JULY 27 (legislative day, JULY 10), 1990.-Ordered to be printed Mr. PELL, from the Committee on Foreign Relations, REPORT [To accompany Treaty Doc. 101-5, 101st Congress, 1st Session] The Committee on Foreign Relations, to which was referred the Convention between the Government of the United States of America and the Government of the Republic of India for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, together with a related protocol, signed at New Delhi on September 12, 1989, having considered the same, reports favorably thereon, without amendment, and recommends that the Senate give its advice and consent to ratification. I. PURPOSE The principal purposes of the proposed income tax treaty between the United States and the Republic of India ("India") are to reduce or eliminate double taxation of income earned by citizens and residents of either country from sources within the other country, and to prevent avoidance or evasion of the income taxes of the two countries. The proposed treaty is intended to continue to promote close economic cooperation between the two countries and to eliminate possible barriers to trade caused by overlapping tax jurisdictions of the two countries. It is intended to enable the countries to cooperate in preventing avoidance and evasion of taxes. II. BACKGROUND The proposed income tax treaty and protocol between the United States and India were signed at New Delhi on September 12, 1989, and were amplified by an exchange of notes and a memorandum of understanding signed the same day. No income tax treaty is currently in force between the United States and India. A previous income tax treaty, which contained a "tax-sparing" provision, was signed on November 10, 1959, but did not receive the advice and consent of the Senate to ratification by the United States. The treaty was withdrawn from further consideration by the Senate on June 8, 1964. The proposed treaty and protocol were transmitted to the Senate for advice and consent to its ratification on October 31, 1989. The proposed treaty and protocol were the subject of a hearing before the Senate Committee on Foreign Relations on June 14, 1990. III. SUMMARY The proposed treaty is similar to other recent U.S. income tax treaties, the 1981 proposed U.S. model income tax treaty ("U.S. model treaty"), and the 1977 model income tax treaty of the Organization for Economic Cooperation and Development ("OECD model treaty"). However, there are certain deviations from those documents. Some of the treaty's provisions are based on articles of the 1980 model treaty developed by the United Nations for use between developed and developing countries ("United Nations model treaty"). Other provisions are included in order to accommodate aspects of the Tax Reform Act of 1986 ("1986 Act"). As in other U.S. tax treaties, the objectives of the treaty are achieved principally by each country agreeing to limit, in certain specified situations, its right to tax income derived from its territory by residents of the other. For example, the treaty provides that neither country may tax business income derived from sources within that country by residents of the other unless the business activities in the taxing country are substantial enough to constitute a permanent establishment or fixed base (Articles 7 and 15). Similarly, the treaty contains certain visitor exemptions under which residents of one country performing personal services in the other are not required to pay tax in the other unless their contact with the other exceeds specified minimums (Articles 15, 16, 18, 21, and 22). The proposed treaty provides that dividends, interest, royalties, capital gains, and certain other income derived by a resident of either country from sources within the other country generally may be taxed by both countries (Articles 10, 11, 12, and 13). Generally, however, dividends, interest, and royalties received by a resident of one country from sources within the other country are to be taxed by the source country on a restricted basis (Articles 10, 11, and 12). In situations where the country of source retains the right under the proposed treaty to tax income derived by residents of the other country, the treaty generally provides for the relief of the potential double taxation by the country of residence allowing a tax credit for taxes paid to the country of source. Like other U.S. tax treaties, the proposed treaty contains a "saving clause." Under this provision, the United States retains the right (with certain exceptions) to tax its citizens and residents as if the treaty had not come into effect. In addition, the treaty contains the standard provision that the treaty may not be applied to deny any taxpayer any benefits otherwise allowed under the domestic law of the country or under any other agreement between the two countries; that is, the treaty may only be applied to the benefit of taxpayers. The proposed treaty differs in certain respects from other U.S. income tax treaties and from the U.S. model treaty. The major differences are as follows: (1) The U.S. excise tax on insurance premiums paid to a foreign insurer is generally covered by the treaty. This is a departure from older U.S. tax treaties. The U.S. model and some recent U.S. treaties, such as the treaties with the United Kingdom, France, and Hungary, generally cover this excise tax. (2) The proposed treaty provides rules for determining when a person is a resident of either the United States or India, and hence entitled to benefits under the treaty. The proposed treaty, like the U.S. model, provides tie-breaker rules for determining the residence for treaty purposes of "dual residents," i.e., persons who, but for the tie-breaker rules, would have residence status