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Published online by Cambridge University Press: 27 February 2017
On July 1, 1957, the United States and Pakistan signed a Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to Taxes on Income. Although, at that time, it was one of the few double taxation treaties that the United States had entered into with a developing country, it followed, for the most part, the template established by earlier tax treaties negotiated with the more developed nations. A major distinguishing factor, however, was the inclusion of a tax-sparing credit provision, by means of which the coverage of the foreign tax credit accorded U.S. taxpayers for certain foreign taxes paid or deemed to have been paid was extended to certain taxes that were ordinarily levied by Pakistan but which had been “spared” as part of the latter’s incentive program for the stimulation of economic development. Three other treaties—with India, Israel, and the United Arab Republic—presented to the Senate for ratification at approximately the same time also contained tax-sparing provisions. However, none of these tax-sparing provisions was ever put into effect. The Convention with Pakistan was approved with a reservation excluding the sparing provisions, on the basis that the Pakistani tax concession which was to be credited for “phantom” taxes deemed paid had expired. The other three treaties never received the assent of the Senate and were subsequently withdrawn from the Senate Committee on Foreign Relations in 1964. No other tax-sparing provisions have been negotiated by the United States, although other tax incentive schemes have been presented to the Senate. These, too, have failed to be approved. The failure to agree to any such provision utilizing tax incentives as a form of development assistance is often deemed to be the major reason for the notable dearth of tax conventions between the United States and the developing states, as the latter are particularly interested in the inclusion of tax-sparing credit provisions in the double taxation treaties that they agree to sign. This failure is, in turn, rooted in the severe and at times persuasive criticism levied against the principle of granting tax-sparing credits—especially in the form in which they were to be granted in the four aforementioned treaties—and in the consequent hostility of the Senate Committee on Foreign Relations, as perceived by those responsible for negotiating U.S. tax treaties, toward provisions of this sort.
1 10 UST 984, TIAS No. 4232 [hereinafter Convention]. Ratification of the Convention was advised by the Senate with a reservation on July 9, 1958, and the President ratified the Convention subject to the same reservation on November 6, 1958. Pakistan ratified the agreement on May 2, 1959. The instruments of ratification were exchanged at Karachi on May 21, 1959, and the treaty entered into force as of May 21, 1959.
2 The interest of developing countries in negotiating tax-sparing agreements stems from their widespread reliance on tax incentives to spur private investment in and the concomitant development of their economies. See, e.g., MacDonald, , Recent Legislation in Nigeria and Ghana Affecting Foreign Private Direct Investment, 6 Int. Lawyer 548, 563-65 (1971)Google Scholar; Salacuse, , Egypt's New Law on Foreign Investment: The Framework for Economic Openness, 9 Int. Lawyer 647, 655 (1975)Google Scholar. See generally J. Heller & K. Kaufman, Tax Incentives for Industry in Less Developed Countries (1963); Landau, , Direct Foreign Investments in Developing Countries?, 4 J. L. & Econ. Dev. 182 (1969)Google Scholar; Lent, , Tax Incentives in Developing Countries, in R. Bird & O. Oldman, Readings on Taxation in Developing Countries, 362 (3d ed. 1975)Google Scholar; General Secretariat of the Organization of American States, Tax Incentives for Industrial Development in Latin America, Doc. CIES/1138 (English)/Add. 3 (1967). Such incentives may be nullified, however, without provision being made for tax sparing. See text accompanying notes 31 & 32 infra.
3 There are exceptions to this principle as in the case of sham corporations whose “corporate veil” may be “pierced” to prevent the abusive use of such “shells” for the avoidance of taxes. See Gregory v. Helvering, 293 U.S. 465 (1935); Lloyd F. Noonan, 52 T.C. 907 (1969), aff'd per curiam, 451 F.2d 992 (9th Cir. 1971); Shaw Constr. Co., 35 T.C. 1102 (1961), affd, 323 F.2d 316 (9th Cir. 1963); Alan S. Davis, T.C. Memo 1970-170, CCH Dec. 30,200(M), 29 T.C.M. 749. Cf. James Realty Co. v. United States, 280 F.2d 394 (8th Cir. 1960). In Johansson v. United States, 336 F.2d 809 (5th Cir. 1964), a non resident alien taxpayer was not permitted to shield his U.S.- source personal income from taxation under Section 871 of the U.S. Internal Revenue Code by means of a wholly owned Swiss corporation which was found to have “no legitimate business purpose” but for qualifying the income for the tax benefits accorded by the existing U.S.-Swiss income tax treaty. Such disregard of a corporate entity deemed to be a sham is most often based on the business activity test of Moline Properties, Inc. v. Coram'r, 319 U.S. 463 (1943). See, e.g., Estate of Miller v. Comm'r, 239 F.2d 729, 734 (9th Cir. 1956) (“it is of importance to inquire whether the arrangements adopted have no purpose germane to the conduct by the business of the parties other than tax minimization“); Aldon Homes, Inc., 33 T.C. 582 (1959). Exceptions also exist to recognize the economic unity of an affiliated group of corporations, permitting such a group to file consolidated tax returns in specified circumstances. See Internal Revenue Code of 1954, §1510 [hereinafter I.R.C; section numbers without further attribution refer to the Internal Revenue Code of 1954]. Most foreign related corporations, however, are excluded from participating in the filing of consolidated returns. For a summary of the most significant exceptions to the separate entity principle, see the Treasury Department's April 1976 report entitled “U.S. Taxation of the Undistributed Income of Controlled Foreign Corporations,” prepared by the Office of International Tax Affairs for consideration by the House Ways and Means Committee Task force on the Taxation of Foreign Income.
