Rev. Rul. 79-65

Advice has been requested whether a dividend to be paid to a Netherlands Antilles corporation under the circumstances described below will be subject to a reduced rate of withholding of United States tax pursuant to Article VII(1) of the 1948 Income Tax Convention between the United States and the Netherlands, T.D. 5778, 1950-1 C.B. 92, as extended to the Netherlands Antilles by the Protocol of June 15, 1955, T.D. 6153, 1955-2 C.B. 777 (the Convention), and as modified and supplemented by the Protocol of October 23, 1963, 1965-1 C.B. 624 (the Protocol).

P, a foreign corporation organized in 1975 under the laws of the Netherlands Antilles, owns all the stock of S, a domestic corporation.

P's sole shareholder is an individual, A, who is not a citizen or a resident of the United States, the Netherlands, or the Netherlands Antilles.

A's country of residence does not have a tax convention with the United States. P does not have a permanent establishment in the United States.

S was incorporated in state X on June 30, 1971. S is an operating company that has never had any income from interest, dividends, or passive investment. S had issued and outstanding 10x shares of voting stock, each share of which is entitled to one vote. S had gross income for taxable year 1975, 1976, and 1977 of 50x dollars, 55x dollars, and 65x dollars, respectively.

In the past when S has paid dividends to P, P in turn has paid dividends to A that were identical in amount to those paid by S to P. S plans to pay another dividend to P during 1978.

Article VII(1) of the Convention, as it applies to the Netherlands Antilles, provides that:

The rate of United States tax on dividends derived from a United States corporation by a resident or corporation of the Netherlands not engaged in trade or business in the United States through a permanent establishment shall not exceed 15 percent: Provided that such rate of tax shall not exceed 5 percent if such Netherlands corporation controls, directly or indirectly, at least 95 percent of the entire voting power in the corporation paying the dividend and not more than 25 percent of the gross income of such paying corporation is derived from interest and dividends, other than interest and dividends from its own subsidiary corporation. Such reduction of the rate to 5 percent shall not apply if the relationship of the two corporations has been arranged or is maintained primarily with the intention of securing such reduced rate.

Section 505.302(c)(1) of the Convention withholding regulations provides, in part, that under the proviso of Article VII(1) of the Convention, dividends derived from a domestic corporation by an Antilles corporation that controls, directly or indirectly, at the time the dividend is paid, 95 percent or more of the entire voting power in the corporation paying the dividend are subject to United States tax at a rate not in excess of 5 percent if (i) not more than 25 percent of the gross income of the paying corporation for the three year period immediately preceding the taxable year in which the dividend is paid consists of dividends and interest, (ii) the relationship between the paying corporation and the Antilles corporation has not been arranged or maintained primarily with the intention of securing the reduced rate of 5 percent, and (iii) the Antilles corporation at no time during the taxable year in which such dividends are derived has engaged in trade or business within the United States through a permanent establishment.

In the instant situation, S declined to provide information when requested by the Internal Revenue Service to establish that the relationship between S and P was not arranged or maintained primarily with the intention of securing the 5 percent rate. Specifically, S was requested to demonstrate that business exigencies dictated the organization of P in the Netherlands Antilles and that any dividends distributed from P to A were paid not merely as a result of the receipt of a distribution from S. S failed to provide information that the corporate structure of P and S is not an arrangement primarily motivated by tax avoidance purposes.

Consequently, all requirements for obtaining the 5 percent rate have not been satisfied.

Accordingly, the dividend to be paid to P by S during 1978 will not qualify for the withholding of United States tax at the rate of 5 percent. The dividends will qualify for the 15 percent rate if the dividends constitute dividends derived from a United States corporation by a resident or corporation of the Netherlands Antilles.