ing treaty benefits by establishing investing entities in India, inasmuch as third-country investors may be unwilling to share ownership of such investing entities on a 50-50 basis with U.S. or Indian residents or other qualified owners to meet the ownership test of the anti-treaty shopping provision. The base erosion test, which limits the ability of a treaty-country entity to shift its income to persons that are not treaty-country residents, provides protection from the potential abuse of an Indian conduit. Finally, India imposes significant taxes of its own and retains high source taxes in its treaties on payments to third-country residents; these taxes may deter third-country investors from seeking to use Indian entities to make U.S. investments. On the other hand, the Committee is aware that implementation of the tests for treaty shopping set forth in the treaty may raise factual, administrative, or other issues that cannot currently be foreseen. The Committee emphasizes that the provision as proposed must be implemented so as to serve as an adequate tool for preventing possible treaty-shopping abuses in the future.

(2) Developing country concessions

The proposed treaty contains a number of developing country concessions, some of which are found in other U.S. income tax treaties with developing countries. The most important of these concessions are listed below.

Definition of permanent establishment.-The proposed treaty departs from the U.S. and OECD model treaties by providing for relatively broad source-basis taxation. The proposed treaty's permanent establishment article, for example, permits the country in which business activities are carried on to tax the activities sooner, in certain cases, than it would be able to under either of the model treaties. Under the proposed treaty, a building site or construction or assembly or installation project (or supervisory activities related to such projects) creates a permanent establishment if it exists in a country for more than 120 days; under the U.S. model, a building site, etc., must last for at least one year. Thus, for example, under the proposed treaty, business profits attributable to an installation project in India are taxable by India if the project lasts for more than 120 days. Similarly, under the proposed treaty, the use of a drilling rig in a country for more than 120 days creates a permanent establishment there; under the U.S. model, drilling rigs must be present in a country for at least one year. Most tax treaties between the United States and developing countries provide a permanent establishment threshold of six months for building sites and drilling rigs.

Moreover, the proposed treaty contains a 90-day permanent establishment threshold with respect to the furnishing of certain services in one of the countries. Although the U.S. model is silent with respect to the determination of a permanent establishment in cases involving services, the preferred treaty position of the United States in conventions with developing countries has been a minimum of 183 days.

In addition, an independent agent of an enterprise may constitute a permanent establishment of that enterprise under the proposed treaty if the agent's activities are devoted 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 treaty does not contain this rule, although it is contained in some U.S. treaties with developing countries.

Treatment of fees for included services.-The proposed treaty treats in the same manner as royalties certain "fees for included services." Fees for included services are defined (in paragraph 4 of Article 12) generally to mean payments of any kind to any person in consideration for the rendering of any technical or consultancy services (including through the provision of services of technical or other personnel) if such services either (a) are ancillary and subsidiary to the application or enjoyment of the right, property, or information for which a royalty payment is received; or (b) make available technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design. (Clarifications to the definition of fees for included services, and understandings regarding the scope of included services, are discussed at length in Part VIII, "Explanation of Treaty Provisions.")

The treatment of service fees provided in the proposed treaty is a departure from the domestic law of both the United States and India. The Committee understands that under Indian statutory law, a broad range of service fees (fees for technical, managerial, or consultancy services performed anywhere) is subject to a 30-percent gross basis tax if paid by an Indian resident. The proposed treaty both narrows the range of service fees subject to gross basis taxation and reduces the applicable tax rate. Under U.S. statutory law, fees for services performed inside the United States are subject to tax on a net basis if effectively connected with a U.S. trade or business of a nonresident alien or foreign corporation or on a gross basis (at the rate of 30 percent) only if not effectively connected. Paragraph IV of the proposed protocol (Ad Article 12) clarifies that, if fees for included services may be taxed by the United States under Article 12 but are subject to net basis tax under internal U.S. law, the level of that net basis taxation (or, where applicable, the sum of that net basis tax and the amount of the tax allowable under paragraph 1 of Article 14 (Permanent Establishment Tax) with respect to those fees) is not to exceed the gross basis tax at the limited rates imposed under Article 12. The term "fees for included services" is not defined (apart from the proposed treaty) in the domestic laws of either country.