4 U.S.-source income of foreign corporations which is unconnected with the conduct of a trade or business in the United States and is of a“passive” character (e.g., dividends, interest, gains from the sale or exchange of certain property) is taxed at a flat rate of 30 percent. I.R.C. §881(a). Non resident alien individuals are taxed in a like manner under Section 871(a). A foreign corporation which is engaged in a “trade or business within the United States” (as defined in Section 864 (b)) is taxed as if it were a domestic corporation to the extent its income is “effectively connected” with the conduct of that trade or business. I.R.C. §882(a)(T). If a non resident alien individual is in such a position, he, too, is taxed as if he were a resident, specifically at the applicable graduated tax rate provided for under Sections 1 and 1201(b). I.R.C. §871(b).
5 I.R.C. Section 7701(a)(4) and (5) determines whether a corporation is foreign or domestic, the test being one based upon place of incorporation rather than the “seat of management” standards utilized by many other nations such as Great Britain, France, and Germany. See Jones, Anti-Avoidance Measures in the United Kingdom, in J. Jones, Tax Havens and Measures Against Tax Evasion and Avoidance in The EEC 52, 63 (1974) (“In effect, the central management and control of a company is where the board of directors meet … [t]he place of incorporation has little relevance… . If in fact the directors of the subsidiary control the company it will be resident where they meet“); Harvard Law School, Taxation in the United Kingdom Sec. 5/2.2 (1964); Harvard Law School, Taxation in France Sec. 11/2.2 (1966) (concept of siège social); Landwehrmann, , Legislative Development of International Corporate Taxation in Germany: Lessons for and from the United States, 15 Harv. Int. L.J. 238, 240 n.10 (1974)Google Scholar (place of management test used if no statutory seat described in its certificate of incorporation). According to Section 7701(a)(30), only a “domestic corporation” is considered a “United States person.“
6 I.R.C. §882(a) (1). See note 4 supra.
7 There are those who argue that deferral provides an undesirable impetus for multinational corporations (MNC's) to invest more sums abroad than would be warranted in a tax neutral system and that such investment occurs at the expense of domestic investment and the level of domestic unemployment. See, e.g., S. Surrey, P. McDaniel, & J. Pechman, Federal Tax Reform for 1976, at 77-92 (1976). But see Stobaugh, , How Investment Abroad Creates Jobs at Home, 50 Harv. Bus. Rev. 118 (Sept.-Oct. 1972)Google Scholar, for the contrary position. Numerous unsuccessful efforts have been made to completely eliminate deferral based primarily on its perceived perversity. See, e.g., the Burke-Hartke Bill, S. 151/H.R. 62, 93d Cong., 1st Sess. (1973); and the Hartke and Hollings amendments to the Tax Reform Bill of 1976, H.R. 10612, 94th Cong., 2d Sess. (1976), reprinted at 122 Cong. Rec. 10, 988 (daily ed. June 29, 1976), 122 Cong. Rec. 13,776 (daily ed. Aug. 6, 1976).
8 The abusive use of tax-haven subsidiaries stems from the ability of MNC's to manipulate their money flows and funnel funds from affiliated enterprises through a tax haven, thereby avoiding large portions of the U.S. and foreign taxes otherwise due. See, e.g., Note, , The Swiss Base Company: Tax Avoidance Device for Multinationals, 50 Notre Dame Lawyer 645 (1975)Google Scholar. The United States utilizes several tools to curb such tax avoidance. I.R.C. Section 482, for example, provides the Secretary of the Treasury with the necessary authority to reallocate gross income, deductions, credits, and allowances among two or more businesses (whether or not affiliated and regardless of their place of incorporation) “in order to prevent evasion of taxes or clearly to reflect the income of any such organizations, trades, or businesses.” See, e.g., Lufkin Foundry & Mach. Co. v. Comm'r, 468 F.2d 805, rehearing denied, 468 F.2d 808 (5th Cir. 1972). Subpart F (Sections 951-964) also provides a mechanism for stemming tax avoidance by eliminating the deferral privilege for certain U.S. shareholders of “controlled foreign corporations” engaged in those tax-haven operations described in Section 954. Such shareholders are thus taxed currently on their allocable portions of the foreign corporation's foreign-source income regardless of whether or not they have actually received that income. See, e.g., Estate of Leonard E. Whitlock, 59 T.C. 490, 507 (1972), aff'd, 494 F.2d 1297 (10th Cir. 1974), noted in 63 Geo. L.J. 815 (1975), 5 Denver J. Int. L. & Policy 135 (1975). See generally Liebman, , The Tax Treatment of Joint Venture Income under Subpart F: Some Issues and Alternatives, 32 Bus. Lawyer 341 (1977)Google Scholar; Liebman, Note on the Tax Treatment of Joint Venture Income under Subpart F: An Addendum, id. at 1819. Foreign personal holding company income is treated in a like manner under Sections 551-558, which impute a ratable distribution of “undistributed foreign personal holding company income” to the U.S. shareholders “of certain foreign corporations meeting defined conditions. See Marsman v. Comm'r, 205 F.2d 335 (4th Cir. 1953).
9 Capital-export neutrality requires that foreign and domestic profits be taxed at identical rates in the aggregate. Capital-import neutrality, on the other hand, would dictate that all taxpayers in any one country pay the same ultimate tax rate on the profits earned from activities in that country. Finally, “national” neutrality implies that the return on capital shared between the national government and the taxpayer be identical regardless of whether the capital is invested at home or abroad. See Patrick, , U.S. Tax Policy and Foreign Investments—Legislative and Treaty Issues, 5 Denver J. Int. L. & Policy 1, 2 n.2 (1975)Google Scholar.
10 I.R.C. §901(b) (1). Non resident aliens and foreign corporations are also allowed a foreign tax credit for foreign taxes paid on income effectively connected with the conduct of a U.S. trade or business. I.R.C. §906. See generally E. Owens, The Foreign Tax Credit (1961).
11 “ I.R.C. §902(a).
12 The deemed-paid credit is also granted for the taxes paid by “second” and “third tier” subsidiaries of a U.S. parent (foreign subsidiaries of the foreign corporation whose shares are held by the U.S. taxpayers) as long as certain conditions are met, primarily that the U.S. parent own five percent or more of the second and third tier corporations’ voting stock. I.R.C. §902(b) (3).
