to which the interest income is attributable for tax purposes under the laws of the source State. Thus, if interest arising in a Contracting State 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 interest 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 8 of the OECD Commentaries to Article 11. See also paragraph 24 of the OECD Commentaries to Article 1 (General Scope).

Subparagraph (a) applies to interest beneficially owned by any financial institution (including an insurance company). The rate of tax at source on such interest may not exceed 4.95 percent of the gross amount of the interest. This rate is based on Venezuela’s statutory rate of interest withholding when the payment is made to financial institutions.

Subparagraph (b) applies to all other categories of interest that are not dealt with in subparagraph (a) or paragraph 3. That subparagraph imposes a ceiling of 10 percent of the gross amount of such interest.

Paragraph 3

Paragraph 3 specifies three categories of interest that are exempt from source State taxation. The first category, described in subparagraph 3(a), is interest paid by that State or one of its political subdivisions or local authorities. The second category, described in subparagraph 3 (b), is interest beneficially owned by the other State or one of its political subdivisions, local authorities or by an instrumentality wholly owned by that State. Paragraph 9 of the Protocol defines these instrumentalities to include the U.S. Export-Import Bank, the Federal Reserve Banks, the Overseas Private Investment Corporation, the Venezuelan Banco de Comercio Exterior, the Banco Central de Venezuela and the Fondo de Inversiones de Venezuela. The Protocol also allows the competent authorities to agree on the inclusion of other such instrumentalities. The function of the Banco de Comercio Exterior, according to the legislation creating it, is the “promotion of exports and investments.” The legislation creating the Fondo de Inversiones de Venezuela states that the objectives of that entity are “to implement the privatization and restructuring of public entities, to assist in the financing of the development of the economic structure of the country, and the promotion of approved international investment projects.” The Banco Central de Venezuela is the Central Bank of Venezuela.

Finally, subparagraph 3 (c) describes the third category of interest which shall be exempt from source State taxation, interest beneficially owned by a resident of the other State with respect to debt obligations that have been made, guaranteed or insured, directly or indirectly, by that other State or one of its wholly owned instrumentalities described in the preceding two sentences.

Paragraph 4

Paragraph 4 provides anti-abuse exceptions to the source State reductions in tax provided in paragraphs 2 and 3 for two classes of interest payments.

The first exception, in subparagraph (a) of paragraph 4, deals with so-called "contingent interest." Under this provision interest arising in one of the Contracting States that is determined by reference to the receipts, sales, income, profits or other cash flow of the debtor or a related person, to any change in the value of any property of the debtor or a related person or to any dividend, partnership distribution or similar payment made by the debtor to a related person, also may be taxed in the Contracting State in which it arises, and according to the laws of that State, but if the beneficial owner is a resident of the other Contracting State, the gross amount of the interest may be taxed at a rate not exceeding the rate prescribed in subparagraph b) of paragraph 2 of Article 10 (Dividends).

The second exception, in subparagraph (b) of paragraph 4, is consistent with the policy of Code sections 860E(e) and 860G(b) that excess inclusions with respect to a real estate mortgage investment conduit (REMIC) should bear full U.S. tax in all cases. Without a full tax at source

foreign purchasers of residual interests would have a competitive advantage over U.S. purchasers at the time these interests are initially offered. Also, absent this rule the U.S. FISC would suffer a revenue loss with respect to mortgages held in a REMIC because of opportunities for tax avoidance created by differences in the timing of taxable and economic income produced by these interests.

Paragraph 5

The term "interest" as used in Article 11 is defined in paragraph 2 to include, inter alia, income from debt claims of every kind, whether or not secured by a mortgage. Penalty charges for late payment are excluded from the definition of interest. Interest that is paid or accrued subject to a contingency is within the ambit of Article 11. This includes income from a debt obligation carrying the right to participate in profits, unless such income is characterized as a dividend under the laws of the source State. The term does not, however, include amounts that are treated as dividends under Article 10 (Dividends).