The proposed treaty treats these service fees for foreign tax credit purposes as derived from sources in the country permitted to impose a gross-basis tax under Article 12, regardless of where the activities giving rise to the income take place. Unlike the treaty's source rule that applies to other types of income for foreign tax credit purposes, this source rule does not yield to conflicting statutory source rules that apply for foreign tax credit purposes. Thus, in the case of a U.S. taxpayer earning service fees that are subject to Indian gross-basis tax under Article 12 for services conducted in the United States, the taxpayer's foreign source income for foreign tax credit limitation purposes will be increased by the amount of such fees.

Despite the fact that the treatment of fees for included services under the proposed treaty represents a significant concession from Indian statutory law that is unique to date, that treatment also constitutes a ceding by the United States of tax jurisdiction, of unprecedented scope in U.S. tax treaties, over income of a U.S. person that is treated as U.S. source under the Code. It generally is not U.S. treaty policy to cede tax jurisdiction, by allowing a foreign tax credit, over royalty or fee income of a U.S. person that is treated as U.S. source under the Code (although, for example, the treaty with Australia provides a royalty source rule that differs significantly from the Code and also applies for foreign tax credit purposes). Inasmuch as the included services under the proposed treaty are all related to the use or transfer of specialized skill or proprietary knowledge or information, source country taxation of fees for included services can be expected to be imposed primarily by India rather than by the United States.

Source basis taxation.-Additional concessions to source basis taxation in the proposed treaty include a maximum rate of source country tax on interest that is higher than that provided in the U.S. model treaty; a maximum rate of source country tax on dividends that is higher than that provided in the U.S. model treaty; taxing jurisdiction on the part of the source country as well as the residence country with respect to income not otherwise specifically dealt with by the proposed treaty; and broader source country taxation of personal services income (especially directors' fees), capital gains and entertainers' income than that allowed by the U.S. model.

Taxation of business profits.-Under the U.S. model and many other U.S. income tax treaties, a country may tax only the business profits of a resident of the other country to the extent those profits are attributable to a permanent establishment situated within the first country. The proposed treaty expands the definition of business profits beyond the traditional definition to include profits that are derived from sources within the country where a permanent establishment exists from (a) sales of goods or merchandise of the same or similar kind as those sold through the permanent establishment, or (b) other business activities of the same or similar kind as those effected through the permanent establishment. This expanded definition follows the United Nations model treaty. It should be noted that although this rule provides for broader source basis taxation than does the rule contained in the U.S. model, it is less broad in some respects than the general "force of attraction' rule of Code section 864(c)(3).

Also following the United Nations model treaty is a rule in the proposed treaty that limits certain deductions for expenses incurred on behalf of a permanent establishment by the enterprise's head office.

Certain equipment leasing.-In addition to containing the traditional definition of royalties which is found in most U.S. tax treaties (including the U.S. model), the proposed treaty provides that royalties include payments for the use of, or the right to use, industrial, commercial, or scientific equipment. These payments are often considered rentals by other treaties, subject to business profits rules which generally permit the source country to tax such

profits only if they are attributable to a permanent establishment located in that country, and in such case, the tax is computed on a net basis. By contrast, the proposed treaty permits gross-basis source country taxation of these payments, at a rate not to exceed 10 percent, if the payments are not attributable to a permanent establishment situated in that country.2

Committee comment.-The Committee is concerned that such provisions not be viewed as the starting point for future negotiations with developing countries. It must be clearly recognized that several of the rules of the proposed treaty represent substantial concessions by the United States, and that such concessions must be met (as they are in this case) with substantial concessions by the treaty partner. Thus, future negotiations with developing countries should not assume, for example, that the definition of a permanent establishment provided in this treaty will necessarily be available in every case; rather, such a definition will only be adopted in the context of an agreement that satisfactorily addresses the concerns of the United States.

