then the other country, is to make a correlative adjustment to the amount of the tax charged on its resident on those profits. In determining the correlative adjustment, the other country is to give due regard to the other provisions of the proposed treaty and, if necessary, the competent authorities of the two countries will consult with each other.

The proposed treaty omits the U.S. model provision stating that this article is not intended to limit any law in either country that permits the distribution, apportionment, or allocation of income, deductions, credits, or allowances between non-independent persons when such law is necessary to prevent evasion of taxes or to reflect clearly the income of those persons. That provision generally clarifies that the United States retains the right to apply its intercompany pricing rules (Code sec. 482) and its rules relating to the allocation of deductions (Code secs. 861, 862, 863, and 864, and applicable regulations). As reflected in the Technical Explanation, the Committee understands that the United States retains the right under the proposed treaty to apply its intercompany pricing and deduction allocation rules, notwithstanding the omission of the standard language.

In general

ARTICLE 10. DIVIDENDS

This article generally reduces to 20 percent the rate of tax that one of the countries can levy on the gross amount of dividends paid to "portfolio" investors of the other country and to 14 percent the rate of tax on dividends paid to "direct" investors. The proposed treaty also permits the branch profits tax and the branch-level tax on excess interest to be imposed at a 14 percent rate. The proposed treaty provides that the dividend recipient's country of residence may also tax the dividend under its internal laws.

U.S. taxation of dividends paid to foreign persons

The United States generally imposes a 30-percent withholding tax on the gross amount of U.S. source dividends (other than dividends paid by an "80/20 company" described in Code section 861(c)) paid to nonresident alien individuals and foreign corporations. The 30-percent tax does not apply if the foreign recipient is engaged in a trade or business in the United States and the dividends are effectively connected with that trade or business. In such a case, the foreign recipient is subject to U.S. tax like a U.S. person at the standard graduated tax rates, on a net basis. For purposes of the 30-percent tax, U.S. source dividends are dividends paid by a U.S. corporation (other than a corporation that has elected status as a possession corporation under Code sec. 936). Also treated as U.S. source dividends for this purpose are certain dividends paid by a foreign corporation, if at least 25 percent of the gross income of the foreign corporation, in the prior three-year period, was effectively connected with a U.S. trade or business. The U.S. tax imposed on dividends paid by a foreign corporation is often referred to as a "second-level" withholding tax.

For taxable years beginning after December 31, 1986, a U.S. branch of a foreign corporation is subject to a branch profits tax in

the United States on any deemed repatriation of the branch's U.S. effectively connected earnings and profits. The branch profits tax rate is 30 percent (but can be reduced or eliminated by treaty), and is levied on the branch's dividend equivalent amount. The branch profits tax provision generally replaces the second-level dividend withholding tax (discussed above) which the United States imposed prior to the 1986 Act.

In addition to the branch profits tax, a foreign corporation is also subject to a branch-level interest tax on "excess interest." For this purpose, "excess interest" means the interest deducted by the foreign corporation in computing its U.S. effectively connected income, to the extent that the deduction exceeds the interest paid by the U.S. trade or business. The branch-level tax on excess interest is an amount equal to the tax the foreign corporation would have paid had a wholly owned U.S. corporation paid it an amount of interest equal to the amount of "excess interest."

Tunisian system for taxing dividends

In the past, Tunisian source dividends generally have been subject to the tax on income from movable capital in Tunisia. This tax has been collected through withholding at source, at a rate of 30 percent with respect to bearer shares, and 20 percent with respect to registered shares. The Committee understands that Tunisia has recently amended its internal laws, and in doing so has reduced (or in some cases eliminated) this tax.

Proposed treaty rules

Under the proposed treaty, dividends paid by a company that is a resident of one country to a resident of the other country are taxable by both countries. The proposed treaty generally limits the rate of tax that the payor's country of residence may impose on dividends paid to a beneficial owner in the other country, however. None of the limitations on taxation of dividends apply to taxation of the company in respect of the profits out of which the dividends are paid. The limitation is 20 percent or 14 percent, depending on the relationship between the payor and the payee. The 14-percent rate of source-country tax applies to dividends if the beneficial owner is a company (other than a partnership) that owns at least 25 percent of the voting stock of the company paying the dividends. The 20-percent rate applies to dividends in all other cases.

