69–119 

110TH CONGRESS EXEC. REPT. " ! SENATE 2d Session 110–17 

TAX CONVENTION WITH ICELAND 

SEPTEMBER 11, 2008.—Ordered to be printed 

Mr. DODD, from the Committee on Foreign Relations, 

submitted the following 

R E P O R T 

[To accompany Treaty Doc. 110–17] 

The Committee on Foreign Relations, to which was referred the 

Convention between the Government of the United States of America and the Government of Iceland for the Avoidance of Double 

Taxation and the Prevention of Fiscal Evasion with Respect to 

Taxes on Income, and accompanying Protocol, signed at Washington on October 23, 2007 (the ‘‘Treaty’’) (Treaty Doc. 110–17), 

having considered the same, reports favorably thereon with one 

declaration, as indicated in the resolution of advice and consent, 

and recommends that the Senate give its advice and consent to 

ratification thereof, as set forth in this report and the accompanying resolution of advice and consent. 

CONTENTS 

Page 

I. Purpose ........................................................................................................... 1 

II. Background .................................................................................................... 2 

III. Major Provisions ............................................................................................ 2 

IV. Entry Into Force ............................................................................................ 5 

V. Implementing Legislation ............................................................................. 6 

VI. Committee Action .......................................................................................... 6 

VII. Committee Recommendation and Comments .............................................. 6 

VIII. Resolution of Advice and Consent to Ratification ....................................... 7 

IX. Annex.—Technical Explanation .................................................................... 7 

I. PURPOSE

The Treaty is intended to promote and facilitate trade and investment between the United States and Iceland, principally 

through the elimination or reduction in withholding taxes on certain cross-border payments of dividends, interest, and royalties. In 

addition, the Treaty contains an anti-treaty-shopping provision intended to limit abuse of the Treaty by third-country residents, 

which has been a problem associated with the current tax treaty 

with Iceland. 

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II. BACKGROUND

The Treaty replaces an existing income tax treaty with Iceland, 

which was concluded in 1975. The main impetus for negotiating a 

new treaty with Iceland was to obtain an anti-treaty-shopping provision that would limit abuse of the existing treaty with Iceland by 

third-country residents, otherwise known as a ‘‘Limitation on Benefits’’ or ‘‘LOB’’ provision. As noted in the President’s Letter of 

Transmittal for the Treaty, there has been ‘‘substantial abuse of 

the existing Treaty’s provisions by third country investors.’’ In response to questions from the committee the Treasury Department 

described the evidence on which they based this assertion as follows: 

A Treasury Department report to Congress, ‘‘Earning Stripping, Transfer 

Pricing and U.S. Income Tax Treaties,’’ released in November 2007 (2007 

Treasury Report), describes abuses of the U.S. tax treaty network by thirdcountry investors, particularly through inappropriate reductions in withholding tax. The 2007 Treasury Report presented data, gathered from U.S. 

tax returns, on deductible payments such as interest made by U.S. companies to related foreign companies located in treaty jurisdictions. The data 

suggested that tax treaties that have no LOB provision and a zero rate of 

withholding tax on deductible payments, such as our treaties with Iceland 

and Hungary, had begun to be abused by third-country investors. In particular, the 2007 Treasury Report notes that while in 1996 almost no U.S.- 

source interest was paid by foreign-controlled U.S. companies to related 

parties in Iceland and Hungary, payments of such interest had increased 

by 2004 to over $2 billion. In addition, publicly available information indicates that many of those related parties were ultimately owned by corporations from third countries. This evidence strongly suggests the existence of 

treaty abuse by third-country residents. 

Modern tax treaties negotiated by the Department of Treasury 

generally contain a Limitation on Benefits provision; however, the 

existing treaty with Iceland contains no such provision and thus is 

easily abused by third-country investors. The new Treaty contains 

a comprehensive Limitation on Benefits provision, which is described in greater detail below. Presumably, if the Treaty is ratified, as a result of the new Limitation on Benefits provision, the 

amount of tax revenue that the United States is currently losing 

through the abuse of the existing treaty will be reduced. 

III. MAJOR PROVISIONS

Although the need for a Limitation on Benefits provision was the 

main reason for negotiating a new tax treaty with Iceland, a number of other changes were made in the new Treaty. A detailed article-by-article analysis of the Treaty may be found in the Technical 

Explanation published by the Department of the Treasury on July 

10, 2008, which is reprinted in the Annex. In addition, the staff of 

the Joint Committee on Taxation prepared an analysis of the Treaty, Document JCX-58–08 (July 8, 2008), which was of great assistance to the committee in reviewing the Treaty. What follows is a 

discussion of certain key provisions. 

1. Dividends, Interest, and Royalties 

Like the existing treaty, the new Treaty provides for reduced 

source-country taxation of cross-border dividends and would eliminate withholding taxes on all cross-border interest payments with 

minor exceptions. See Articles 10 and 11. Yet, while the existing 

treaty eliminates withholding taxes on all cross-border payments of 

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royalties, the new Treaty would allow a withholding tax of up to 

five percent on certain royalties with respect to trademarks and 

certain trademark-related industrial, commercial, or scientific experience, motion picture films, or works for use in connection with 

television. See Article 12(2). 

2. Permanent Establishment and Services 

In general, U.S. bilateral tax treaties attempt to ensure that a 

person or entity is not subject to undue and overly burdensome taxation in instances in which the taxpayer has minimal contacts with 

the taxing jurisdiction. This is accomplished in the Treaty through 

provisions under which each country generally agrees not to tax 

business income derived from sources within that country by residents of the other country unless the business activities in the taxing country are substantial enough to constitute a permanent establishment. See Article 7(1). A permanent establishment is generally defined as ‘‘a fixed place of business through which the business of an enterprise is wholly or partly carried on.’’ See Article 

5(1). Examples include a place of management, offices, branches, 

and factories. See Article 5(2). The Treaty contains certain exemptions under which residents of one country performing services in 

the other country will not be required to pay tax in the other country unless their contacts with the other country exceed specified 

minimums. See Articles 14 and 16. These provisions are in line 

with the 2006 U.S. Model Tax Treaty. 

3. Limiting Treaty Abuse 

As noted above in Section II, the main reason for updating the 

U.S. bilateral tax treaty with Iceland was to obtain a Limitation on 

Benefits provision, which is designed to avoid treaty-shopping by 

limiting use of the treaty’s benefits to persons who are intended to 

receive the advantage of those benefits. The new Treaty’s LOB provision is in line with the 2006 U.S. Model Tax Treaty. The provision generally limits treaty benefits to treaty country residents 

such that only those residents with a sufficient nexus to the United 

States or Iceland will receive benefits. For example, the LOB provision provides that a treaty country company whose shares are regularly traded on a recognized stock exchange may qualify for treaty 

benefits if the company satisfies one of two tests: either the company must be primarily traded on a recognized stock exchange in 

its country of residence or the company’s primary place of management and control must be in its country of residence. See Article 

21(2). This requirement ensures that there is an adequate connection to the company’s claimed country of residence. 

The Treaty also includes special anti-abuse rules intended to 

deny benefits in certain circumstances in which an Icelandic-resident company earns U.S.-source income attributable to a thirdcountry permanent establishment and is subject to little or no tax 

in the third jurisdiction and Iceland. Similar anti-abuse rules are 

included in other recent treaties, including the Convention with 

Bulgaria. The 2006 U.S. Model Tax Treaty, however, does not include rules addressing so-called ‘‘triangular arrangements.’’ The 

Department of Treasury indicated that the ‘‘Department’s current 

policy is to incorporate the so-called ‘triangular rule’ into tax treaties in which the treaty partner exempts from tax certain foreign 

4 

source income such that a tax treaty may be used inappropriately 

in conjunction with certain branch structures to exempt fully from 

tax certain U.S.-source payments.’’ The Department of Treasury 

additionally noted that it is considering whether to include such a 

rule in the next update of the 2006 U.S. Model Tax Treaty. 

