porations to foreign persons are not, or whether it would not be more appropriate to treat stock gains no more favorably than dividends.

Bills have been introduced this year in both Houses of Congress that would tax as effectively connected income gains derived by foreign persons from the sale of stock of domestic corporations in cases where the foreign person holds or held at least 10 percent of the stock of the domestic corporation.2 Unlike the unsuccessful House bill provision of 1989, the 1990 bills generally do not override existing contrary treaties. The proposed treaty would thus prevent the operation of the bill vis-a-vis Finnish residents if the bill is passed.

As a general matter, the Committee is concerned about recommending consent to ratification of a treaty that forbids a tax that the Congress may decide to impose as the result of a change in its internal tax law policy. Although prior Congresses may have believed that the gains realized by foreign persons from the disposition of stock in U.S. companies were properly excluded, as a statutory matter, from the U.S. tax base, whether for reasons of administrability or for other reasons, Congress may decide that it is no longer appropriate to do so in the case of substantial foreign shareholders in U.S. companies. The Congress could further decide that, just as it is inappropriate in treaties to reduce source country taxation of dividends to zero, it is similarly inappropriate to reduce to zero the rate of tax on gain from stock that pays such dividends, or that it is inappropriate to reduce such tax to zero in all cases and for all types of dispositions.

Alternatively, the Congress could decide that, while a tax on stock gains should be imposed by statute, it may properly be waived in treaties, or at least treaties with countries that, in Congress's view, impose an adequate level of tax on the types of stock gains of its residents that would otherwise be subject to tax under the statute. As reflected in the OECD model and many existing treaties, for example, countries that do impose tax on the stock gains of foreign persons often waive such taxes in treaties, although because of differences in definitions of the term "gains" in other countries, those treaties may not operate in precisely the same manner as a U.S. income tax treaty, using U.S. definitions of the term "gain," would operate. (The U.S. model treaty also provides for waiver of the tax, but the U.S. model was last revised at a time when such a waiver would not have reduced any U.S. tax otherwise imposed by the Code, and thus could only have reduced foreign country taxes.)

Imposition of U.S. tax on U.S. stock gains of Finnish residents, and imposition of Finnish capital tax on Finnish stock of U.S. persons or Finnish income tax on Finnish stock gains of U.S. persons, are in many cases prohibited under the present U.S.-Finland income tax treaty. Continued prohibition of that tax in the proposed treaty may be seen by some as a benefit to U.S. taxpayers (or the U.S. fisc) at the expense of the Finnish fisc. Whether or not the Senate agrees to a new treaty with Finland, if Congress enacts the

*H.R. 4308, sec. 201, 101st Cong., 2d Sess. (1990); S. 2410, sec. 201, 101st Cong., 2d Sess. (1990).

stock gains tax that the treaty protects Finnish residents from paying, it is unclear whether the United States and Finland would agree to retention or removal of the present treaty restriction on each country's ability to tax stock gains of foreign persons. Consideration might be given, by both parties to the treaty, to questions such as how the imposition or elimination of this tax is likely to affect the taxation by Finland of U.S. residents, as well as the taxation by the United States of Finnish residents.

The Committee does not believe that its general concern about entering into treaties in conflict with pending tax policy changes necessitates a reservation to this treaty. It is not clear if or when Congress will enact a tax on foreign persons' stock gains; if Congress does not do so, then there will have been no need to take action on this issue. In addition, the Congress might conclude that the waiver contained in the proposed treaty is in the best interests of the United States and its residents when taking into consideration the level of investment and income flows between the United States and Finland.

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.

VIII. EXPLANATION OF TREATY PROVISIONS

A detailed, article-by-article explanation of the proposed income tax treaty between the United States and Finland is presented below. Also presented below are explanations of the notes exchanged when the proposed treaty was signed. The notes are explained together with the articles of the proposed treaty to which they relate.

ARTICLE 1. PERSONAL SCOPE

The personal scope article describes the persons who may claim the benefits of the proposed treaty and contains other rules regarding the general scope of the treaty, including the "saving clause. The proposed treaty generally applies to residents of the United States and to residents of Finland, with specific exceptions designated in other articles (e.g., Articles 24 (Nondiscrimination) and 26 (Exchange of Information and Administrative Assistance)) and discussed below. This follows other U.S. income tax treaties, the U.S. model income tax treaty, and the OECD model income tax treaty. Residence is defined in Article 4.

