BECHTEL SAYS 'PERMANENT ESTABLISHMENT' SHOULD NOT INCLUDE CERTAIN CONSTRUCTION SITES.

SUMMARY: M.E. Lawson, international tax manager for Bechtel Corp., San Francisco, has made suggestions relating to tax treaty negotiations with Thailand. Lawson first recommends that the treaty "clearly distinguish between true royalties for the use of patented or copyrighted property or processes and business income from unique services provided to a single client." Second, it would be desirable to define "permanent establishment" to include a building site or construction project only if it exists for more than 36 months. That would allow U.S. construction companies to perform work on small or medium-sized construction projects in Thailand, Lawson says. Finally, Lawson suggests that that the treaty provide for no withholding, or withholding at a very low rate, on dividends and interest payments, because the corporate income out of which dividends are paid is subject to the Thailand company tax at a 35-percent rate.

The following comments and suggestions are submitted with respect to the recently announced tax treaty negotiations with Thailand.

Bechtel Group, Inc. and its affiliates are engaged in the engineering and construction industry in the United States and in numerous foreign countries. We are particularly concerned with the taxation of income from engineering, construction, procurement, and construction management activities performed both inside and outside Thailand for Thai clients.

1. BUSINESS INCOME VS. ROYALTY INCOME. We would urge that the tax treaty with Thailand clearly distinguish between true royalties for the use of patented or copyrighted property or processes, and business income from unique services provided to a single client.

In recent years, an unfavorable trend has arisen in the interpretation of existing tax treaties, and in negotiations of new treaties, with respect to the definition of royalty income. Indonesia, for example, has taken the position that gross payments for engineering services should be taxed under the U.S.-Indonesia Tax Treaty as royalty income. Typically, the withholding rate on gross payments for such services is higher than the profit margin provided by contract, resulting in a net economic loss to the engineering firm.

Royalty treatment for tax purposes is appropriate only where multiple parties are able to obtain licenses to use the same intellectual property, and where more than 100% of the costs of producing such property can be recovered through such licensing. Business income or personal services income treatment is appropriate where a consultant or other service provider is able to recover the costs of performing services from one client only.

For a discussion of the definitions of royalty income and business income treatment, see, e.g. the Commentary on the 1977 OECD Model Treaty, Article 12, Concerning the Taxation of Royalties, at Paragraph 12, ¹ and the Observations with respect to Guideline 12, Royalties, of the 1979 U.N. Guidelines and Model Income Tax Treaty. ²

2. CONSTRUCTION SITES AS PERMANENT ESTABLISHMENTS. It would be desirable to define a "permanent establishment" to include a building site or construction or installation project only if it exists for more than 36 months. This would make it economically feasible for a U.S. construction firm to perform work on smaller and medium-sized construction projects in Thailand, or vice-versa.

3. WITHHOLDING ON DIVIDENDS AND INTEREST PAYMENTS. It would be desirable for the treaty to provide for no withholding, or withholding at a very low rate, on dividends and interest payments. With respect to dividends, the corporate income out of which dividends are paid is subject to the Thailand company tax at a 35% rate. Any additional Thai withholding tax on dividends paid from such corporate income would likely put a U.S. shareholder into an excess foreign tax credit position.

Very truly yours,

² Id., section 91.12, at pp. 91-56, 91-57.