TESTIMONY OF WILLIAM A. REINSCH, PRESIDENT
NATIONAL FOREIGN TRADE COUNCIL
THE RATIFICATION OF AN INCOME TAX TREATY AND VARIOUS PROTOCOLS
BEFORE THE SENATE COMMITTEE ON FOREIGN RELATIONS
FEBRUARY 2, 2006
Mr. Chairman and Members of the Committee:
The National Foreign Trade Council (NFTC) is pleased to recommend ratification of the treaties and protocols under consideration by the Committee today. We appreciate the Chairman’s actions in scheduling this hearing so early in the year, and we strongly urge the Committee to reaffirm the United States’ historic opposition to double taxation by giving its full support to the pending Bangladesh Tax Treaty and the Protocols with Sweden and France.
The NFTC, organized in 1914, is an association of some 300 U.S. business enterprises engaged in all aspects of international trade and investment. Our membership covers the full spectrum of industrial, commercial, financial, and service activities, and the NFTC therefore seeks to foster an environment in which U.S. companies can be dynamic and effective competitors in the international business arena. To achieve this goal, American businesses must be able to participate fully in business activities throughout the world, through the export of goods, services, technology, and entertainment, and through direct investment in facilities abroad. As global competition grows ever more intense, it is vital to the health of U.S. enterprises and to their continuing ability to contribute to the U.S. economy that they be free from excessive foreign taxes or double taxation and impediments to the flow of capital that can serve as barriers to full participation in the international marketplace. Foreign trade is fundamental to the economic growth of U.S. companies. Tax treaties are a crucial component of the framework that is necessary to allow that growth and to balanced competition.
This is why the NFTC has long supported the expansion and strengthening of the U.S. tax treaty network and why we are here today to recommend ratification of the Tax Treaty with Bangladesh and the Protocols with Sweden and France.
TAX TREATIES AND THEIR IMPORTANCE TO THE UNITED STATES
Tax treaties are bilateral agreements between the United States and foreign countries that serve to harmonize the tax systems of the two countries with respect to persons involved in cross-border investment and trade. Tax treaties eliminate this double taxation by allocating taxing jurisdiction over the income between the two countries. In the absence of tax treaties, income from international transactions or investments may be subject to double taxation, first by the country where the income arises and again by the country of the recipient’s residence.
In addition, the tax systems of most countries impose withholding taxes, frequently at high rates, on payments of dividends, interest, and royalties to foreigners, and treaties are the mechanism by which these taxes are lowered on a bilateral basis. If U.S. enterprises earning such income abroad cannot enjoy the reduced foreign withholding rates offered by a tax treaty, they are liable to suffer excessive and noncreditable levels of foreign tax and to be at a competitive disadvantage relative to traders and investors from other countries that do have such benefits. Tax treaties serve to prevent this barrier to U.S. participation in international commerce.
If U.S. businesses are going to maintain a competitive position around the world, we need a treaty policy that protects them from multiple or excessive levels of foreign tax on cross border investments, particularly if their competitors already enjoy that advantage. The United States has lagged behind other developed countries in eliminating this withholding tax and leveling the playing field for cross‑border investment. The European Union (EU) eliminated the tax on intra‑EU, parent‑subsidiary dividends over a decade ago and dozens of bilateral treaties between foreign countries have also followed that route. The majority of OECD countries now have bilateral treaties in place that provide for a zero rate on parent‑subsidiary dividends.
Tax treaties also provide other features that are vital to the competitive position of U.S. businesses. For example, by prescribing internationally agreed thresholds for the imposition of taxation by foreign countries on inbound investment, and by requiring foreign tax laws to be applied in a nondiscriminatory manner to U.S. enterprises, treaties offer a significant measure of certainty to potential investors. Another extremely important benefit which is available exclusively under tax treaties is the mutual agreement procedure. This bilateral administrative mechanism provides another opportunity for the avoidance of double taxation on cross-border transactions.
Taxpayers are not the only beneficiaries of tax treaties. Treaties protect the legitimate enforcement interests of the United States by providing for the administration of U.S. tax laws and the implementation of U.S. treaty policy. The article that provides for the exchange of information between tax authorities is an excellent example of the benefits that result from an expanded tax treaty network. Treaties also offer the possibility of administrative assistance in the collection of taxes between the relevant tax authorities.
