It is understood that the substantiality requirement of subparagraph b) is intended to prevent a narrow case of treaty-shopping abuses in which a company attempts to qualify for treaty benefits by engaging in de minimis connected business activities that have little economic cost or effect with respect to the company's business as a whole. Whether a trade or business is substantial for purposes of this paragraph will be determined based on all the facts and circumstances. Such determination will take into account the comparative sizes of the trades or businesses in each Contracting State (measured by reference to asset values, income and payroll expenses), the nature of the activities performed in each Contracting State, and, in cases where a trade or business is conducted in both Contracting States, the relative contributions made to that trade or business in each Contracting State. In making each determination or comparison, due regard will be given to the relative sizes of the U.S. and Netherlands economies.

In any case, however, a trade or business will be deemed substantial if, for the preceding taxable year, or for the average of the three preceding taxable years, the asset value, the gross income, and the payroll expense that are related to the trade or business in the firstmentioned State equal at least 7.5 percent of the resident's (and any related parties') proportionate share of the asset value, gross income and payroll expense, respectively, that generated the income in the other State, and the average of the three ratios exceeds 10 percent. If the resident owns, directly or indirectly, less than 100 percent of an activity conducted in either State, only the resident's proportionate interest in such activity will be taken into account for purposes of the test described in this paragraph. The following examples demonstrate the application of the substantiality requirement.

Example 1 (i) V, a resident of a country that does not have a tax treaty with the Netherlands, wants to acquire a Netherlands financial institution. However, since its country of residence does not have a tax treaty with the Netherlands, any dividends generated by the investment would be subject to a Netherlands withholding tax of 25%. V establishes a U.S. corporation with one office in a small town to provide investment advice to local residents. That U.S. corporation acquires the Netherlands financial institution with capital provided by V.

(ii) The Netherlands source income is generated from business activities in the Netherlands that are related to the investment advisory business conducted by the U.S. parent. However, the substantiality test would not be met in this example, so the dividends would remain subject to withholding in the Netherlands at a rate of 25% rather than the rate provided in Article 10 (Dividends).

Example 2 (i) S is a banking organization that is organized and managed and controlled in the Netherlands. S has a large number of local branches and customers in the Netherlands and sufficient employees to provide banking services to those customers. However, because the banking market in the Netherlands is crowded with competitors, S determined that it needed to establish branches outside the Netherlands in order to expand its business. In accordance with that plan, S established branches in several major cities in the United States to engage in the same type of banking business as in the Netherlands. Over time, the U.S. branches have grown significantly, and now are equal in size to the entire Netherlands business of S.

(ii) The business activities of the U.S. branches of S are related to the business conducted by S in the Netherlands. Because S has a large number of local branches and employees in the Netherlands, the activities of S in the Netherlands are substantial for purposes of subparagraph 4 b) of Article 26 (Limitation on Benefits).

Example 3 NLCo, a Netherlands corporation, owns 100 percent of the stock of USCo, a U.S. corporation, and 50 percent of the stock of NLSub, a Netherlands corporation. NLCo does not directly conduct an active trade or business. USCo and NLSub are actively engaged in the music business. USCo has a number of employees who are responsible for discovering new recording artists. USCo also produces recordings and is responsible for production and distrib ution within the United States. Employees of NLSub are responsible for promoting the recordings in the Netherlands and developing a distribution strategy for the rest of Europe. European sales of U.S. recording artists contribute substantiality to the profitability of USCo.

NLCo receives payments of interest and dividends from USCo. In order for these payments to be entitled to treaty benefits under paragraph 4 of Article 26, NLCo must be considered to be engaged in the active conduct of a trade or business in the Netherlands. Under subparagraph 4 b), because NLCo and USCo are related persons, the activities conducted in the Netherlands and attributed to NLCo must be substantial in relation to the activities conducted by USCo. NLCo will be deemed to satisfy this requirement if the ratio of the assets, income and payroll attributable to NLCo to the assets, income and payroll attributable to USCo are at least 10 percent and each ratio is at least 7.5 percent.

For each of the four most recently concluded taxable years, the asset values, gross income and payroll expenses of these corporations that are attributable to the trade or business were as follows:

USCo | NLSub

Assets | $300 | $50

Income | 50 | 10

Payroll | 60 | 10

NLCo has no assets, income or payroll that are attributable to the trade or business. The assets, income and payroll of NLSub that are related to the trade or business may be attributed to NLCo, however, under subparagraph c), since NLCo is connected to NLSub by reason of its 50% beneficial ownership in NLSub. Accordingly, 50 percent of NLSub's assets, income and payroll are attributed to NLCo. The amounts attributed to NLCo and the percentage of USCo's corresponding amounts are as follows:

NLCo | NLCo as a Percentage of USCo

Assets | 8.3 | $25

Income | 10.0 | 5

Payroll | 8.3 | 5

Since none of these percentages is greater than 10 percent, NLCo does not meet the requirements for the safe harbor described above. Moreover, application of the threeyear average rule does not change the result, since the relevant amounts for the three preceding years (and the resulting ratios) are equal to those for the first preceding taxable year.

Nevertheless, NLCo will still qualify for benefits with respect to dividends received from USCo. The activities performed by NLSub are substantial in relation to those of USCo, taking into account the contributions of each company to the overall business of the group.