The term interest also includes income that is treated as interest by the taxation law of the Contracting State in which the income arises. Thus, for purposes of the Convention amounts that the United States will treat as interest include

(i) the difference between the issue price and the stated redemption price at maturity of a debt instrument, i.e., original issue discount (OID), which may be wholly or partially realized on the disposition of a debt instrument (section 1273),

(ii) amounts that are imputed interest on a deferred sales contract (section 483), (iii) amounts treated as interest or OID under the stripped bond rules (section 1286),

(iv) amounts treated as original issue discount under the below-market interest rate rules (section 7872),

(v) a partner's distributive share of a partnership's interest income (section 702), (vi) the interest portion of periodic payments made under a "finance lease" or similar contractual arrangement that in substance is a borrowing by the nominal lessee to finance the acquisition of property,

(vii) amounts included in the income of a holder of a residual interest in a REMIC (section 860E), because these amounts generally are subject to the same taxation treatment as interest under U.S. tax law, and

(viii) embedded interest with respect to notional principal contracts.

Paragraph 6

Paragraph 6 provides an exception to the taxing rules of paragraphs 2 and 3 in cases where the beneficial owner of the interest carries on business through a permanent establishment in the State of source or performs independent personal services from a fixed base situated in that State and the interest is attributable to that permanent establishment or fixed base. In such cases the provisions of Article 7 (Business Profits) or Article 14 (Independent Personal Services) will apply and the State of source will retain the right to impose tax on such interest income on a net

basis.

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 interest 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 8 of Article 7.

Paragraph 7

Paragraph 7 provides a general source rule with two exceptions. Interest is considered to arise in a Contracting State if paid by a resident of that State (including that State itself or one of its political subdivisions or local authorities). As a first exception, interest that is borne by a permanent establishment or fixed base in one of the States is considered to arise in that State. For this purpose, interest is considered to be borne by a permanent establishment or fixed base if it is allocable to taxable income of that permanent establishment or fixed base. Likewise, if the person paying the interest, whether or not he is a resident of a Contracting State, derives profits that are taxable in one of the Contracting States on a net basis under paragraphs of Article 5 (Income from Immovable Property (Real Property)) or paragraph 1 of Article 13 (Gains), and the interest is allocable to those profits, it shall be deemed to arise in that State.

Paragraph 8

Paragraph 8 provides that in cases involving special relationships between persons, Article 11 applies only to that portion of the total interest payments that would have been made absent such special relationships (i.e., an arm’s length interest payment). Any excess amount of interest paid remains taxable according to the laws of the United States and Venezuela, respectively, with due regard to the other provisions of the Convention. Thus, if the excess amount would be treated under the source country's law as a distribution of profits by a corporation, such amount could be taxed as a dividend rather than as interest, but the tax would be subject, if appropriate, to the rate limitations of paragraph 2 of Article 10 (Dividends).

The term "special relationship" is not defined in the Convention. In applying this paragraph the United States considers the term to include the relationships described in Article 9, which in turn correspond to the definition of "control" for purposes of section 482 of the Code.

This paragraph does not address cases where, owing to a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the interest is less than an arm’s length amount. In those cases a transaction may be characterized to reflect its substance and interest may be imputed consistent with the definition of interest in paragraph 2. Consistent with Article 9 (Associated Enterprises) the United States would apply section 482 or 7872 of the Code to determine the amount of imputed interest in those cases.

Relation to Other Articles

Notwithstanding the foregoing limitations on source country taxation of interest, the

saving clause of paragraph 4 of Article 1 permits the United States to tax its residents and citizens as if the Convention had not come into force.

As with other benefits of the Convention, the benefits of limited source State taxation under paragraphs 2, 3 and 4(a), are available to a resident of the other State only if that resident is entitled to those benefits under the provisions of Article 17 (Limitation on Benefits).