The Treaty includes a transition period during which taxpayers 

impacted by the new LOB provisions will have an opportunity to 

restructure their transactions. The Treaty allows a person to claim 

benefits under the existing treaty even after the new Treaty has 

entered into force, by electing to have the existing treaty apply to 

them for up to one year. This ‘‘election’’ is available to any person 

‘‘entitled to greater benefits’’ under the existing treaty than that 

person is entitled to under the new Treaty. See Article 27(3). The 

Department of Treasury has explained that this transition period 

was needed in order to reach agreement in 2007 with Iceland on 

the inclusion of the Limitation on Benefits provision. 

4. Fiscally Transparent Entities 

The 2006 U.S. Model Tax Treaty allows recipients of ‘‘income, 

gains, or profits’’ through an entity that is fiscally transparent 

under the tax laws of the recipient’s residence to enjoy the same 

treaty benefits on that income as they would have if the ‘‘income, 

gains, or profits’’ had been received by them directly. Fiscallytransparent entities (a subset of which are called ‘‘disregarded entities’’) are entities that act as a conduit, apportioning all income received to those holding an interest in the entity. 

The provision in the Iceland Treaty for fiscally transparent entities closely parallels the provision in the 2006 U.S. Model Tax 

Treaty. But, rather than referring to ‘‘an entity that is fiscally 

transparent,’’ the Iceland Treaty specifies that the entity be ‘‘a 

partnership, trust, or estate.’’ See Article 1(6). Treasury’s Technical 

Explanation makes clear that this is intended to include U.S. limited liability companies (‘‘LLCs’’) that are treated as partnerships 

or as disregarded entities for U.S. tax purposes, including LLCs 

with only one member. In response to Committee questions, the 

Department of Treasury explained why the phrase ‘‘fiscally transparent’’ was not used, even though the intended meaning of the 

provision appears to be the same, as follows: 

Paragraph 6 of Article 1 of the proposed treaty with Iceland does not use 

the U.S. Model’s phrase ‘‘fiscally transparent’’ because that term does not 

have meaning under the domestic law of Iceland. During the course of the 

negotiations, the Treasury Department obtained agreement in principle 

with Iceland over the intent and application of paragraph 6 of Article 1. Accordingly, the Treasury Department believes that the rule will be interpreted and applied by Iceland consistent with the language in the U.S. 

Model Tax Treaty. 

5. Students, Business Trainees, and Researchers 

The Treaty generally provides that students, business trainees, 

and researchers visiting the other treaty country are exempt from 

host country taxation on certain types of payments received. See 

Articles 16 and 19. 

6. Exchange of Information 

The Treaty provides for the exchange of information between the 

tax authorities of each country that is relevant to carrying out the 

5 

provisions of the agreement or the domestic tax laws of either 

country. See Article 25. 

7. Pensions, Alimony, and Child Support 

The Treaty differs from the 2006 U.S. Model Tax Treaty in some 

key ways with respect to pensions, alimony, and child support. 

Like the 2006 U.S. Model Tax Treaty, the Iceland Treaty provides that pension distributions owned by a resident of a treaty 

country are only taxable in the recipient’s country of residence. The 

2006 U.S. Model Tax Treaty, however, contains an exception to this 

provision under which a pension beneficiary’s country of residence 

must exempt from tax a pension amount or other similar remuneration that would be exempt from tax in the other contracting 

country where the pension fund is established, as if the beneficiary 

had been a resident of that other country. The Treaty does not contain this exception. 

Another difference from the 2006 U.S. Model Tax Treaty is that 

the Treaty makes no mention of the tax treatment of child support 

amounts that are paid to a resident of either country. Under the 

2006 U.S. Model Tax Treaty, child support payments paid to a resident of a contracting country are exempt from tax in either country. Because the Treaty makes no mention of the tax treatment of 

child support payments, it would be governed by Article 20 (Other 

Income), which assigns the exclusive right to tax to the country of 

residence of the recipient. In response to Committee questions, the 

Treasury Department explained that although this was a departure 

from the Model, the result achieved was similar because in most 

cases child support payments are exempt from tax under the domestic law of both the United States and Iceland. 

In addition, the Treaty does not contain provisions that deal with 

the tax treatment of cross-border pension contributions. These provisions cover, among other things, the tax treatment of pension 

contributions (paid by an individual or an individual’s employer) 

when an individual is a participant or beneficiary of a pension fund 

resident in one country, but is employed in the other country. In 

response to Committee questions regarding this omission, the 

Treasury Department offered the following explanation: 

The proposed treaty with Iceland does not address the tax treatment of 

cross-border pension contributions primarily for two reasons. First, the U.S. 

Model pension funds provision provides for deductibility in one State of contributions to a pension fund of the other State only where the pension fund 

‘‘generally corresponds’’ to a pension fund in the first state. The provision 

is, therefore, only appropriate if the two countries have pension systems 

that are similar. During the course of negotiations, it became clear that Iceland and the United States have very different pension systems. As a result, the provision was not appropriate to include in the proposed treaty. 

Second, Iceland had limited flexibility in changing by tax treaty its rules 

for taxing pensions, because those rules are technically under Iceland’s pension law, not its tax law. 

IV. ENTRY INTO FORCE

The United States and Iceland shall notify each other in writing 

through diplomatic channels when their respective applicable procedures for the entry into force of this Treaty have been satisfied. 

This Treaty shall enter into force on the date of receipt of the later 

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1The present treaty between the United States and Iceland is one of only eight U.S. income 

tax treaties that do not include a Limitation on Benefits provision of any type. The Iceland Treaty, along with treaties with Hungary and Poland are the only three of the eight that provide 

for complete exemption from withholding on interest payments from one treaty country to the 

other treaty country. 

of these notifications. The various provisions of this Treaty will 

have effect as described in paragraphs 2 and 3 of Article 27. 

V. IMPLEMENTING LEGISLATION

As is the case generally with income tax treaties, the Treaty is 

self-executing and does not require implementing legislation for the 

United States. 

VI. COMMITTEE ACTION

The committee held a public hearing on the Treaty on July 10, 

2008. Testimony was received from Mr. Michael Mundaca, Deputy 

Assistant Secretary (International), Office of Tax Policy, U.S. Department of the Treasury and Ms. Emily S. McMahon, Deputy 

Chief of Staff to the Joint Committee on Taxation. A transcript of 

this hearing can be found in the Annex to Executive Report 110– 

15. 

On July 29, 2008, the committee considered the Treaty and ordered it favorably reported by voice vote, with a quorum present 

and without objection. 

VII. COMMITTEE RECOMMENDATION AND COMMENTS

The Committee on Foreign Relations believes that the Treaty is 

a significant improvement over the existing treaty with Iceland, in 

particular because of the inclusion of the Limitation on Benefits 

provision that prevents treaty shopping. The committee therefore 

urges the Senate to act promptly to give advice and consent to ratification of the Treaty, as set forth in this report and the accompanying resolution of advice and consent. 