in each of the treaty countries. Unlike the U.S. model, the proposed treaty does not treat a dual residence company as a resident of the country under whose laws it was created. The proposed treaty expressly provides that a dual resident company is outside the scope of the treaty for most purposes. (3) The definition of a permanent establishment in the proposed treaty is broader than that in the U.S. model and in many existing U.S. treaties. The principal areas in which the proposed treaty departs from the U.S. model are in its inclusion in the permanent establishment definition of a warehouse (in relation to a person providing storage facilities to others); a farm; a sales outlet; a drilling rig or ship or other installation or structure used for the exploration or development of natural resources in a country for more than 120 days (rather than 12 months); a construction project lasting more than 120 days (rather than 12 months); and an individual performing services (other than certain services to which royalty treatment applies under Article 12) for more than 90 days. Also, the inclusion in the time period of supervisory activity connected with construction activity is a departure from the U.S. model. These departures from the U.S. model, however, are similar to the corresponding provisions of the United Nations model treaty and other recent U.S. income tax treaties with developing countries. In addition, an independent agent of an enterprise constitutes a permanent establishment under the proposed treaty if the agent habitually secures orders in that other country wholly or almost wholly on behalf of that enterprise and the transactions between the agent and the enterprise are not made under arm's-length conditions; the U.S. model does not contain this rule, although a few U.S. treaties with developing countries do. (4) The proposed treaty differs from the U.S. model in not providing investors in real property in the country not of their residence with an election to be taxed on such investments on a net basis. Current U.S. law independently provides a net-basis election to foreign persons. The Committee understands that net basis taxation. of Indian real property income is provided under Indian domestic law. (5) The proposed treaty departs from the U.S. model treaty's definition of "business profits" by excluding income from the provision of certain services or from the rental of certain personal property (see discussion under "Committee Comments," Part VI, following). Instead, such income is treated similarly to royalties. Thus, such income is taxable in the source country on a gross basis (at a reduced rate), rather than on a net basis as business income. (6) The proposed treaty provides that a country may estimate on a reasonable basis the business profits attributable to a permanent establishment in accordance with the principles contained in the Business Profits article, if the correct amount is incapable of determination or the determination presents exceptional difficulties. Recent U.S. income tax treaties and the U.S. model treaty do not contain this provision. This rule is expected to be applied only in unusual cases. (7) In computing taxable business profits, deductions generally are allowed for expenses, wherever incurred, that are incurred for the purposes of the permanent establishment. These deductions include a reasonable allocation of executive and general administrative expenses, research and development expenses, interest, and other expenses incurred by the head office of the enterprise. However, the proposed treaty precludes deductions for amounts paid by the permanent establishment to the head office of the enterprise (other than reimbursements of actual expenses) for the use of patents, know-how or other rights, or for specific services performed or for management services. These rules limiting deductions are not found in the U.S. or OECD model treaties, but are patterned after rules contained in the United Nations model treaty. Similar rules are contained in certain other U.S. income tax treaties with developing countries. (8) The proposed treaty, unlike the U.S. model, provides that business profits can be attributed to a permanent establishment if they are derived from sales or other activities similar to those effected through the permanent establishment (even if not carried out by the permanent establishment). This rule is consistent with the United Nations model and certain other U.S. treaties. (9) Consistent with changes made to the Internal Revenue Code by the 1986 Act, the proposed protocol specifies that a country may tax business profits that are properly attributable to a permanent establishment or fixed base, even after the permanent establishment or fixed base has ceased to exist. (10) The Shipping and Air Transport articles of both the U.S. model and the proposed treaty permit only the country of residence to tax income from the operation of ships or aircraft in international traffic. The two treaties, however, contain certain differences with respect to the types of income which qualify for this treatment. Whereas the U.S. model generally treats all profits from the rental of ships or aircraft operated in international traffic as qualifying income, the proposed treaty includes in this category income from the rental of ships or aircraft only if the income is derived by an enterprise that operates ships or aircraft in international traffic and only if the rental is incidental to any activity directly connected with such transportation. Moreover, the U.S. model treats the profits of a resident of one of the countries from the use, maintenance, or rental of containers (including trailers, barges, and related equipment for the transport |