13 See generally E. Owens & G. Ball, The Indirect Credit (1975).
14 I.R.C. §903.
15 See Hellawell, , United States Income Taxation and Less Developed Countries: ACritical Appraisal, 66 Colum. L. Rev. 1393 (1966)CrossRefGoogle Scholar. Cf. United States v. Woodmansee,388 F.Supp. 36 (N.D.Cal. 1975) (holding that the foreign tax credit “cannot ariseout of foreign taxes paid or accrued on income which is exempt from the United Statesincome tax“).
16 I.R.C. §904(a). This so-called overall limitation allows the averaging of taxes paid to high and low tax foreign countries. Prior to 1977, an alternative per country limitation was also used in which the numerator of the limiting fraction was based on the taxpayer's taxable income in each foreign country for which credits were claimed, each calculation being performed separately on a country-by-country basis. The per country limitation was eliminated by Section 1031(a) of the Tax Reform Act of 1976. Pub. L. No. 94-455, 90 Stat. 1520.
17 Compare, e.g., Rev. Rul. 76-215, 1976 Int. Rev. Bull., No. 23, at 6 (disallowing a foreign tax credit for the share of oil production retained by the Indonesian Government under a production-sharing contract, deemed in substance to be a non creditable royalty since Indonesia collects its share regardless of the profitability or performance of the venture) with Rev. Rul. 75-377, 1975-2 CUM. BULL. 294 (holding, inter alia, the Venezuelan Branch Profits Tax to be “an income tax by United States standards“). See generally Biddle v. Comm'r, 302 U.S. 573, 578-79 (1938) (the definition of a creditable foreign income tax is to be derived by a comparison with the U.S. income tax statutes).
18 See Surrey, , International Tax Conventions: How they Operate and What they Accomplish, 23 J. Tax. 364 (1965)Google Scholar.
19 Tax treaties have the particular advantage of enabling the resulting tax treatment to be individually tailored to the trade and investment flows between the two signatories. On the other hand, they are often difficult to alter once the time-consuming negotiations have concluded.
20 For example, “permanent establishment” provisions describe the type of activities which constitute a taxable establishment in a foreign country. Other provisions might define deductions from earned income allowable in computing the tax base or provide reciprocal exemptions for the residents of each signatory who visit the territory of the other signatory for limited periods of time. See Articles 1-5 of the Organisation for Economic Co-operation and Development Fiscal Committee, Draft Double Taxation Convention (1963), reprinted in Tax Treaties (P-H) f 1007, [hereinafter OECD Draft Convention], which are the prototype for many of the tax treaties among developed countries, and Articles 1-5 of the U.S. Treasury Department's Model Income Tax Treaty of May 17, 1977, reprinted in Tax Treaties (P-H) fl 1019 [hereinafter U.S. Model Tax Treaty], the supposed template for many future U.S. tax treaties. The U.S. Model Tax Treaty of May 18, 1976, is reprinted in A. Kroll, Pli Seventh Annual Institute on International Taxation 291 (1976). See generally Bischel, Understanding United States Income Tax Treaties, in U.S. Taxation of International Operations (P-H) fi 5008 et seq. (1972). For a discussion of the problems which arise when two jurisdictions characterize or tax partnerships differently, see Leongard, , Tax Treaties, Partnerships and Partners: Exploration of a Relationship, 29 Tax Lawyer 31 (1975)Google Scholar.
21 See, e.g., Articles 24-28 of the OECD Draft Convention, supra note 20, and Articles 24-26 of the U.S. Model Tax Treaty, supra note 20.
22 See Surrey, , The Pakistan Tax Treaty and “Tax Sparing,” 11 Nat. Tax J. 156 (1958)CrossRefGoogle Scholar.
23 Investment income flows from the developing to the developed countries without much set-off in the opposite direction due to the dearth of investors from the developing states deriving income in the developed nations. See Irish, , International Double Taxation Agreements and Income Taxation at Source, 23 Int. & Comp. L.Q. 292, 296 (1974)Google Scholar; Smith, , The Functions of Tax Treaties, 12 Nat. Tax J. 317, 321 (1959)CrossRefGoogle Scholar; Comment, , The United States Tax Treaty Program with Developing Countries, 2 J. Int. L. & Econ. 230 (1968)Google Scholar. A State Department spokesman has explained the problem in the following fashion:The reason that our tax treaties have so far contributed little to this goal [of encouraging maximum private participation in the development of underdevelopedareas] is that many of their standard provisions assume a mutual flow of trade,capital, and investment income which normally exists only between countries on acomparable level of economic development.Statement by Thorsten V. Kalijarvi, Assistant Secretary of State for Economic Affairs, in 2 Joint Comm. on Internal Revenue, Legislative History of United Statestax Conventions 2278 (1962) [hereinafter Legislative History]. See also Statementon the U.S.-Brazil Tax Treaty by Stanley S. Surrey, Assistant Secretary of the Treasury, before the Senate Committee on Foreign Relations, October 5, 1967, in Tax Treaties (P-H) f119,133, at p. 19,127.
24 “[T]he sacrifice made by the treasury of the developing country in not being recognized by the developed country from which the investment comes merely means that there is a transfer of tax revenue from the former to the latter.” Atchabahian, , Some Aspects of International Double Taxation Between Developed and Developing Countries, 25 Bull. Int. Fisc. Doc. 451, 463 (1971)Google Scholar.
25 Surrey, supra note 18, at 366. See also Proposed Income Tax Convention Between the United States and Brazil, Memorandum prepared by the Staff of the Joint Comm. on Internal Revenue Taxation, in Senate Comm. On Foreign Relations, Tax Conventions with Brazil, France, and the Philippines, S. Exec. Rep. No. 5, 90th Cong., 2d Sess. 12 (1968) [hereinafter S. Exec. Rep. No. 5].