A. TREATY SHOPPING

As discussed, one of the most important features of this Treaty 

is the addition of a strong Limitation on Benefits provision, which 

is intended to limit abuse of the Treaty with Iceland by third-country residents. With the entry into force of the provision, however, 

it is reasonable to expect that the treaty-shopping now occurring 

through the Iceland Treaty will shift to other countries with favorable tax regimes and with which the United States has a tax treaty 

with similar advantages, including an exemption from withholding 

taxes on cross-border interest payments but no Limitation on Benefits provision to prevent abuse. There are two countries that fit this 

description for which there are tax treaties that are currently in 

force: Hungary and Poland.1 Consequently, these two countries will 

likely attract those currently abusing the Iceland tax treaty. In addition, as noted by the Treasury Department in response to Committee questions on this subject, there is already evidence that the 

treaty with Hungary is being substantially abused by third-country 

investors. 

The Treasury Department has indicated that ‘‘[u]pdating the 

agreements with Hungary and Poland is a key part of the Treasury 

7 

Department’s effort to protect the U.S. tax treaty network from 

abuse.’’ Moreover, the Department stated that negotiations are ongoing with Hungary and in a preliminary stage with Poland. The 

committee urges the Treasury Department in such negotiations not 

to settle for anything less than a robust Limitation on Benefits provision that can be readily enforced by the United States, particularly in the case of Hungary. The committee is encouraged by the 

fact that the Treasury Department has made this a priority. In the 

committee’s view, the Treasury Department should strengthen 

anti-treaty-shopping provisions in tax treaties whenever possible, 

with a particular focus on closing the loophole created by those 

U.S. tax treaties currently in force that do not have an anti-treatyshopping provision. 

B. RESOLUTION

The proposed resolution of advice and consent for the Treaty includes a declaration. 

Declaration 

The committee has included a proposed declaration, which states 

that the Treaty is self-executing, as is the case generally with income tax treaties. The committee has in the past included such a 

statement in the committee’s report but, in light of the recent Supreme Court decision, Medellı ́n v. Texas, 128 S. Ct. 1346 (2008), 

the committee has determined that a clear statement in the Resolution is warranted. A further discussion of the committee’s views 

on this matter can be found in Section VIII of Executive Report 

110–12. 

VIII. RESOLUTION OF ADVICE AND CONSENT TO RATIFICATION

Resolved (two-thirds of the Senators present concurring therein), 

SECTION 1. SENATE ADVICE AND CONSENT SUBJECT TO A DECLARATION 

The Senate advises and consents to the ratification of the Convention between the Government of the United States of America 

and the Government of Iceland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes 

on Income, and accompanying Protocol, signed at Washington on 

October 23, 2007 (Treaty Doc. 110–17), subject to the declaration 

of section 2. 

SECTION 2. DECLARATION 

The advice and consent of the Senate under section 1 is subject 

to the following declaration: 

This Convention is self-executing. 

IX. ANNEX.—TECHNICAL EXPLANATION

DEPARTMENT OF THE TREASURY TECHNICAL EXPLANATION OF THE

CONVENTION BETWEEN THE GOVERNMENT OF THE UNITED STATES

OF AMERICA AND THE GOVERNMENT OF ICELAND FOR THE AVOIDANCE OF DOUBLE TAXATION AND THE PREVENTION OF FISCAL EVASION WITH RESPECT TO TAXES ON INCOME. 

This is a technical explanation of the Convention between the 

Government of the United States and the Government of Iceland 

8 

For the Avoidance Of Double Taxation and the Prevention of Fiscal 

Evasion with Respect to Taxes on Income, signed on October 23, 

2007 (the ‘‘Convention’’). 

Negotiations took into account the U.S. Treasury Department’s 

current tax treaty policy, and the Treasury Department’s Model Income Tax Convention. Negotiations also took into account the 

Model Tax Convention on Income and on Capital, published by the 

Organisation for Economic Cooperation and Development (the 

‘‘OECD Model’’), and recent tax treaties concluded by both countries. 

The Technical Explanation is an official guide to the Convention 

and an accompanying Protocol. It reflects the policies behind particular Convention and Protocol provisions, as well as understandings reached during the negotiations with respect to the application and interpretation of the Convention and Protocol. References in the Technical Explanation to ‘‘he’’ or ‘‘his’’ should be 

read to mean ‘‘he or she’’ or ‘‘his and her.’’ 

ARTICLE 1 (GENERAL SCOPE)

Paragraph 1 

Paragraph 1 of Article 1 provides that the Convention applies 

only to residents of the United States or Iceland except where the 

terms of the Convention provide otherwise. Under Article 4 (Resident) a person is generally treated as a resident of a Contracting 

State if that person is, under the laws of that State, liable to tax 

therein by reason of his domicile, citizenship, residence, or other 

similar criteria. However, if a person is considered a resident of 

both Contracting States, Article 4 provides rules for determining a 

State of residence (or no State of residence). This determination 

governs for all purposes of the Convention. 

Certain provisions are applicable to persons who may not be residents of either Contracting State. For example, paragraph 1 of Article 23 (Non-Discrimination) applies to nationals of the Contracting States. Under Article 25 (Exchange of Information and Administrative Assistance), information may be exchanged with respect to residents of third states. 

Paragraph 2 

Paragraph 2 states the generally accepted relationship both between the Convention and domestic law and between the Convention and other agreements between the Contracting States. That is, 

no provision in the Convention may restrict any exclusion, exemption, deduction, credit or other benefit accorded by the tax laws of 

the Contracting States, or by any other agreement between the 

Contracting States. The relationship between the non-discrimination provisions of the Convention and other agreements is addressed not in paragraph 2 but in paragraph 3. 

Under paragraph 2, for example, if a deduction would be allowed 

under the U.S. Internal Revenue Code (the ‘‘Code’’) in computing 

the U.S. taxable income of a resident of Iceland, the deduction also 

is allowed to that person in computing taxable income under the 

Convention. Paragraph 2 also means that the Convention may not 

increase the tax burden on a resident of a Contracting States beyond the burden determined under domestic law. Thus, a right to 

9 

tax given by the Convention cannot be exercised unless that right 

also exists under internal law. 

It follows that, under the principle of paragraph 2, a taxpayer’s 

U.S. tax liability need not be determined under the Convention if 

the Code would produce a more favorable result. A taxpayer may 

not, however, choose among the provisions of the Code and the 

Convention in an inconsistent manner in order to minimize tax. 

Thus, a taxpayer may use the Convention to reduce its taxable income, but may not use both treaty and Code rules where doing so 

would thwart the intent of either set of rules. For example, assume 

that a resident of Iceland has three separate businesses in the 

United States. One is a profitable permanent establishment and 

the other two are trades or businesses that would earn taxable income under the Code but that do not meet the permanent establishment threshold tests of the Convention. One is profitable and 

the other incurs a loss. Under the Convention, the income of the 

permanent establishment is taxable in the United States, and both 

the profit and loss of the other two businesses are ignored. Under 

the Code, all three would be subject to tax, but the loss would offset the profits of the two profitable ventures. The taxpayer may not 

invoke the Convention to exclude the profits of the profitable trade 

or business and invoke the Code to claim the loss of the loss trade 

or business against the profit of the permanent establishment. (See 

Rev. Rul. 84–17, 1984–1 C.B. 308.) If, however, the taxpayer invokes the Code for the taxation of all three ventures, he would not 

be precluded from invoking the Convention with respect, for example, to any dividend income he may receive from the United States 

that is not effectively connected with any of his business activities 

in the United States. 