The proposed treaty provides that it does not restrict any benefits accorded by internal law or by any other agreement between the United States and Finland. Thus, the treaty will apply only where it benefits taxpayers.

Like all U.S. income tax treaties, the proposed treaty is subject to a "saving clause." Under this clause, with specific exceptions described below, the treaty is not to affect the taxation by the United States of its residents or its citizens. By reason of this saving clause, unless otherwise specifically provided in the proposed treaty, the United States will continue to tax its citizens who are

residents of Finland as if the treaty were not in force. "Residents" for purposes of the treaty (and thus, for purposes of the saving clause) include corporations and other entities as well as individuals who are not treated as residents of the other country under the treaty tie-breaker provisions governing dual residents (paragraphs 2 and 3 of Article 4 (Residence)).

Under Code section 877 ("Expatriation to avoid tax"), a former U.S. citizen whose loss of citizenship had as one of its principal purposes the avoidance of U.S. income, estate or gift taxes, will, in certain cases, be subject to tax for a period of 10 years following the loss of citizenship. The treaty contains the standard provision found in the U.S. model and most recent treaties specifically retaining the right to tax former citizens. Even absent a specific provision the Internal Revenue Service has taken the position that the United States retains the right to tax former citizens resident in the treaty partner (Rev. Rul. 79-152, 1979-1 C.B. 237).

Exceptions to the saving clause are provided for certain benefits conferred by the treaty, namely: correlative adjustments to the income of enterprises associated with other enterprises the profits of which were adjusted by the other country (Article 9, paragraph 2); reductions in taxation of child support (Article 18, paragraph 4); exemption from residence country tax (or in the case of the United States, citizenship country tax) on social security benefits and other public pensions paid by the other country (Article 18, paragraph 1(b)); relief from double taxation (Article 23); nondiscrimination (Article 24); and mutual agreement procedures (Article 25).

In addition, the saving clause does not apply to the following benefits conferred by one of the countries with respect to individuals who are neither citizens of the conferring country nor "lawful permanent residents" in the conferring country: exemption from tax on compensation from government service to the other country (Article 19); exemption from tax on certain payments for the purposes of educating and supporting students, trainees, and business apprentices (Article 20); and certain fiscal privileges of diplomats referred to in the treaty (Article 27). The term "lawful permanent resident" is defined under the Code and generally has the same meaning as the term "immigrant status" used in the corresponding provision of the U.S. model treaty. For U.S. purposes, an individual has "immigrant status" in the United States if he has been admitted to the United States as a permanent resident under U.S. immigration laws (i.e., he holds a "green card").

ARTICLE 2. TAXES COVERED

The proposed treaty generally applies to the income taxes of the United States and Finland, and to the Finnish tax on capital.

United States

In general

In the case of the United States, the proposed treaty applies to the Federal income taxes imposed by the Internal Revenue Code, but excluding the accumulated earnings tax, the personal holding company tax, and social security taxes. The proposed treaty also

applies to the excise taxes with respect to private foundations and the excise tax on insurance premiums paid to foreign persons.

Tax on insurance premiums

Code rules.-Under the Code the United States imposes an excise tax on certain insurance premiums received by a foreign insurer from insuring a U.S. risk or a U.S. person (Code secs. 4371-4374). Unless waived by treaty, the excise tax applies to those premiums which are exempt from U.S. net basis income tax. Under the Code (in the absence of a contrary treaty provision), a foreign insurer is subject to U.S. net basis income tax on income in situations where that insurance income is effectively connected with a U.S. trade or business. However, a foreign insurer insuring U.S. risks ordinarily will not be viewed as conducting a U.S. trade or business, and thus will not be subject to U.S. income tax, if it has no U.S. office or agent and operates in the United States solely through independent brokers. In these situations, the insurance excise tax is imposed (except as otherwise provided in a treaty) on the premiums paid for that insurance.3

The excise tax may be viewed as serving the same function as the tax imposed on dividends, interest, and other types of passive income paid to foreign investors. In general, the excise tax applies to insurance covering risks wholly or partly within the United States where the insured is (1) a U.S. person or (2) a foreign person engaged in a trade or business in the United States. Under the Code, the excise tax generally applies to a premium on any such insurance unless the amount is effectively connected with the conduct of a trade or business in the United States and not exempt by treaty from the statutory net basis tax.