(3) Insurance excise tax

The proposed treaty covers (i.e., waives) the U.S. excise tax on insurance premiums paid to foreign insurers. Thus, for example, an Indian insurer or reinsurer without a permanent establishment in the United States can collect premiums on policies covering a U.S. risk or a U.S. person free of this tax. However, the tax is imposed to the extent that the risk is reinsured by the Indian insurer or reinsurer with a person not entitled to the benefits of the proposed treaty or another treaty providing exemption from the tax. This latter rule is known as the "anti-conduit" clause.

Although waiver of the excise tax appears in the 1981 U.S. model treaty, recent waivers of the excise tax have raised serious Committee and other Congressional concerns. For example, concern has been expressed over the possibility that they may place U.S. insurers at a competitive disadvantage to foreign competitors in U.S. markets, if insubstantial tax is imposed by the other country to the treaty (or any other country) on the insurance income of its residents (or the income of companies with which they reinsure their risks). Moreover, in such a case waiver of the tax does not serve the purpose of treaties to avoid double taxation, but instead has the undesirable effect of eliminating all taxation.

The U.S.-Barbados and U.S.-Bermuda tax treaties each contained such a waiver as originally signed. In its report on the Bermuda treaty, the Committee expressed the view that those waivers should not have been included. The Committee stated that future waivers should not be given by Treasury in its future treaty negotiations without prior consultations with the appropriate committees of Congress. In addition, the waiver of the tax in the treaty with the United Kingdom (where the tax was waived without the "anticonduit" clause) has been followed by a number of legislative efforts to redress a perceived competitive imbalance created by the

waiver.

2 If the payments are attributable to such a permanent establishment, then the business profits article of the proposed treaty applies.

The proposed treaty waives imposition of the excise tax on premiums paid to residents of India. The Committee understands that, unlike Bermuda and Barbados, India imposes substantial tax on income, including insurance income, of its residents. In addition, it is understood that the Indian insurance industry is nationalized and is subject to significant regulatory control. Unlike the U.K. waiver, moreover, the Indian treaty waiver contains the standard anti-conduit language. On balance, and giving the appropriate consideration to the information provided by the Treasury Department with respect to this issue, the Committee believes that the practical effect of the waiver of the tax in this treaty is in fact to reduce double taxation, rather than to give Indian insurers competing in the U.S. market a significantly more favorable overall tax burden than their U.S. counterparts, and thus is consistent with the criteria the Committee has previously laid down for waiver of the tax. (4) Exchange of information

The exchange of information article contained in the proposed treaty differs, in some respects, from the corresponding articles of the OECD and U.S. model treaties. The primary difference between the U.S. model and the proposed treaty (and OECD model) is that the U.S. model contains a clause that requires each treaty country to assist in the collection of taxes to the extent necessary to ensure that treaty benefits provided by the other country are enjoyed only by persons entitled to those benefits under the treaty. In providing such assistance, the U.S. model does not impose on the other country an obligation to carry out administrative measures that are at variance with its internal measures for tax collection, or that are contrary to its sovereignty, security, or public policy. Assistance in collection can be useful, for example, in a case where an entity located in a country with which the United States has a treaty serves as a nominee for a third-country resident. If the entity, on behalf of the third-country resident, receives a dividend from a U.S. corporation with respect to which a reduced rate of tax (as provided for by the treaty) is inappropriately withheld, the entity, as a withholding agent, is technically liable to the United States for the underpaid amount of tax. However, without assistance from the government of the treaty country in which the entity is resident, enforcement of that liability may be difficult.

The Committee believes that it would be preferable for the United States to seek the assistance of the Indian Government for tax collection assistance purposes. However, given the circumstances applicable to this treaty, including the requirement in the proposed treaty that India obtain information requested by the United States in a manner consistent with the terms of the U.S. model treaty, the absence of the collection assistance provision in the proposed treaty does not, in the Committee's opinion, warrant a reservation.

VII. BUDGET IMPACT

The Committee has been informed by the staff of the Joint Committee on Taxation that the proposed treaty is estimated to have a minimal negative effect on annual budget receipts.