The proposed protocol clarifies that the 14-percent rate does not apply to dividends paid by a U.S. regulated investment company (RIC) or real estate investment trust (REIT). Moreover, in the case of dividends paid by a REIT other than to a beneficial owner who is an individual owning a less than 25 percent interest in the REIT, the rate of withholding applicable under U.S. law applies (i.e., 30 percent).

The proposed treaty defines dividends to mean income from shares, "jouissance" shares or "jouissance" rights, founders' shares or other rights, not being debt-claims, participating in profits, as well as income from other corporate rights which is subjected to the same taxation treatment as income from shares by the internal laws of the distributing company's country of residence. According to the proposed protocol, the term "dividends" also includes income

from any income-producing financial transactions, including debt obligations, carrying the right to participate in profits, to the extent so characterized under the internal law of the country in which the income arises.

The limitation contained in the proposed treaty on the rate of withholding tax will not apply if the recipient of the dividend has a permanent establishment or fixed base in the source country and the shares with respect to which the dividend is paid are effectively connected with the permanent establishment or fixed base. In that case, the dividend is taxed as business profits (Article 7) or as income from independent personal services (Article 14), as appropriate. In addition, the saving clause assures that the reduced withholding tax rate does not apply with respect to U.S. source dividends received by U.S. citizens who are resident in Tunisia (Article 22(2)).

Under the proposed protocol, the country in which a corporate resident of the other country has a permanent establishment is authorized to impose a branch profits tax and a branch-level tax on excess interest payments, in accordance with its internal law, on the profits attributable to, or excess interest payments allocable to, the permanent establishment, and on income from real property (Article 6) and related capital gains (Article 13(1)) which are subject to tax in that country. The rates of these branch-level taxes generally are not to exceed 14 percent. In computing net profits which are subject to a branch profits tax, any income tax imposed by the source country on the income of the permanent establishment are allowed as a deduction.

ARTICLE 11. INTEREST

Subject to numerous exceptions (such as those for portfolio interest, bank deposit interest, and short term original issue discount), the United States imposes a 30-percent tax, collected by withholding, on U.S. source interest paid to foreign persons under the same rules that apply to dividends. For purposes of the 30-percent tax, U.S. source interest generally is interest on debt obligations of U.S. persons, other than a U.S. person that meets the foreign business requirements of Code section 861 (c) (e.g., an 80/20 company). Also subject to the 30-percent tax is interest paid by the U.S. trade or business of a foreign corporation.

As well as allowing a taxpayer's country of residence to tax interest income, the proposed treaty generally allows the imposition of a withholding tax at source on interest. The proposed treaty limits the rate of tax to 15 percent of the gross amount of the interest, however, in situations where the interest is beneficially owned by a resident of the other country. This 15-percent rate contrasts with the U.S. model position, often not achieved, that interest should be exempt from tax at source.

Certain exceptions apply to the general rule that permits both the residence country and, at a limited rate, the source country to tax interest. First, in cases where interest is derived from sources within one country by the government of the other country or its agency or instrumentality which is exempt from tax in its residence country, such interest is exempt from source-country tax

under the proposed treaty. Second, interest that is beneficially derived by a bank or similar financial institution with respect to an obligation with a maturity of at least seven years is exempt from tax in the source country. Third, source-country tax exemption is granted to interest paid by the Government of Tunisia (or its political subdivisions or local authorities) to a U.S. resident who provided loans to that government, subdivision, or agency.

The proposed treaty defines "interest" as income from debtclaims of every kind, whether or not secured by mortgage, and (unless it is treated as a dividend in accordance with Article 19 (Dividends)) whether or not carrying a right to participate in the debtor's profits, and in particular, income from government securities and from bonds, debentures, including premiums and prizes attaching to bonds or debentures. Penalty charges for late payment are not treated as interest under the proposed treaty.