26 This is usually a necessary tradeoff in the light of the profit-maximization impetus behind most private investment. Cf. Imam, , A New Solution for Solving the Problem of Double Taxation of Dividends, 29 Bull. Int. Fisc. Doc. 327, 328 (1975)Google Scholar.
27 As noted in a report (dated November 17, 1967) prepared at the request of the UNCTAD Secretariat, the “failure to take adequate steps to avoid frustrating the fiscal policies of the [developing countries] has in some cases adversely affected relationships between governments and individual foreign enterprises,” Stikker, , The Role of Private Enterprise in Investment and Promotion of Exports in Developing Countries: Taxation Aspects, 22 Bull. Int. Fisc. Doc. 383, 391 (1968)Google Scholar. ECOSOC Resolution 1273 of August 4, 1967, mandated that tax treaties with developing countries provide “for favourable tax treatment” for investments by, inter alia, “measures which would assure to them [i.e., the investments] the full benefit of any tax incentives allowed by the country of investment.” 43 ESCOR, Supp. (No. 1) 5, UN Doc. E/4429 (1967), reprinted in Annex I of United Nations Department of Economic and Social Affairs, Tax Treaties between Developed and Developing Countries, UN Doc. E/4614, ST/ECA/110, at 26 (1969) [hereinafter 1st UN Report].
28 The United States has two tax treaties presently in force with developing countries, specifically those with Pakistan and Trinidad and Tobago. Several developing countries have accepted the terms of treaties currently extant between the United States and their former “mother countries,” the United Kingdom and Belgium (viz., Barbados, Burundi, Gambia, Jamaica, Malawi, Nigeria, Rwanda, Sierra Leone, Zaire, and Zambia). See Kelley, , Tax Treaties between the United States and Developing Countries: The Need for a New U.S. Incentive, 65 AJIL 159 (1971)Google Scholar; Tax Treaties (P-H) 1f 1011 (status of each signed tax treaty as of July 29, 1977). Cyprus had assumed the terms of the U.S. income tax treaty with the United Kingdom but terminated the arrangement as of December 31, 1967, T.D. Release F-1068, Oct. 31, 1967. See Tax Treaties (P-H) fl 89,156 n.3. A new treaty was signed on April 19, 1974, but it has yet to be released or submitted to the Senate. See Tax Treaties (P-H) fl 1011. In contrast, the developed countries of Western Europe have negotiated many tax agreements with developing states. See Statement by Surrey in Legislative History, supra note 23; Comment, supra note 23, at 234; and the references in note 33 infra.
29 As has been mentioned, four treaties were negotiated with developing countries (Pakistan, India, Israel, and the United Arab Republic) containing tax-sparing provisions, but none of these provisions ever came into effect. The Treasury Department subsequently negotiated treaties that extended the domestic investment tax credit (equal to seven percent at the time) to investments in developing countries with whom the United States had included the requisite treaty clause. Treaties with such a provision were concluded with Brazil, Israel, and Thailand between 1965 and 1967, but the Senate would not approve these particular clauses because of a domestic recession militating against incentives for foreign investment, and the treaties never entered into force. See S. Exec. Rep. No. 5, supra note 25, at 2, 13; Hellawell, supra note 15, at 1419 n. 81; Kelley, supra note 28, at 160. At the same time, an attempt was made to allow taxpayers to take charitable deductions under I.R.C. Section 170 for contributions to otherwise qualified developing country charities in Brazil, Thailand, and the Philippines. These, too, were rejected by the Senate on the grounds that charitable deductions had fostered such excessive abuse domestically that an extension of the privilege was unwarranted and might only serve to exacerbate the abuses. Article XIII D(1) of the March 4, 1942 U.S. income tax treaty with Canada, 56 Stat. 1399, T.S. No. 983, as modified by Article 1(e) of the Supplementary Convention of Aug. 6, 1956, 8 UST 1619, 1622-23, TIAS No. 3916, however, does include such a clause. See Pearson, , The OECD Draft Double Taxation Convention and Recent United States Treaties, 48 Taxes 426, 431-35 (1970)Google Scholar. See also S. Exec. Rep. No. 5, supra note 25, at 3; Hellawell, supra note 15, at 1419 n. 81. The most recent tax treaties include altogether different concessions. In Article 11 of the Income Tax Convention, October 28, 1975, United States-Egypt (Tax Treaties (P-H) |34,100, at fi34,lll), tax exemptions are only granted by Egypt to U.S. corporations so long as the profits are not taxable by the United States. Thus, Egypt retains the primary right to tax income earned within its jurisdiction, and it will not relinquish tax revenues to the U.S. by reason of its tax exemptions. In the Income Tax Convention, November 20, 1975, United States-Israel (Tax Treaties (P-H) 1F52.100, at 1F1T52, 110, 52,126), certain cash grants bestowed upon U.S. taxpayers by the Israeli Government (a program reportedly no longer in effect) are not to be included in gross income for U.S. tax purposes (Art. 10) and compulsory loans are treated as taxes on income for purposes of the foreign tax credit (Art. 26 (2)). The Senate has yet to pass on«these provisions. The income tax treaty with the Republic of Korea (Tax Treaties (P-H) 1(56,100, signed June 4, 1976) is also awaiting Senate approval. In an exchange of notes on June 4, 1976 (id., at 1(56,133), the U.S. Ambassador to Korea recognized the importance Korea places on negotiating special investment incentives to promote the flow of U.S. capital and technology and assured the Korean Minister of Foreign Affairs that “when circumstances permit,” the United States will be prepared to resume discussions with a view to incorporating provisions into this Convention that will minimize the interference of the United States tax system with incentives offered