Similarly, nothing in the Convention can be used to deny any 

benefit granted by any other agreement between the United States 

and Iceland. For example, if certain benefits are provided for military personnel or military contractors under a Status of Forces 

Agreement between the United States and Iceland, those benefits 

or protections will be available to residents of the Contracting 

States regardless of any provisions to the contrary (or silence) in 

the Convention. 

Paragraph 3 

Paragraph 3 specifically relates to non-discrimination obligations 

of the Contracting States under other agreements. The provisions 

of paragraph 3 are an exception to the rule provided in paragraph 

2 of this Article under which the Convention shall not restrict in 

any manner any benefit now or hereafter accorded by any other 

agreement between the Contracting States. 

Subparagraph 3(a) provides that, notwithstanding any other 

agreement to which the Contracting States may be parties, a dispute concerning whether a measure is within the scope of this Convention shall be considered only by the competent authorities of the 

Contracting States, and the procedures under this Convention exclusively shall apply to that dispute. Thus, procedures for dealing 

with disputes that may be incorporated into trade, investment, or 

other agreements between the Contracting States shall not apply 

for the purposes of determining the scope of the Convention. 

10 

Subparagraph 3(b) provides that, unless the competent authorities determine that a taxation measure is not within the scope of 

this Convention, the non-discrimination obligations of this Convention exclusively shall apply with respect to that measure, except for 

such national treatment or most-favored-nation (‘‘MFN’’) obligations as may apply to trade in goods under the General Agreement 

on Tariffs and Trade (‘‘GATT’’). No national treatment or MFN obligation under any other agreement shall apply with respect to that 

measure. Thus, unless the competent authorities agree otherwise, 

any national treatment and MFN obligations undertaken by the 

Contracting States under agreements other than the Convention 

shall not apply to a taxation measure, with the exception of GATT 

as applicable to trade in goods. 

Paragraph 4 

Paragraph 4 contains the traditional saving clause found in all 

U.S. treaties. The Contracting States reserve their rights, except as 

provided in paragraph 5, to tax their residents and citizens as provided in their internal laws, notwithstanding any provisions of the 

Convention to the contrary. For example, if a resident of Iceland 

performs professional services in the United States and the income 

from the services is not attributable to a permanent establishment 

in the United States, Article 7 (Business Profits) would by its terms 

prevent the United States from taxing the income. If, however, the 

resident of Iceland is also a citizen of the United States, the saving 

clause permits the United States to include the remuneration in 

the worldwide income of the citizen and subject it to tax under the 

normal Code rules (i.e., without regard to Code section 8 94(a)). 

However, subparagraph 5(a) of Article 1 preserves the benefits of 

special foreign tax credit rules applicable to the U.S. taxation of 

certain U.S. income of its citizens resident in Iceland. See paragraph 4 of Article 22 (Relief from Double Taxation). 

For purposes of the saving clause, ‘‘residence’’ is determined 

under Article 4. Thus, an individual who is a resident of the United 

States under the Code (but not a U.S. citizen) but who is determined to be a resident of Iceland under the tie-breaker rules of Article 4 would be subject to U.S. tax only to the extent permitted by 

the Convention. The United States would not be permitted to apply 

its statutory rules to that person to the extent the rules are inconsistent with the Convention. 

However, the person would be treated as a U.S. resident for U.S. 

tax purposes other than determining the individual’s U.S. tax liability. For example, in determining under Code section 957 whether a foreign corporation is a controlled foreign corporation, shares 

in that corporation held by the individual would be considered to 

be held by a U.S. resident. As a result, other U.S. citizens or residents might be deemed to be United States shareholders of a controlled foreign corporation subject to current inclusion of Subpart 

F income recognized by the corporation. See, Treas. Reg. section 

301.7701 (b)-7(a)(3). 

Under paragraph 4, the United States also reserves its right to 

tax former citizens and former long-term residents for a period of 

ten years following the loss of such status. Thus, paragraph 4 allows the United States to tax former U.S. citizens and former U.S. 

long-term residents in accordance with Section 877 of the Code. 

11 

Section 877 generally applies to a former citizen or long-term resident of the United States who relinquishes citizenship or terminates long-term residency before June 17, 2008 if either of the following criteria exceed established thresholds: (a) the average annual net income tax of such individual for the period of 5 taxable 

years ending before the date of the loss of status, or (b) the net 

worth of such individual as of the date of the loss of status. 

The United States defines ‘‘long-term resident’’ as an individual 

(other than a U.S. citizen) who is a lawful permanent resident of 

the United States in at least 8 of the prior 15 taxable years. An 

individual is not treated as a lawful permanent resident for any 

taxable year in which the individual is treated as a resident of Iceland under this Convention, or as a resident of any country other 

than the United States under the provisions of any other tax treaty 

of the United States, and in either case the individual does not 

waive the benefits of the relevant convention. 

Paragraph 5 

Paragraph 5 sets forth certain exceptions to the saving clause. 

The referenced provisions are intended to provide benefits to citizens and residents even if such benefits do not exist under internal 

law. Paragraph 5 thus preserves these benefits for citizens and 

residents of the Contracting States. 

Subparagraph 5(a) lists certain provisions of the Convention that 

are applicable to all citizens and residents of a Contracting State, 

despite the general saving clause rule of paragraph 4:(1) Paragraph 

2 of Article 9 (Associated Enterprises) grants the right to a correlative adjustment with respect to income tax due on profits reallocated under Article 9. 

(2) Paragraphs 2 and 4 of Article 17 (Pensions, Social Security, 

and Annuities) provide exemptions from source or residence State 

taxation for certain pension distributions and social security payments. 

(3) Article 22 (Relief from Double Taxation) confirms to citizens 

and residents of one Contracting State the benefit of a credit for 

income taxes paid to the other or an exemption for income earned 

in the other State. 

(4) Article 23 (Non-Discrimination) protects residents and nationals of one Contracting State against the adoption of certain discriminatory practices in the other Contracting State. 

(5) Article 24 (Mutual Agreement Procedure) confers certain benefits on citizens and residents of the Contracting States in order to 

reach and implement solutions to disputes between the two Contracting States. For example, the competent authorities are permitted to use a definition of a term that differs from an internal 

law definition. The statute of limitations may be waived for refunds, so that the benefits of an agreement may be implemented. 

Subparagraph 5(b) provides a different set of exceptions to the 

saving clause. The benefits referred to are all intended to be granted to temporary residents of a Contracting State (for example, in 

the case of the United States, holders of non-immigrant visas), but 

not to citizens or to persons who have acquired permanent residence in that State. If beneficiaries of these provisions travel from 

one of the Contracting States to the other, and remain in the other 

long enough to become residents under its internal law, but do not 

12 

acquire permanent residence status (i.e., in the U.S. context, they 

do not become ‘‘green card’’ holders) and are not citizens of that 

State, the host State will continue to grant these benefits even if 

they conflict with the statutory rules. The benefits preserved by 

this paragraph are: (1) the host country exemptions for government 

service salaries and pensions under Article 18 (Government Service), certain income of visiting students and trainees under Article 

19 (Students and Trainees), and the income of diplomatic agents 

and consular officers under Article 26 (Members of Diplomatic Missions and Consular Posts). 