As in the case of dividends, if interest is paid on debt that is effectively connected with a permanent establishment or fixed base in the source country, the interest is taxed as business profits (Article 7) or as income from independent personal services (Article 14), as the case may be. That is, the 15-percent rate limitation and exemptions of this article do not apply. In addition, the reduced withholding tax rate does not apply with respect to U.S. source interest received by U.S. citizens who are resident in Tunisia (Article 22(2)). The proposed treaty provides a source rule for interest. Interest is sourced within a country if the payor is the government of that country, including its political subdivisions or local authorities, or a resident of that country. If, however, the interest is borne by a permanent establishment or fixed base that the payor has in one of the treaty countries and the indebtedness was incurred in connection with that permanent establishment or fixed base, interest has its source in that country, regardless of the residence of the payor. Generally, this is consistent with U.S. source rules (Code secs. 861 and 862) which provide as a general rule that interest income is sourced in the country in which the payor is resident, and with the effect of the Code provision that taxes similarly to U.S. source interest income the interest paid by the U.S. trade or business of a foreign corporation.

The proposed treaty addresses the issue of interest charges between related parties by providing that the amount of interest for purposes of applying this article is the amount of arm's-length interest. Where any amount designated as interest paid by a person to any related person (Article 9) exceeds an amount which would have been paid to an unrelated person, the proposed treaty's interest provisions apply only to so much of the interest as would have been paid to an unrelated person. The excess payment may be taxed by each country according to its own law, including the other provisions of the proposed treaty where applicable. For example, excess interest paid to a parent corporation might be treated as a dividend under local law and thus be entitled to the benefits of Article 10 of the proposed treaty.

ARTICLE 12. ROYALTIES

Under the same system that applies to dividends and interest, the United States imposes a 30-percent withholding tax on noneffectively connected U.S. source royalties paid to foreign persons. Generally, royalties are from U.S. sources if they are for the use of property located in the United States. U.S. source royalties include royalties for the use of, or the right to use, intangible assets in the United States.

Tunisia generally imposes a 26.4-percent withholding tax (or in some cases, a 21-percent withholding tax) on Tunisian source royalties paid to nonresident persons.

Under the proposed treaty, royalties derived by a resident of one country from sources within the other country (the "source country") generally are taxable by both the country of residence and the source country; however, the source-country tax rate may not exceed a rate specified by the proposed treaty. Under the saving clause, the reduced withholding tax rate does not apply with respect to U.S. source royalties received by U.S. citizens who are resident in Tunisia (Article 22(2)).

The proposed treaty provides that a maximum source-country tax rate of 15 percent applies to payments of any kind made as consideration for the use of, or the right to use, copyrights of literary, artistic, or scientific works, (including cinematographic film or films or tapes used for radio or television broadcasting). In addition, this rate applies to payments of any kind made as consideration for the use of, or the right to use, patents, trademarks, designs, models, plans, secret processes or formulae, or for information concerning industrial, commercial, or scientific experience. Also taxed at a 15-percent rate are gains derived from the sale, exchange, or other disposition of any such property or rights to the extent that the amounts realized on such disposition are contingent on the productivity, use, or disposition of the property or rights.

A maximum source-country tax rate of 10 percent applies to royalties for the use of, or the right to use, industrial, commercial, or scientific equipment, but excluding ships, aircraft, or containers used in international traffic. (Payments for use of such vessels are taxable only under Articles 7 (Business Profits), 8 (Shipping and Air Transport), or 14 (Independent Personal Services). The 10-percent rate also applies to payments of any kind received by a resident of one of the countries as remuneration for technical or economic studies, wherever prepared, which are paid out of public funds of the other country (or a political subdivision or local authority), or remuneration for the performance of accessory technical assistance for the use of property or rights described in this paragraph to the extent that such assistance is performed in the country where the payment or the property or right has its source. As in the case of dividends and interest, if the property or right giving rise to the royalty is effectively connected with a permanent establishment or a fixed base, the royalty is taxed as business profits (Article 7) or as income from independent personal services (Article 14), as appropriate.

As in the case of interest, if a royalty is paid between related persons (Article 9) and exceeds an arm's-length amount, the excess