The treatment of insurance income of foreign insurers is complicated somewhat in situations where, as is usually the case, some portion of the risk is reinsured with other insurers in order to spread the risk. In situations where the foreign insurer is engaged in a U.S. trade or business and thus subject to the U.S. income tax, reinsurance premiums, whether paid to a U.S. or a foreign reinsurer, are allowed as deductions. Accordingly, the foreign insurer is taxable only on the income attributable to the portion of the risk it retains. However, while generally no excise tax is imposed on the insurance policy issued by the foreign insurer doing business in the United States, the one-percent excise tax on reinsurance is imposed if and when that insurer reinsures that U.S. risk with a foreign insurer not subject to U.S. net basis income tax.

Proposed treaty.-The insurance excise tax described above is covered by the proposed treaty, but only to the extent that the foreign insurer does not reinsure the risks in question with a person not entitled to relief from this tax under the proposed treaty or another U.S. treaty. The exchange of notes states an intent to develop procedures to ensure that this "anti-conduit" rule will be applied without undue administrative burden.

3 The excise tax is currently imposed at a rate of four percent of the premiums paid on casualty insurance and indemnity bonds, and one percent of the premiums paid on life, sickness, and accident insurance, annuity contracts, and reinsurance (Code secs. 4371-4374).

More specifically, income of a Finnish insurer from the insurance of U.S. risks or U.S. persons will not be subject to the insurance excise tax (except in situations where the risk is reinsured with a company not entitled to the exemption). This treaty waiver applies notwithstanding that insurance income is not attributable to a U.S. permanent establishment maintained by the Finnish insurer and hence is not subject to U.S. net basis tax pursuant to the business profits article (Article 7) and other income article (Article 21). This treatment is a departure from the existing tax treaty with Finland, but is similar to that provided in some other recent U.S. tax treaties, for example, the treaties with France and Hungary, and the pending treaties with Germany, India, and Spain. The excise tax on premiums paid to foreign insurers is a covered tax under the U.S. model treaty.

In exempting from the U.S. income tax and the insurance excise tax all insurance income which is not attributable to a permanent establishment in the United States, the proposed treaty makes two changes in the statutory rules governing the taxation of insurance income of Finnish insurers. First, any insurance income which is effectively connected with a U.S. trade or business but is not attributable to a U.S. permanent establishment will not be subject to U.S. income tax. This exemption is contained in the existing treaty. As is true under the existing treaty, those Finnish insurers which continue to maintain a U.S. permanent establishment after the proposed treaty enters into force will remain subject to the U.S. income tax on their net U.S. insurance income attributable to the permanent establishment.

Second, Finnish insurers not engaged in a U.S. trade or business generally will no longer be subject to the insurance excise tax. This exemption is not contained in the existing treaty. The insurance excise tax will continue to apply, however, in situations where a Finnish insurer with no U.S. trade or business reinsures a policy it has written on a U.S. risk with a foreign reinsurer, other than a resident of Finland or another insurer entitled to exemption under a different tax treaty (such as the U.S.-France treaty). The tax liability may be imposed on the Finnish insurer which in this situation is viewed as the U.S. resident person transferring the premium to the foreign reinsurer. The excise tax will apply to such reinsurance even where the Finnish insurance company has a U.S. trade or business, but no U.S. permanent establishment, and thus will not be subject to U.S. income tax on the net income it derives on the portion of the risk it retains.

For example, assume a Finnish company not engaged in a U.S. trade or business insures a U.S. casualty risk and receives a premium of $200. The company reinsures part of the risk with a Danish insurance company (not currently entitled to exemption from the excise tax) and pays that Danish company a premium of $100. The four-percent excise tax on casualty insurance applies to the premium paid to the Finnish insurance company to the extent of the $100 reinsurance premium. Thus, the U.S. insured is liable for an excise tax of $4, which is four percent of the portion of its premium paid to the Finnish insurer which was used by the Finnish insurer to reinsure the risk. It is the responsibility of the U.S. insured to determine to what extent, if any, the risk is to be reinsured with a