Paragraph 6 

Paragraph 6 provides that an item of income derived by a fiscally 

transparent entity is considered to be derived by a resident of a 

Contracting State to the extent that the resident is treated under 

the taxation laws of the State where he is resident as deriving the 

item of income. This paragraph applies to any resident of a Contracting State who is entitled to income derived through an entity 

that is treated as fiscally transparent under the laws of either Contracting State. For example, if a corporation resident in Iceland distributes a dividend to an entity that is treated as fiscally transparent for U.S. tax purposes, the dividend will be considered derived by a resident of the United States only to the extent that the 

taxation laws of the United States treat one or more U.S. residents 

(whose status as U.S. residents is determined, for this purpose, 

under U.S. tax laws) as deriving the dividend income for U.S. tax 

purposes. In the case of a partnership, the persons who are, under 

U.S. tax laws, treated as partners of the entity would normally be 

the persons whom the U.S. tax laws would treat as deriving the 

dividend income through the partnership. Thus, it also follows that 

persons whom the United States treats as partners but who are not 

U.S. residents for U.S. tax purposes may not claim a benefit under 

the Convention for the dividend paid to the entity. Although these 

partners are treated as deriving the income for U.S. tax purposes, 

they are not residents of the United States for purposes of the treaty. If, however, they are treated as residents of a third country 

under the provisions of an income tax convention which that country has with Iceland, they may be entitled to claim a benefit under 

that convention. In contrast, if an entity is organized under U.S. 

laws and is classified as a corporation for U.S. tax purposes, dividends paid by a corporation resident in Iceland to the U.S. entity 

will be considered derived by a resident of the United States since 

the U.S. corporation is treated under U.S. taxation laws as a resident of the United States and as deriving the income. 

Because the entity classification rules of the State of residence 

govern, the results in the examples discussed above would obtain 

even if the entity were viewed differently under the tax laws of Iceland (e.g., as not fiscally transparent in the first example above 

where the entity is treated as a partnership for U.S. tax purposes 

or as fiscally transparent in the second example where the entity 

is viewed as not fiscally transparent for U.S. tax purposes). Moreover, these results follow regardless of whether the entity is organized in the United States, Iceland, or in a third country. For example, income from sources in Iceland received by an entity organized under the laws of Iceland, which is treated for U.S. tax purVerDate Aug 31 2005 15:57 Sep 15, 2008 Jkt 000000 PO 00000 Frm 00012 Fmt 6659 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-17.TXT sfrela2 PsN: MIKEB
13 

poses as a corporation and is owned by a U.S. shareholder who is 

a U.S. resident for U.S. tax purposes, is not considered derived by 

the shareholder of that corporation even if, under the tax laws of 

Iceland, the entity is treated as fiscally transparent. These results 

also follow regardless of whether the entity is disregarded as a separate entity under the laws of one jurisdiction but not the other, 

such as a single owner entity that is viewed as a branch for U.S. 

tax purposes and as a corporation for tax purposes of in Iceland. 

Where income is derived through an entity organized in a third 

state that has owners resident in one of the Contracting States, the 

characterization of the entity in that third state is irrelevant for 

purposes of determining whether the resident is entitled to treaty 

benefits with respect to income derived by the entity. 

In general, paragraph 6 relates to entities that are not subject 

to tax at the entity level, as distinct from entities that are subject 

to tax, but with respect to which tax may be relieve under an integrated system. Entities falling under this description in the United 

States include partnerships, common investment trusts under section 584 and grantor trusts. This paragraph also applies to U.S. 

limited liability companies ((‘‘LLCs’’), including an LLC with only 

one member), that are treated as partnerships or as disregarded 

entities for U.S. tax purposes. The taxation laws of a Contracting 

State may treat an item of income as income of a resident of that 

State even if the resident is not subject to tax on that particular 

item of income. For example, if a Contracting State has a participation exemption for certain foreign-source dividends and capital 

gains, such income or gains would be regarded as income or gain 

of a resident of that State who otherwise derived the income or 

gain, despite the fact that the resident could be exempt from tax 

in that State on the income or gain. 

Paragraph 6 is not an exception to the saving clause of paragraph 4. Accordingly, paragraph 6 does not prevent a Contracting 

State from taxing an entity that is treated as a resident of that 

State under its own tax law. For example, if a U.S. LLC with members who are residents of Iceland elects to be taxed as a corporation 

for U.S. tax purposes, the United States will tax that LLC on its 

worldwide income on a net basis, without regard to whether Iceland views the LLC as fiscally transparent. 

ARTICLE 2 (TAXES COVERED)

This Article specifies the U.S. taxes and the taxes of Iceland to 

which the Convention applies. With two exceptions, the taxes specified in Article 2 are the covered taxes for all purposes of the Convention. A broader coverage applies for purposes of Articles 23 

(Non-Discrimination) and 25 (Exchange of Information and Administrative Assistance). Article 23 applies with respect to all taxes, including those imposed by state and local governments. Article 25 

applies with respect to all taxes imposed at the national level. 

Paragraph 1 

Paragraph 1 identifies the category of taxes to which the Convention applies. Paragraph 1 is based on the U. S. and OECD Models 

and defines the scope of application of the Convention. The Convention applies to taxes on income, including gains, imposed on behalf 

of a Contracting State, irrespective of the manner in which they 

14 

are levied. Except with respect to Article 23 state and local taxes 

are not covered by the Convention. 

Paragraph 2 

Paragraph 2 also is based on the U.S. and OECD Models and 

provides a definition of taxes on income, on capital and on capital 

gains. The Convention covers taxes on total income, on total capital, or any part of income and includes tax on gains derived from 

the alienation of property. The Convention does not apply, however, to social security charges, or any other charges where there 

is a direct connection between the levy and individual benefits. Social security and unemployment taxes (Code sections 1401, 3101, 

3111 and 3301) are excluded from coverage. The Convention also 

does not apply to property taxes, except with respect to Article 23. 

Paragraph 3 

Paragraph 3 lists the taxes in force at the time of signature of 

the Convention to which the Convention applies. 

The existing covered taxes of Iceland are identified in subparagraph 3(a). These taxes are i) the income taxes to the state and ii) 

the income taxes to the municipalities. 

Subparagraph 3(b) provides that the existing U.S. taxes subject 

to the rules of the Convention are the Federal income taxes imposed by the Code, together with the excise taxes imposed with respect to private foundations (Code sections 4940 through 4948). 

Paragraph 4 

Under paragraph 4, the Convention will apply to any taxes that 

are identical, or substantially similar, to those enumerated in paragraph 3, and which are imposed in addition to, or in place of, the 

existing taxes after October 23, 2007, the date of signature of the 

Convention. The paragraph also provides that the competent authorities of the Contracting States will notify each other of any significant changes that have been made in their laws, whether tax 

laws or non-tax laws, that affect significantly their obligations 

under the Convention. Non-tax laws that may affect a Contracting 

State’s obligations under the Convention may include, for example, 

laws affecting bank secrecy. 

ARTICLE 3 (GENERAL DEFINITIONS)

Article 3 provides general definitions and rules of interpretation 

applicable throughout the Convention. Certain other terms are defined in other articles of the Convention. For example, the term 

‘‘resident of a Contracting State’’ is defined in Article 4 (Resident). 

The term ‘‘permanent establishment’’ is defined in Article 5 (Permanent Establishment). These definitions are used consistently 

throughout the Convention. Other terms, such as ‘‘dividends,’’ ‘‘interest’’ and ‘‘royalties’’ are defined in specific articles for purposes 

only of those articles. 

Paragraph 1 

Paragraph 1 defines a number of basic terms used in the Convention. The introduction to paragraph 1 makes clear that these 

definitions apply for all purposes of the Convention, unless the context requires otherwise. This latter condition allows flexibility in 

15 

the interpretation of the treaty in order to avoid results not intended by the treaty’s negotiators. 