by the Government of the Republic of Korea and that will be consistent with the income tax policies of the United States Government regarding other developing countries. Similar exchanges took place between the United States and Trinidad and Tobago in connection with the tax treaty presently in force with that country. See Statement on Proposed Income Tax Treaty with Trinidad and Tobago by Edwin S. Cohen, Assistant Secretary of the Treasury for Tax Policy, before the Senate Committee on Foreign Relations, Oct. 6, 1970, in Tax Treaties (P-H) 1(85,061, at pp. 85,030-31. See also the exchange between the United States and Morocco in connection with a tax treaty signed on August 1, 1977. Letter from Abdel Kader Benslimane, Minister of Finance, Kingdom of Morocco, to the Honorable Robert Anderson, U.S. Ambassador to Morocco (Aug. 1, 1977) (seeking a confirmation of the U.S. Government's commitment to resume discussions on granting a tax-sparing credit against the U.S. tax on U.S. citizens and residents investing in Morocco should the Senate reconsider its position on such credits), in Tax Treaties (P-H) fl64,130, at p. 64,117. It is significant to note that the Trindidad and Tobago treaty, as assigned, contains a special provision for the deferral of taxes on exchanges of technical assistance in the event such technology transfers are rendered in exchange for stock in the recipient corporation. See Art. 7 of the Income Tax Convention, Jan. 12, 1970, TIAS No. 7047, Tax Treaties (P-H) 1f85,030, at 1(85,037 (effective Jan. 1, 1970). Although the Senate ratified the treaty, it reserved its acceptance of Article 7 because it deemed the encouragement of overseas private investment by U.S. taxpayers to be inappropriate in view of the prevailing economic considerations such as the current balance of payments deficit. See Tax Treaties (P-H) Kf85,001; 85,063, at p. 85,052. The United States has also entered into several exchanges of notes agreements with developing countries for the limited purpose of providing relief from the double taxation of aircraft and shipping earnings. See, e.g., Agreement on Taxation of Aircraft Earnings, Dec. 29-31, 1975, United States-Chile, TIAS No. 8252 (effective Jan. 1, 1975); Agreement on Taxation of Aircraft Earnings, Nov. 26-Dec. 29, 1976, United States-India, TIAS No. 8569 (effective Jan. 1, 1976). For a list of such agreements in effect as of July 24, 1976, see Tax Treaties (P-H) 1(1014.
30 See Hausman, , The Andean Pact Model Convention as Viewed by the Capital Exporting Nations, 29 Bull. Int. Fisc. Doc. 99, 100 (1975)Google Scholar. Admittedly, a treaty has been signed with the Philippines on October 1, 1976, without reference to any investment incentive provisions. See Tax Treaties (P-H) |74,100. There has also been a spate of recent negotiations with Bangladesh, Botswana, Costa Rica, India, Iran, Jamaica, Malta, Singapore, Sri Lanka, Tunisia, and Zambia. See 9 Tax Treaties (P-H), Rep. Bull. No. 16, at fl6.1 (April 29, 1977); 8 Tax Treaties (P-H), Rep. Bull. No. 17, at K17.1 (Nov. 21, 1975). In addition, negotiations with Indonesia, Kenya, and the Republic of China are reportedly near completion. See 9 Tax Treaties (P-H), Rep. Bull. No. 16, at |16.1 (April 29, 1977). This upsurge in developing country negotiations may signal a willingness on the part of such countries to forego tax-sparing credits. However, the aforementioned exchanges of notes between the United States and Korea, Trinidad and Tobago, and Morocco (see note 29 supra) as well as the attempts at finding an acceptable treaty incentivein lieu of tax-sparihg in the Israeli and Egyptian treaties (see note 29 supra) indicates that the tax-sparing issue is far from dormant. If anything, the pressure on the United States to agree to some form of tax incentive for overseas investment may be mounting.
31 See Stikker, supra note 27, at 390. The International’ Chamber of Commerce notes that this aspect of the foreign tax credit system “bears especially unfairly” on developing countries which attempt to encourage development by either low corporate tax rates or special tax concessions. See Report of the Commission of Taxation, Doc. 180/ 122, 2.IV.1970, reprinted in International Chamber of Commerce, Tax Treaties Between Developed and Developing Countries, 24 Bull. Int. Fisc. Doc. 448, 454 (1970). See also United Nations Department of Economic and Social Affairs, Tax Treaties between Developed and Developing Countries: Sixth Report, UN Doc. E/5761, ST/ ESA/42, at 57 (1976) [hereinafter 6th UN Report].
32 Many developed countries have recognized this nullification effect and have reacted by granting the desired tax-sparing credits. See, e.g., Landwehrmann, supra note 5, at 259 (West Germany). The United States has also publicly recognized this nullification effect. See, e.g., Letter from John Foster Dulles to the President, July 8, 1957, in 2 Tax Treaties (CCH) f6246, at p. 6215; Statement of Dan Throop Smith, Deputy to the Secretary of the Treasury, in Legislative History, supra note 23, at 2201; Senate Comm. On Foreign Relations, Report on Double Taxation Conventions, S. Exec. Rep. No. 1, 85th Cong., 1st Sess. (1958), in 2 Tax Treaties (CCH) 1f6247, at p.6216 [hereinafter S. Exec. Rep. No. 1].
33 See Tax Sparing by European Countries, 12 EUR. TAX. 1/10 (1972) (summaries of tax-sparing credits granted by Austria, Belgium, Denmark, Finland, France, West Germany, Greece, Italy, the Netherlands, Norway, Spain, Sweden, Switzerland, and the United Kingdom); Norr, , Jurisdiction to Tax and International Income, 17 Tax L. Rev. 431, 447 (1962)Google Scholar (tax-sparing by Japan).
34 See Surrey, supra note 22, at 158. For an interesting discussion of tax-sparing and the concept of tax neutrality which is critical of those who would place tax neutrality above all other considerations, see Haynes, , Tax Treaties and Tax Neutrality; A Proposal Being Considered by Indonesia, 56 Minn. L. Rev. 755 (1972)Google Scholar.