A framework for the resolution of disputes with respect to overlapping claims by the respective governments is also provided for in tax treaties. In particular, the practices of the Competent Authorities under the treaties have led to agreements, known as “Advance Pricing Agreements” or “APAs,” through which tax authorities of the United States and other countries have been able to avoid costly and unproductive proceedings over appropriate transfer prices for the trade in goods and services between related entities. APAs, which are agreements jointly entered into between one or more countries and particular taxpayers, have become common and increasingly popular procedures for countries and taxpayers to settle their transfer pricing issues in advance of dispute. The clear trend is that treaties are becoming an increasingly important tool used by tax authorities and taxpayers alike in striving for fairer and more efficient application of the tax laws.
AGREEMENTS BEFORE THE COMMITTEE
The Swedish Protocol that is before the committee today updates an existing agreement between Sweden and the United States signed over a decade ago. The protocol improves a convention that has stimulated increased investment, greater transparency, and a stronger economic relationship between our two countries. The NFTC commends Treasury for its determination to facilitate increased trade and investment through this protocol and the other agreements under consideration.
The NFTC has for years urged adjustment of U.S. treaty policies to allow for a zero withholding rate on related-entity dividends, and we praise the Treasury for making further progress in this protocol with Sweden. This agreement continues the important contribution toward improving the economic competitiveness of U.S. companies achieved in prior agreements with the Netherlands, Japan, the United Kingdom, Australia, and Mexico. We thank the committee for its prior support of this evolution in U.S. tax treaty policy and we strongly urge you to continue that support by approving the Swedish Protocol.
The existence of a withholding tax on cross-border, parent-subsidiary dividends, even at the five percent rate previously typical in U.S. treaties, has served as a tariff-like impediment to cross-border investment flows. Without a zero rate, the combination of the underlying corporate tax and the withholding tax on the dividend will often leave parent companies with an excess of foreign tax credits. Because these excesses are unusable, the result is a lower return from a cross-border investment than a comparable domestic investment. Tax treaties are designed to prevent this distortion in the investment decision-making process by reducing multiple taxation of profits within a corporate group, and they serve to prevent the hurdle to U.S. participation in international commerce. Eliminating the withholding tax on cross-border dividends means that U.S. companies with stakes in Swedish companies will now be able to meet their foreign competitors on a level playing field.
Another notable inclusion is a zero withholding rate on dividends paid to pension funds which should attract investment from those funds into U.S. stocks. Also reflected is modern U.S. tax treaty policy regarding when reduced U.S. withholding rates will apply to dividends paid by Regulated Investment Companies (RICs) and Real Estate Investment Trusts (REITs), as well as recent U.S. law changes aimed at preserving taxing jurisdiction over certain individuals who terminate their long‑term residence within the United States.
Additionally, important safeguards are included in the Swedish Protocol to prevent treaty shopping. For example, in order to qualify for the lowered rates specified by the agreement, companies must meet certain requirements so that foreigners whose governments have not negotiated a tax treaty with Sweden or the U.S. cannot free-ride on this treaty. Provisions in the protocol are intended to ensure that its benefits accrue only to those for which they are intended.
The French Protocols that are before the committee today represent updates and improvements to existing agreements. These protocols will enhance an already flourishing economic relationship between our two countries. Included in the updated agreements are current U.S. tax treaty policies regarding hybrid entities and the application of reduced withholding tax rates for dividends paid by RICs and REITs. Another notable inclusion in the French Protocols recognizes reciprocal pension and retirement benefits for individuals of either country eliminating double taxation on contributions and payments paid by or for an individual to a pension or retirement plan, reducing the burden on individuals working for foreign subsidiaries of companies in either country.
Including REITs in the French Convention will stimulate foreign direct investment into the U.S. and provide greater incentives for French foreign nationals to keep that income in the U.S. Such measures are integral to fostering an atmosphere conducive to the investment needs of both foreign nationals and U.S. businesses, specifically in the financial services industry.
The tax treaty with Bangladesh represents a new tax treaty relationship for the United States. The agreement is a significant step forward in the U.S. economic relationship with Bangladesh. As a modernizing nation, Bangladesh is in a developmental phase, which gives rise to opportunities for American business because of the projects and the economic development that an expanding infrastructure will allow. Without a similar tax arrangement, U.S. companies that are interested in investing in or trading with Bangladesh are at a competitive disadvantage.
While the Bangladesh Treaty does not go as far as other agreements (e.g., in eliminating withholding taxes for dividends, interest, and royalties), it represents an important starting point in a growing economic relationship with Bangladesh. The Bangladesh Treaty reflects current U.S. tax treaty policy for agreements with developing nations, and it includes appropriate measures to prevent treaty shopping. The NFTC strongly supports action to create the competitive balance afforded to U.S. enterprises by this tax treaty.