The geographical scope of the Convention with respect Iceland is 

set out in subparagraph 1(a). It encompasses the territory of Iceland, including its territorial sea, and any area beyond the territorial sea within which Iceland, in accordance with international 

law, exercises jurisdiction or sovereign rights with respect to the 

sea bed, its subsoil and its adjacent waters, and their natural resources. 

The geographical scope of the Convention with respect to the 

United States is set out in subparagraph 1(b). It encompasses the 

United States of America, including the states, the District of Columbia and the territorial sea of the United States. The term does 

not include Puerto Rico, the Virgin Islands, Guam or any other 

U.S. possession or territory. For certain purposes, the term ‘‘United 

States’’ includes the sea bed and subsoil of undersea areas adjacent 

to the territorial sea of the United States. This extension applies 

to the extent that the United States exercises sovereignty in accordance with international law for the purpose of natural resource 

exploration and exploitation of such areas. This extension of the 

definition applies, however, only if the person, property or activity 

to which the Convention is being applied is connected with such 

natural resource exploration or exploitation. Thus, it would not include any activity involving the sea floor of an area over which the 

United States exercised sovereignty for natural resource purposes 

if that activity was unrelated to the exploration and exploitation of 

natural resources. This result is consistent with the result that 

would be obtained under Section 638, which treats the continental 

shelf as part of the United States for purposes of natural resource 

exploration and exploitation. 

Subparagraph 1(c) defines the term ‘‘person’’ to include an individual, a trust, a partnership, a company and any other body of 

persons. The definition is significant for a variety of reasons. For 

example, under Article 4, only a ‘‘person’’ can be a ‘‘resident’’ and 

therefore eligible for most benefits under the treaty. Also, all ‘‘persons’’ are eligible to claim relief under Article 24 (Mutual Agreement Procedure). 

The term ‘‘company’’ is defined in subparagraph 1(d) as a body 

corporate or an entity treated as a body corporate for tax purposes 

in the state where it is organized. The definition refers to the law 

of the state in which an entity is organized in order to ensure that 

an entity that is treated as fiscally transparent in its country of 

residence will not get inappropriate benefits, such as the reduced 

withholding rate provided by subparagraph 2(b) of Article 10 (Dividends). It also ensures that the Limitation on Benefits provisions 

of Article 21 will be applied at the appropriate level. 

Subparagraph 1(e) defines the term ‘‘enterprise’’ as any activity 

or set of activities that constitutes the carrying on of a business. 

The term ‘‘business’’ is not defined, but subparagraph (k) provides 

that it includes the performance of professional services and other 

activities of an independent character. Both subparagraphs are 

identical to definitions recently added to the OECD Model in connection with the deletion of Article 14 (Independent Personal Services) from the OECD Model. The inclusion of the two definitions is 

intended to clarify that income from the performance of profesVerDate Aug 31 2005 15:57 Sep 15, 2008 Jkt 000000 PO 00000 Frm 00015 Fmt 6659 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-17.TXT sfrela2 PsN: MIKEB
16 

sional services or other activities of an independent character is 

dealt with under Article 7 (Business Profits) and not Article 20 

(Other Income). 

The terms ‘‘enterprise of a Contracting State’’ and ‘‘enterprise of 

the other Contracting State’’ are defined in subparagraph 1(f) as an 

enterprise carried on by a resident of a Contracting State and an 

enterprise carried on by a resident of the other Contracting State. 

An enterprise of a Contracting State need not be carried on in that 

State. It may be carried on in the other Contracting State or a 

third state (e.g., a U.S. corporation doing all of its business in the 

other Contracting State would still be a U.S. enterprise). Although 

not explicitly stated in the Convention, these terms also encompass 

an enterprise conducted through an entity (such as a partnership) 

that is treated as fiscally transparent in the Contracting State 

where the entity’s owner is resident. In accordance with Article 4 

(Resident), entities that are fiscally transparent in the Contracting 

State in which their owners are resident are not considered to be 

residents of that State (although income derived by such entities 

may be taxed as the income of a resident, if taxed in the hands of 

resident partners or other owners). An enterprise conducted by 

such an entity will be treated as carried on by a resident of a Contracting State to the extent its partners or other owners are residents. This approach is consistent with the Code, which under section 875 attributes a trade or business conducted by a partnership 

to its partners and a trade or business conducted by an estate or 

trust to its beneficiaries. 

Subparagraph 1(g) provides that the terms ‘‘a Contracting State’’ 

and ‘‘the other Contracting State’’ shall mean Iceland or the United 

States, as the context requires. 

Subparagraph 1(h) defines the term ‘‘international traffic.’’ The 

term means any transport by a ship or aircraft except when such 

transport is solely between places within a Contracting State. This 

definition is applicable principally in the context of Article 8 (Shipping and Air Transport). The definition combines with paragraphs 

2 and 3 of Article 8 to exempt from tax by the source State income 

from the rental of ships or aircraft that is earned both by lessors 

that are operators of ships and aircraft and by those lessors that 

are not (e.g., a bank or a container leasing company). 

The exclusion from international traffic of transport solely between places within a Contracting State means, for example, that 

carriage of goods or passengers solely between New York and Chicago would not be treated as international traffic, whether carried 

by a U.S. or a foreign carrier. The substantive taxing rules of the 

Convention relating to the taxation of income from transport, principally Article 8 (Shipping and Air Transport), therefore, would not 

apply to income from such carriage. Thus, if the carrier engaged in 

internal U.S. traffic were a resident of Iceland (assuming that were 

possible under U.S. law), the United States would not be required 

to exempt the income from that transport under Article 8. The income would, however, be treated as business profits under Article 

7 (Business Profits), and therefore would be taxable in the United 

States only if attributable to a U.S. permanent establishment of 

the foreign carrier, and then only on a net basis. The gross basis 

U.S. tax imposed by section 887 would never apply under the circumstances described. If, however, goods or passengers are carried 

17 

by a carrier resident in Iceland from a non-U.S. port to, for example, New York, and some of the goods or passengers continue on 

to Chicago, the entire transport would be international traffic. This 

would be true if the international carrier transferred the goods at 

the U.S. port of entry from a ship to a land vehicle, from a ship 

to a lighter, or even if the overland portion of the trip in the United 

States was handled by an independent carrier under contract with 

the original internation≥al carrier, so long as both parts of the trip 

were reflected in original bills of lading. For this reason, the Convention, following the U.S. Model, refers in the definition of ‘‘international traffic,’’ to ‘‘such transport’’ being solely between places in 

the other Contracting State, while the OECD Model refers to the 

ship or aircraft being operated solely between such places. The formulation in the Convention is intended to make clear that, as in 

the above example, even if the goods are carried on a different aircraft for the internal portion of the international voyage than is 

used for the overseas portion of the trip, the definition applies to 

that internal portion as well as the external portion. 

Finally, a ‘‘cruise to nowhere,’’ i.e., a cruise beginning and ending 

in a port in the same Contracting State with no stops in a foreign 

port, would not constitute international traffic. 

Subparagraph 1(i) designates the ‘‘competent authorities’’ for Iceland and the United States. In the case of Iceland, the competent 

authority is the Minister of Finance or his authorized representative. The U.S. competent authority is the Secretary of the Treasury 

or his delegate. The Secretary of the Treasury has delegated the 

competent authority function to the Commissioner of Internal Revenue, who in turn has delegated the authority to the Deputy Commissioner (International) LMSB. With respect to interpretative 

issues, the Deputy Commissioner (International) LMSB acts with 

the concurrence of the Associate Chief Counsel (International) of 

the Internal Revenue Service. 