35 See Surrey, supra note 22, at 159; Surrey, supra note 18, at 336.
36 See United Nations Department of Economic and Social Affairs, Tax Treaties between Developed and Developing Countries: Third Report, UN Doc. E/5123, ST/ ECA/166, at 98 (1972) [hereinafter 3d UN Report]; 1st UN Report, supra note 27, at 42; Atchabahian, supra note 24, at 465. Other critiques of little merit include:
(a.) The United States should not include tax-sparing in its treaty with Pakistan since the British did not do so. See Surrey, supra note 22, at 161. Of course, there is no reason for the United States to follow the British example. In any event, the United Kingdom now has a tax-sparing agreement with Pakistan, as well as like agreements with Barbados, Israel, Jamaica, Malaysia, Malta, Portugal, Singapore, and Trinidad and Tobago. See Tax Sparing by European Countries, 8 Eur. Tax. 121, 128 (1968).
(b.) Tax-sparing would permit tax rates on foreign income to be determined by treaty rather than by legislation and the resulting U.S. tax rate would be determinedby the foreign country. See Surrey, supra note 22, at 157-58; Hollman, , The Pros and Cons of Tax Sparing for Waived Foreign Taxes, 9 J. Tax. 152, 154 (1958)Google Scholar. However, the Senate must consent to the treaty in order for it to be ratified and the scope of the spared tax credit can be delimited sufficiently to prevent giving the foreign country legislative power over U.S. tax rates. Furthermore, sparing is best enacted .through a treaty rather than by statute because of the flexibility and selectivity of the treaty device. See Statement of Mitchell B. Carroll, Counsel to the Tax Committee of the National Foreign Trade Council of New York, in Legislative History, supra note 23, at 2254. See also Costa, Valdes, Latin American Position on the Problems of Tax Agreements between Developed and Developing Countries, 25 Bull. Int. Fisc. Doc. 283, 291 n. 12 (1971)Google Scholar.
(c.) Congress has traditionally manifested an antipathy towards preferential corporate tax rates on foreign income. See Surrey, supra note 22, at 158. At the time this criticism was levied, there was no DISC legislation (I.R.C. §991 et seq., enacted as Title V of the Revenue Act of 1971, Pub. L. No. 92-178, 85 Stat. 497), and the lack of other such preferences is not immutable. The same response is appropriate for Professor Surrey's comment that, merely because the United States recognizes the primary jurisdiction of source countries, it is not necessary that it also accommodate foreign tax waivers. Id. at 161. This is true but does not advance the discussion of whether or not it is a good policy to agree to accommodations of this sort.
(d.) There are numerous administrative difficulties in ascertaining what taxes were not paid. Surrey, supra note 22, at 162. However, as long as the tax to be spared is properly defined, such difficulties should prove manageable. The experience of those developed countries which are engaged in crediting spared taxes may be helpful in this regard.
(e.) Tax-sparing may result in pressures on developing countries to compete among themselves to the detriment of positive tax reform. Id.; P. Musgrave, United States Taxation of Foreign Investment Income: Issues and Arguments 161 (1969). The solution to this problem, however, probably lies in regional agreements between developing countries to limit the “wasteful competition” in tax incentives which may presently exist in spite of the reluctance of the United States to grant sparing credits. See 6th UN Report, supra note 31, at 57.
(f) It is not clear that tax policies should be used to encourage foreign investment and, in any event, the test of which countries the United States desires to “aid” should not depend upon which countries offer tax concessions. See Surrey, supra note 22, at 163-64. However, where appropriate, and in carefully selected circumstances, there is no reason why tax policies may not be utilized as one effective tool for promoting “self-help” forms of foreign aid. In the final analysis, whether or not sparing will have much of an effect on investment decisions, it is conclusive that the increase in revenue to the United States, as long as it refuses to implement tax-sparing credits, comes at the expense of a concomitant loss of potential revenue for developing countries. See Atchabahian, supra note 24, at 465.
(g.) The symbolic value and “emotional appeal” of tax sparing are insufficient reasons for the creation of major loopholes and a significant precedent with unforeseen consequences. See Surrey, supra note 22, at 165-66. Tax sparing, however, has additional benefits which outweigh trie perceived risks (particularly if sparing is first undertaken on a trial basis). It may assist in promoting the foreign economic policy of the United States by improving our relations with developing countries, see Statementf by Kalijarvi, in Legislative History, supra note 23, at 2279, and it may also be utilized as a quid pro quo or “bargaining chip” to obtain more tax treaties with developing countries, a goal which is for the benefit of the United States as well as for those countries with whom it signs treaties. See Hollman, supra, at 153. See also Peterson, , Canada's New Tax Treaties, 23 Can. Tax J. 315 (1975)Google Scholar (changes in Canadian tax laws may serve to induce more developing countries to enter into treaties with Canada).
(h.) Finally, Professor Surrey argues that the present tax credit system does not nullify foreign tax concessions because most U.S. overseas investment is made via foreign subsidiaries and the income derived therefrom is shielded by the deferral principle. See Surrey, supra note 22, at 160. See also Hausman, supra note 30, at 100. However, in some areas and industries (e.g., in Latin America and in mineral extraction enterprises), branch operations prevail. It is thus important to at least provide sparing credits for branch income, see 3d UN Report, supra, at 99, at which point tax equity dictates treating repatriated income from foreign subsidiaries in a like manner. Hence, the rationale for permitting tax concessions to be fully operative on both branch and subsidiary income. See P. Musgrave, supra, at 161.
37 The tax-sparing clause in Article XV(1) of the 1957 U.S.-Pakistan treaty, supra note 1, reads as follows: For the purposes of this credit there shall be deemed to have been paid by a United States domestic corporation the amount by which such Pakistan taxes (other than the business profits tax) have been reduced under the provisions of section 15B of the Income Tax Act, 1922 (XI of 1922) as in effect on the date of the signature of the present Convention: Provided, That any extension made by law of the period within which an industrial undertaking may be set up or commenced in order to obtain the reduction provided in section 15B shall be deemed to be in effect on the date of the signature of the present Convention.