GENERAL COMMENTS ON TAX TREATY POLICY
While we are not aware of any opposition to the treaties under consideration, the NFTC as it has done in the past as a general cautionary note, urges the Committee to reject opposition to the agreements based on the presence or absence of a single provision. No process that is as laden with competing considerations as the negotiation of a full-scale tax treaty between sovereign states will be able to produce an agreement that will completely satisfy every possible constituency, and no such result should be expected. Virtually all treaty relationships arise from difficult and sometimes delicate negotiations aimed at resolving conflicts between the tax laws and policies of the negotiating countries. The resulting compromises always reflect a series of concessions by both countries from their preferred positions. Recognizing this, but also cognizant of the vital role tax treaties play in creating a level playing field for enterprises engaged in international commerce, the NFTC believes that treaties should be evaluated on the basis of their overall effect. In other words, agreements should be judged on whether they encourage international flows of trade and investment between the United States and the other country. An agreement that meets this standard will provide the guidance enterprises need in planning for the future, provide nondiscriminatory treatment for U.S. traders and investors as compared to those of other countries, and meet a minimum level of acceptability in comparison with the preferred U.S. position and expressed goals of the business community.
Mechanical comparisons of a particular treaty’s provisions with the U.S. Model or with treaties with other countries do not provide an appropriate basis for analyzing a treaty’s value. U.S. negotiators are to be applauded for achieving agreements that reflect current U.S. tax treaty policy and the views expressed by the U.S. business community.
The NFTC also wishes to emphasize how important treaties are in creating, implementing, and preserving an international consensus on the desirability of avoiding double taxation, particularly with respect to transactions between related entities. The United States, together with many of its treaty partners, has worked long and hard through the OECD and other fora to promote acceptance of the arm’s length standard for pricing transactions between related parties. The worldwide acceptance of this standard, which is reflected in the intricate treaty network covering the United States and dozens of other countries, is a tribute to governments’ commitment to prevent conflicting income measurements from leading to double taxation and resulting distortions and barriers for international trade. Treaties are a crucial element in achieving this goal because they contain an expression of both governments’ commitment to the arm’s length standard and provide the only available bilateral mechanism, the competent authority procedure, to resolve any disputes about the application of the standard in practice.
We recognize that determination of the appropriate arm’s length transfer price for the exchange of goods and services between related entities is sometimes a complex task that can lead to good faith disagreements between well-intentioned parties. Nevertheless, the points of international agreement on the governing principles far outnumber any points of disagreement. Indeed, after decades of close examination, governments around the world agree that the arm’s length principle is the best available standard for determining the appropriate transfer price because of both its economic neutrality and its ability to be applied by taxpayers and revenue authorities alike by reference to verifiable data.
The NFTC strongly supports the efforts of the Internal Revenue Service and the Treasury to promote continuing international consensus on the appropriate transfer pricing standards, as well as innovative procedures for implementing that consensus. We applaud the continued growth of the APA program, which is designed to achieve agreement between taxpayers and revenue authorities on the proper pricing methodology to be used, before disputes arise. We commend the ongoing efforts of the IRS to refine and improve the operation of the competent authority process under treaties to make it a more efficient and reliable means of avoiding double taxation.
The NFTC also wishes to reiterate its support for the existing procedure by which Treasury consults on a regular basis with this Committee, the tax-writing Committees, and the appropriate Congressional staffs concerning tax treaty issues and negotiations and the interaction between treaties and developing tax legislation. We encourage all participants in such consultations to give them a high priority. We also commend this Committee for scheduling tax treaty hearings quickly after receiving the agreements from the Executive Branch. Doing so enables improvements in the treaty network to enter into effect as quickly as possible.
We would also like to reaffirm our view, frequently voiced in the past, that Congress should avoid occasions of overriding in subsequent domestic legislation the U.S. tax treaty commitments approved by this Committee. We believe that consultation, negotiation, and mutual agreement upon changes, rather than unilateral legislative abrogation of treaty commitments, better supports the mutual goals of treaty partners.
Finally, the NFTC is grateful to the Chairman and the Members of the Committee for their continuing commitment to giving international economic relations prominence in the Committee’s agenda, particularly when the demands upon the Committee’s time are so pressing. We would also like to express our appreciation for the efforts of both Majority and Minority staff in arranging for this hearing to be scheduled and held at this time.
We commend the Committee for its commitment to proceed with ratification of these important agreements as expeditiously as possible.