The term ‘‘national,’’ as it relates to the United States and to Iceland, is defined in subparagraph 1(j). This term is relevant for purposes of Articles 18 (Government Service) and 23 (Non-Discrimination). A national of one of the Contracting States is (1) an individual who is a citizen or national of that State, and (2) any legal 

person, partnership or association deriving its status, as such, from 

the law in force in the State where it is established. 

Subparagraph 1(l) defines the term ‘‘pension scheme’’ to include 

any plan, scheme, fund, trust or other arrangement established in 

a Contracting State that is generally exempt from income taxation 

in that State and that is operated principally to administer or provide pension or retirement benefits or to earn income for the benefit of one or more such arrangements. Subparagraph 1(b) of the 

Protocol provides that in the case of the United States, the term 

‘‘pension scheme’’ includes the following: a trust providing pension 

or retirement benefits under a Code section 401(a) qualified pension plan, profit sharing or stock bonus plan, a Code section 403(a) 

qualified annuity plan, a Code section 403(b) plan, a trust that is 

an individual retirement account under Code section 408, a Roth 

individual retirement account under Code section 408A, or a simple 

retirement account under Code section 408(p), a trust providing 

pension or retirement benefits under a simplified employee pension 

plan under Code section 408(k), a trust described in section 457(g) 

18 

providing pension or retirement benefits under a Code section 

457(b) plan, and the Thrift Savings Fund (section 7701(j)). Section 

401(k) plans and group trusts described in Revenue Ruling 8 1–100 

and meeting the conditions of Revenue Ruling 2004–67 qualify as 

pension funds to the extent they are Code section 401(a) plans or 

other pension schemes. In the case of Iceland, subparagraph 1(a) 

of the Protocol provides that the term ‘‘pension scheme’’ includes 

any pension fund or pension plan qualified under the Pension Act 

or any identical or substantially similar schemes which are created 

under any law enacted after October 23, 2007, the date of signature 

of the Convention. 

Paragraph 2 

Terms that are not defined in the Convention are dealt with in 

paragraph 2. 

Paragraph 2 provides that in the application of the Convention, 

any term used but not defined in the Convention will have the 

meaning that it has under the law of the Contracting State whose 

tax is being applied, unless the context requires otherwise, or the 

competent authorities have agreed on a different meaning pursuant 

to Article 24 (Mutual Agreement Procedure). If the term is defined 

under both the tax and non-tax laws of a Contracting State, the 

definition in the tax law will take precedence over the definition in 

the non-tax laws. Finally, there also may be cases where the tax 

laws of a State contain multiple definitions of the same term. In 

such a case, the definition used for purposes of the particular provision at issue, if any, should be used. 

If the meaning of a term cannot be readily determined under the 

law of a Contracting State, or if there is a conflict in meaning 

under the laws of the two States that creates difficulties in the application of the Convention, the competent authorities, as indicated 

in subparagraph 3(f) of Article 24, may establish a common meaning in order to prevent double taxation or to further any other purpose of the Convention. This common meaning need not conform to 

the meaning of the term under the laws of either Contracting 

State. 

The reference in paragraph 2 to the internal law of a Contracting 

State means the law in effect at the time the treaty is being applied, not the law as in effect at the time the treaty was signed. 

The use of ‘‘ambulatory’’ definitions, however, may lead to results 

that are at variance with the intentions of the negotiators and of 

the Contracting States when the treaty was negotiated and ratified. The reference in both paragraphs 1 and 2 to the ‘‘context otherwise requir[ing]’’ a definition different from the treaty definition, 

in paragraph 1, or from the internal law definition of the Contracting State whose tax is being imposed, under paragraph 2, refers to a circumstance where the result intended by the Contracting States is different from the result that would obtain under 

either the paragraph 1 definition or the statutory definition. Thus, 

flexibility in defining terms is necessary and permitted. 

ARTICLE 4 (RESIDENT)

This Article sets forth rules for determining whether a person is 

a resident of a Contracting State for purposes of the Convention. 

As a general matter only residents of the Contracting States may 

19 

claim the benefits of the Convention. The treaty definition of residence is to be used only for purposes of the Convention. The fact 

that a person is determined to be a resident of a Contracting State 

under Article 4 does not necessarily entitle that person to the benefits of the Convention. In addition to being a resident, a person also 

must qualify for benefits under Article 21 (Limitation On Benefits) 

in order to receive benefits conferred on residents of a Contracting 

State. 

The determination of residence for treaty purposes looks first to 

a person’s liability to tax as a resident under the respective taxation laws of the Contracting States. As a general matter, a person 

who, under those laws, is a resident of one Contracting State and 

not of the other need look no further. For purposes of the Convention, that person is a resident of the State in which he is resident 

under internal law. If, however, a person is resident in both Contracting States under their respective taxation laws, the Article 

proceeds, where possible, to use tie-breaker rules to assign a single 

State of residence to such a person for purposes of the Convention. 

Paragraph 1 

The term ‘‘resident of a Contracting State’’ is defined in paragraph 1. In general, this definition incorporates the definitions of 

residence in U.S. law and that of Iceland by referring to a resident 

as a person who, under the laws of a Contracting State, is subject 

to tax there by reason of his domicile, residence, citizenship, place 

of management, place of incorporation or any other similar criterion. Thus, residents of the United States include aliens who are 

considered U.S. residents under Code section 7701(b). Paragraph 1 

also specifically includes the two Contracting States, and political 

subdivisions and local authorities of the two States, as residents for 

purposes of the Convention. 

Certain entities that are nominally subject to tax but that in 

practice are rarely required to pay tax also would generally be 

treated as residents and therefore accorded treaty benefits. For example, a U.S. Regulated Investment Company (RIC) and a U.S. 

Real Estate Investment Trust (REIT) are residents of the United 

States for purposes of the treaty. Although the income earned by 

these entities normally is not subject to U.S. tax in the hands of 

the entity, they are taxable to the extent that they do not currently 

distribute their profits, and therefore may be regarded as ‘‘liable to 

tax.’’ They also must satisfy a number of requirements under the 

Code in order to be entitled to special tax treatment. 

A person who is liable to tax in a Contracting State only in respect of income from sources within that State or capital situated 

therein or of profits attributable to a permanent establishment in 

that State will not be treated as a resident of that Contracting 

State for purposes of the Convention. Thus, a consular official of 

Iceland who is posted in the United States, who may be subject to 

U.S. tax on U.S. source investment income but is not taxable in the 

United States on non-U.S. source income (see Code section 

7701(b)(5)(B)), would not be considered a resident of the United 

States for purposes of the Convention. Similarly, an enterprise of 

Iceland with a permanent establishment in the United States is 

not, by virtue of that permanent establishment, a resident of the 

United States. The enterprise generally is subject to U.S. tax only 

20 

with respect to its income that is attributable to the U.S. permanent establishment, not with respect to its worldwide income, as it 

would be if it were a U.S. resident. 

Paragraph 2 

Paragraph 2 provides that certain tax-exempt entities such as 

pension schemes and charitable organizations will be regarded as 

residents of a Contracting State regardless of whether they are 

generally liable to income tax in the State where they are established. The inclusion of this provision is intended to clarify the generally accepted practice of treating an entity that would be liable 

for tax as a resident under the internal law of a State but for a 

specific exemption from tax (either complete or partial) as a resident of that State for purposes of paragraph 1. 

