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US Treasury Department announces signing of protocol to US-Germany income tax treaty — Orbitax Tax News & Alerts

The US Treasury Department has announced that the  United States and Germany have signed a protocol to amend the current income tax treaty and protocol between the two countries dated 29 August 1989. The protocol was signed in Berlin on 1 June 2006.

The Treasury Department stated that the protocol significantly reduces tax-related barriers to trade and investment between the United States and Germany, modernizes the treaty to take account of changes in the laws and policies of both countries since the 1989 treaty was signed, and modernizes the treaty relationship between Germany and the United States and brings it into closer conformity with current US tax treaty policy.

The new protocol represents a substantial revision of the current treaty and protocol. It contains amendments to many of the articles in the current treaty, including replacement of the articles on dividends (Art. 10), elimination of double taxation (Art. 23), and limitation on benefits (Art. 28). The key aspect of the revision of Art. 10 is the elimination of source-country withholding taxes on qualified dividends from direct investments in subsidiaries and on dividends paid to pension funds.

The articles in the current treaty on pensions, government service, and social security are also revised, including a new separate article on the treatment of pension plans (Art. 18A) and a revised article on government service (Art. 19).

The article on independent personal services (Art. 14) is eliminated from the current treaty in conformity with the removal of this article from the OECD Model Convention in 2000.

A new provision is added to the mutual agreement procedure (Art. 25) to require mandatory arbitration of certain cases that cannot be resolved by the competent authorities within a specified period of time. This is the first provision of this type to be included in a US tax treaty.

The new protocol includes a replacement of the protocol to the current treaty and includes further a joint declaration by Germany and the United States to undertake consultations for further amendments to Art. 18 regarding the taxation of retirement income in order to reflect legislation recently enacted by Germany on this topic.

The protocol will enter into force when instruments of ratification are exchange by the two countries and will take effect for withholding taxes for amounts paid or credited on or after the first day of January of the year that the protocol enters into force.

Protocol to treaty between Germany and United States – further details

Further details of the newprotocol to the income and capital tax treaty between Germany and the United States , signed on 1 June 2006, have become available. The protocol amends the treaty and deviates from the OECD Model in several aspects.

(a) Dividends:

-   full exemption for inter-company dividends in cases where the parent directly owns shares representing 80% or more of the voting rights in the subsidiary. Ownership through tax transparent entities like a US limited liability company (LLC) or a German partnership does not qualify as direct ownership;
-   5% withholding taxes (WHT) on inter-company dividends where the beneficial owner directly owns at least 10% of the shares and 15% WHT on dividends in all other cases;
-   portfolio dividends to pension funds resident in either contracting state are exempt from WHT;
-   for investment funds, the 15% WHT rate applies. As for German investment funds, which are not subject to tax in Germany, treaty benefits are only granted if at least 90% of the units are held by German residents eligible for treaty benefits;
-   for REITs, the 15% WHT rate applies if either the beneficial owner is an individual or pension fund holding a participation of not more than 10%, the dividends were paid on publicly traded stocks and the beneficial owner holds not more than 5%, or, the beneficial owner holds not more than 10% and the REIT is diversified, i.e. no investment in a single real property equals more than 10% of the total investment in real property.

(b) Limitation on benefits. A resident company will be eligible for treaty benefits only if it satisfies the following conditions:

-   its shares are publicly traded or its primary place of management and control is in the residence state;
-   at least half of the shares are directly or indirectly owned by not more than 5 resident companies of either contracting state satisfying the previous conditions;
-   at least half of its shares or other beneficial interest are owned at least half of the days of the year by resident persons entitled to treaty benefits and less than half of its gross income is expensed as deductible interest to persons not entitled to treaty benefits;

at least 95% of the voting power and the value of its shares are owned directly or indirectly by no more than 7 residents of the EU, EEA or NAFTA equivalently entitled to treaty benefits under their tax treaties; or

-   it satisfies an active trade of business test or is granted treaty benefits by the relevant competent authority.

(c) Triangular provision. No treaty benefits will be available for income that is attributable to a permanent establishment (PE) in a third state and the tax paid is less than 60% of the tax in cases without such a PE. For dividends, interest and royalties subject to the triangular provision, treaty benefits are not denied, but a 15% WHT rate applies. The triangular provision does not apply to royalties for the use of intangibles produced or developed in the PE, or derived in connection with passive income of the PE.

(d) Mutual agreement procedure (MAP). The protocol introduces mandatory arbitration regarding either residence of a natural persons, PE, business profits, associated enterprises and royalties, unless the competent authorities agree on the unsuitability of the case. The competent authorities may also agree on an ad hoc basis that mandatory arbitration shall be used for any other issue covered by the MAP article.