38 See Surrey, supra note 22, at 159-60; P. Musgrave, supra note 36, at 159. Although the incentive to disinvest may be ameliorated by the operation of the deferral principle in the case of foreign subsidiaries [see Singhal, , Taxation for Development: Incentives Affecting Foreign Investment in India, 14 Harv. Int. L.J. 50, 83 (1973)Google Scholar), disinvestment only results in a U.S. tax liability if it is allowed by repatriation. Thus, without a positive incentive to reinvest, funds may be withdrawn for investment elsewhere without the imposition of U.S. tax as long as no dividend (actual or constructive) is distributed.
39 See Surrey, supra note 22, at 159; Statement of Stanley Surrey, Harvard University Law School, in Legislative History, supra note 23, at 2230.
40 See Legislative History, supra note 23, at 2207 (Comment by Senator John F. Kennedy).by Kalijarvi, in Legislative History, supra note 23, at 2279, and it may also be utilized as a quid pro quo or “bargaining chip” to obtain more tax treaties with developing countries, a goal which is for the benefit of the United States as well as for those countries with whom it signs treaties. See Hollman, supra, at 153. See also Peterson, , Canada's New Tax Treaties, 23 Can. Tax J. 315 (1975)Google Scholar (changes in Canadian tax laws may serve to induce more developing countries to enter into treaties with Canada). (h.) Finally, Professor Surrey argues that the present tax credit system does not nullify foreign tax concessions because most U.S. overseas investment is made via foreign subsidiaries and the income derived therefrom is shielded by the deferral principle. See Surrey, supra note 22, at 160. See also Hausman, supra note 30, at 100. However, in some areas and industries (e.g., in Latin America and in mineral extraction enterprises), branch operations prevail. It is thus important to at least provide sparing credits for branch income, see 3d UN Report, supra, at 99, at which point tax equity dictates treating repatriated income from foreign subsidiaries in a like manner. Hence, the rationale for permitting tax concessions to be fully operative on both branch and subsidiary income. See P. Musgrave, supra, at 161. 37 The tax-sparing clause in Article XV(1) of the 1957 U.S.-Pakistan treaty, supra note 1, reads as follows: For the purposes of this credit there shall be deemed to have been paid by a United States domestic corporation the amount by which such Pakistan taxes (other than the business profits tax) have been reduced under the provisions of section 15B of the Income Tax Act, 1922 (XI of 1922) as in effect on the date of the signature of the present Convention: Provided, That any extension made by law of the period within which an industrial undertaking may be set up or commenced in order to obtain the reduction provided in section 15B shall be deemed to be in effect on the date of the signature of the present Convention. 38 See Surrey, supra note 22, at 159-60; P. Musgrave, supra note 36, at 159. Although the incentive to disinvest may be ameliorated by the operation of the deferral principle in the case of foreign subsidiaries [see Singhal, , Taxation for Development: Incentives Affecting Foreign Investment in India, 14 Harv. Int. L.J. 50, 83 (1973)Google Scholar), disinvestment only results in a U.S. tax liability if it is allowed by repatriation. Thus, without a positive incentive to reinvest, funds may be withdrawn for investment elsewhere without the imposition of U.S. tax as long as no dividend (actual or constructive) is distributed. 39 See Surrey, supra note 22, at 159; Statement of Stanley Surrey, Harvard University Law School, in Legislative History, supra note 23, at 2230. 40 See Legislative History, supra note 23, at 2207 (Comment by Senator John F. Kennedy).
41 See note 1 supra.
42 In recommending a reservation to article XV(1), the committee wants to make it perfectly clear that this is without prejudice to future consideration of the matter in the event the Pakistani tax waiver law is reenacted and the question again comes before the committee. There is no occasion for the Senate at this time to decide the question. The committee reserves complete freedom of decision for the future. S. Exec. Rep. No. 1, supra note 32, at 6217. See also Legislative History, supra note 23, at 2287.
43 See note 32 supra.
44 Income Tax Act, 1922 (XI of 1922), Sec. 15B (1974).
45 See note 29 supra.
46 As of 1972, over 70 tax-sparing treaties had already been signed by Japan and the countries of Western Europe alone. See Tax Sparing by European Countries, supra note 33. The OECD Draft Convention, supra note 20, provides two alternatives, an exemption and a credit method, for the elimination of double taxation (Arts. 23A and 23B). However, Comment 48 to the draft recognizes that tax concessions granted by the developing countries to encourage industrialization may be nullified under the credit system. Thus, Comment 49 allows for a deviation from the stated alternatives. One suggested deviation is for the state of the taxpayer's residence to grant a taxsparing (“matching“) credit for the taxes which would have been paid had there been no concession (Comment 50). Under Comment 51, the members of the OECD are left free to settle upon those deviations from the ordinary credit method which they find most appropriate.
47 See Kelley, supra note 28, at 161-62. Cf. Christiaanse, , Tax Treaties Between Developed and Developing Countries, 54 Cahiehs de Droit Fiscal International 31, 38, 40 (1969)Google Scholar. Greece, for example, will not grant concessions to enterprises incorporated or organized in countries which use a tax credit system unless the consequent nullification of such concessions is eliminated concurrently. See Atchabahian, supra note 24, at 463 n.8, citing Tsingris, Grice, 44 Cahiers de Droit Fiscal International 112 (1961). See also the U.S.-Egypt Tax Convention, supra note 29, at Art. 11. The fate of the June 25, 1956 United States tax treaty with Honduras (8 UST 219, TIAS No. 3766, 279 UNTS 178 (effective Jan. 1, 1957)’) is a further example of this adamancy. The treaty was terminated as of December 31, 1966 (see Tax Treaties (P-H) 1f45,001) apparently because Honduras desired that it be amended to include some form of tax sparing. Honduras refused the U.S. counteroffer toextend the seven percent investment credit to the export of capital to Honduras. See Comment, supra note 23, at 238. Talks were subsequently renewed for a new treaty but have recently terminated. See 8 Tax Treaties (P-H), Rep. Bull. No. 9, at f9.1 (March 26, 1975).
48 See-the Tax Reform Act of 1976, supra note 16, at Sec. 1022(a), amending I.R.C. Sec. 1248(d), which repeals the special treatment accorded the sale or, exchange of stock in Less Developed Country Corporations (LDCC's), and Sec. 1033(a), amending I.R.C. Sec. 902, which eliminates the concession for dividends from LDCC's in the calculation of the foreign tax credit limitation.
49 See text accompanying notes 38-40 supra.
50 See 3d UN Report, supra note 36, at 90; note 37 supra.
51 It is assumed that tax credits are to be allowed for taxes actually paid according to language akin to that in Article 23B of the OECD Draft Convention, supra note 20, or Article 23 of the U.S. Model Tax Treaty, supra note 20
52 See note 37 supra.
53 See Government of Pakistan, Central Board of Revenue, Income Tax Manual: Part 1, at Sec. 15B (9th ed. 1974).
54 The income tax rate is presently a flat 30 percent and the supertax is 30 percent of the resulting net income. See Price Waterhouse & Co. U.S.A., Information Guide: Corporate Taxes in 80 Countries 212 (July 1976); Government of Pakistan, Finance Division, Taxation Structure of Pakistan 1974-75, at 43 (1974). For a general explanation of Pakistani tax law, see K. Saeed, Income Tax Law with Practical Problems (1970). Compare Crockett, , “Tax Sparing“: A Legend Finally Reaches Print, 11 Nat. Tax J. 146, 149-50 (1958)Google Scholar, for a description of the Pakistani tax exemptions when the treaty was negotiated in 1957.
55 Not all tax-sparing clauses are as precise as that in the U.S.-Pakistan treaty. Some describe the incentives to be credited in quite general and perhaps overly broad terms. See 3d UN Report, supra note 36, at 89-90.
56 Income Tax Act, 1922 (XI of 1922), §10(2) (va) & (vi). See K. SAEED, supra note 54, at 118-26. Note that the unused portion of the accelerated depreciation allowance may be carried over indefinitely.
57 See Kust, , Tax Sparing in Principle; and as Vitiated by the Pakistan Laws, 9 J. Tax. 150 (1958)Google Scholar.
58 An idea propounded on its own merits in Smith, supra note 23, at 327.
59 See Singhal, supra note 38, at 61.
60 See 3d UN Report, supra note 36, at 90. Compare Art. XI (3) (b) of the Income Tax Agreement, Jan. 5, 1960, India-Japan, 384 UNTS 3 (effective June 31, 1960), which accords tax-sparing credits against Japanese tax to certain denominated concessions granted by India with the proviso that “the scope of the benefit accorded to the taxpayer by the said measures effective on the date of signature of the present agreement is not increased.” Reprinted in G. Pophale, Tax Treaties between India and Foreign Countries 118 (1966).
61 See Surrey, supra note 22, at 158; Surrey, supra note 39, at 2222; Smith, supra note 32,” at 2201. Note that according to I.R.C. Section 7852(d), no provision in the U.S. Internal Revenue Code “shall apply in any case where its application would be contrary to any treaty obligation of the United States in effect on the date of enactment” of the Code. See also I.R.C. §894(a). However, treaties entered into after 1954 do not receive the protection of Section 7852(d). Despite the fact that tax conventions are accorded the status of treaties, their authority is only equal to that of acts of Congress under the supremacy clause and, in case of conflict, the “last in time” principle is the prevailing rule. See Beemer, , Revenue Act of 1962 and United States Treaty Obligations, 20 Tax L. Rev. 125, 127 (1964-1965)Google Scholar and the cases cited therein. Hence, legislation enacted subsequent to the signing of a post-1954 treaty will override the conflicting treaty terms unless there is specific intent to the contrary. Compare Section 110 of the Foreign Investors Tax Act of 1966, Pub. L. No. 89-809, 80 Stat. 1539, 1575 (“No amendment made by this title shall apply in any case where its application would be contrary to any treaty obligation of the United States“) with Section 31 of the Revenue Act of 1962, Pub. L. No. 87-834, 76 Stat. 960, 1069. (I.R.C. Section 7852(d) was made inapplicable to the provisions contained in the 1962 Act, thereby rendering the latter superior to all inconsistent treaty obligations). The suggested draft attempts to avoid the inevitability of abrogation by providing a mandatory negotiating period (with an option to extend) during which time the necessary adjustments may be agreed upon.
62 See 3d UN Report, supra note 36, at 90.
63 See id.
64 See, e.g., Article 2(3) of the Tax Convention between Brazil and Sweden, signed September 17, 1965. reprinted in G. Canto & S. Bille, THe Tax Convention between Brazil and Sweden with Brazilian and Swedish Commentaries (1968). Cf. Pepper, , Tax Relief Provisions Between Developed and Developing Countries, 12 Eur. Tax. 1/3, 1/6 (1972)Google Scholar (5-10 year time periods are reasonable for outright exemptions from taxation).
65 See text accompanying notes 38-40 supra.
66 The Section(s) of the Pakistan Income Tax Act is (are) left blank in light of the the discussion in the text accompanying notes 56-59 supra.
67 Windfalls are not entirely eliminated as there is no way to account for investments that would have been made subsequent to the signing of the treaty regardless of the absence of the tax-sparing credit.
68 This is similar to the suggestion of reducing or denying tax-sparing benefits on earnings remitted to the United States within a certain period of time. See Comment, supra note 23, at 242.
69 See Haynes, supra note 34.
70 See notes 27 and 30 supra.
71 “See Peterson, supra note 36, at 315, 317.
72 Kelley, supra note 28, at 167.