Subparagraph 2(a) applies to pension schemes, as defined in subparagraph 1(l) of Article 3 (General Definitions). Subparagraph 2(b) 

applies to any plan, scheme, fund, trust, company or other arrangement established in a Contracting State that is generally exempt 

from taxation in that State because it is operated exclusively to administer or provide employee benefits. The reference to a general 

exemption is intended to reflect the fact that under U.S. law, certain organizations that generally are considered to be tax-exempt 

entities may be subject to certain excise taxes or to income tax on 

their unrelated business income. Subparagraph 2(c) applies to an 

organization that is established exclusively for religious, charitable, 

scientific, artistic, cultural, or educational purposes and that is a 

resident of a Contracting State. Thus, a section 501(c) organization 

organized in the United States (such as a U.S. charity) that is generally exempt from tax under U.S. law is a resident of the United 

States for all purposes of the Convention. 

Paragraph 3 

If, under the laws of the two Contracting States, and, thus, 

under paragraph 1, an individual is deemed to be a resident of both 

Contracting States, a series of tie-breaker rules are provided in 

paragraph 3 to determine a single State of residence for that individual. These tests are to be applied in the order in which they are 

stated. The first test is based on where the individual has a permanent home. If that test is inconclusive because the individual has 

a permanent home available to him in both States, he will be considered to be a resident of the Contracting State where his personal 

and economic relations are closest (i.e., the location of his ‘‘center 

of vital interests’’). If that test is also inconclusive, or if he does not 

have a permanent home available to him in either State, he will 

be treated as a resident of the Contracting State where he maintains a habitual abode. If he has a habitual abode in both States 

or in neither of them, he will be treated as a resident of the Contracting State of which he is a national. If he is a national of both 

States or of neither, the matter will be considered by the competent 

authorities, who will assign a single State of residence. 

Paragraph 4 

Paragraph 4 seeks to settle dual residence issues for persons 

other than individuals (e.g., companies, trusts, or estates). For example, a dual residence may arise in the case of a company that 

21 

is dually created in both the United States and Iceland or that is 

incorporated in the United States, and therefore treated as a resident of the United States, but that is also considered a resident of 

Iceland because it is managed and controlled in Iceland. In such a 

case, if such a person is, under the rules of paragraph 1, resident 

in both Contracting States, the competent authorities shall seek to 

determine a single State of residence for that person for purposes 

of the Convention. If the competent authorities do not reach an 

agreement on a single State of residence, that company may not 

claim any benefit accorded to residents of a Contracting State by 

the Convention, except those provided in Article 23 (Non-Discrimination) and Article 24 (Mutual Agreement Procedure). Thus, for example, a State cannot impose discriminatory tax measures on a 

dual resident company. 

Dual resident companies may be treated as a resident of a Contracting State for purposes other than that of obtaining benefits 

under the Convention. For example, if a dual resident company 

pays a dividend to a resident of Iceland, the U.S. paying agent 

would withhold on that dividend at the appropriate treaty rate because reduced withholding is a benefit enjoyed by the resident of 

Iceland, not by the dual resident company. The dual resident company that paid the dividend would, for this purpose, be treated as 

a resident of the United States under the Convention. In addition, 

information relating to dual resident companies can be exchanged 

under the Convention because, by its terms, Article 26 (Exchange 

of Information and Administrative Assistance) is not limited to 

residents of the Contracting States. 

ARTICLE 5 (PERMANENT ESTABLISHMENT)

This Article defines the term ‘‘permanent establishment,’’ a term 

that is significant for several articles of the Convention. The existence of a permanent establishment in a Contracting State is necessary under Article 7 (Business Profits) for the taxation by that 

State of the business profits of a resident of the other Contracting 

State. Articles 10 (Dividends), 11 (Interest) and 12 (Royalties) provide for reduced rates of tax at source on payments of these items 

of income to a resident of the other State only when the income is 

not attributable to a permanent establishment that the recipient 

has in the source State. The concept is also relevant in determining 

which Contracting State may tax certain gains under Article 13 

(Capital Gains) and certain ‘‘other income’’ under Article 20 (Other 

Income). 

Paragraph 1 

The basic definition of the term ‘‘permanent establishment’’ is 

contained in paragraph 1. As used in the Convention, the term 

means a fixed place of business through which the business of an 

enterprise is wholly or partly carried on. As indicated in the OECD 

Commentary to Article 5 (see paragraphs 4 through 8), a general 

principle to be observed in determining whether a permanent establishment exists is that the place of business must be ‘‘fixed’’ in 

the sense that a particular building or physical location is used by 

the enterprise for the conduct of its business, and that it must be 

foreseeable that the enterprise’s use of this building or other physical location will be more than temporary. 

22 

Paragraph 2 

Paragraph 2 lists a number of types of fixed places of business 

that constitute a permanent establishment. This list is illustrative 

and non-exclusive. According to paragraph 2, the term permanent 

establishment includes a place of management, a branch, an office, 

a factory, a workshop, and a mine, oil or gas well, quarry or other 

place of extraction of natural resources. 

Paragraph 3 

This paragraph provides rules to determine whether a building 

site or a construction, assembly or installation project, or an installation or drilling rig or ship used for the exploration of natural resources constitutes a permanent establishment for the contractor, 

driller, etc. Such a site or activity does not create a permanent establishment unless the site, project, etc. lasts, or the exploration 

activity continues, for more than twelve months. It is only necessary to refer to ‘‘exploration’’ and not ‘‘exploitation’’ in this context because exploitation activities are defined to constitute a permanent establishment under subparagraph 2(f). Thus, a drilling rig 

does not constitute a permanent establishment if a well is drilled 

in only six months, but if production begins in the following month 

the well becomes a permanent establishment as of that date. 

The twelve-month test applies separately to each site or project. 

The twelve-month period begins when work (including preparatory 

work carried on by the enterprise) physically begins in a Contracting State. A series of contracts or projects by a contractor that 

are interdependent both commercially and geographically are to be 

treated as a single project for purposes of applying the twelvemonth threshold test. For example, the construction of a housing 

development would be considered as a single project even if each 

house were constructed for a different purchaser. 

In applying this paragraph, time spent by a sub-contractor on a 

building site is counted as time spent by the general contractor at 

the site for purposes of determining whether the general contractor 

has a permanent establishment. However, for the sub-contractor 

itself to be treated as having a permanent establishment, the subcontractor’s activities at the site must last for more than 12 

months. If a sub-contractor is on a site intermittently, then, for 

purposes of applying the 12-month rule, time is measured from the 

first day the sub-contractor is on the site until the last day (i.e., 

intervening days that the sub-contractor is not on the site are 

counted). 

These interpretations of the Article are based on the Commentary to paragraph 3 of Article 5 of the OECD Model, which contains language that is substantially the same as that in the Convention. These interpretations are consistent with the generally accepted international interpretation of the relevant language in 

paragraph 3 of Article 5 of the Convention. 

If the twelve-month threshold is exceeded, the site or project constitutes a permanent establishment from the first day of activity. 

Paragraph 4 

This paragraph contains exceptions to the general rule of paragraph 1, listing a number of activities that may be carried on 

through a fixed place of business but which nevertheless do not creVerDate Aug 31 2005 15:57 Sep 15, 2008 Jkt 000000 PO 00000 Frm 00022 Fmt 6659 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-17.TXT sfrela2 PsN: MIKEB
23 

ate a permanent establishment. The use of facilities solely to store, 

display or deliver merchandise belonging to an enterprise does not 

constitute a permanent establishment of that enterprise. The maintenance of a stock of goods belonging to an enterprise solely for the 

purpose of storage, display or delivery, or solely for the purpose of 

processing by another enterprise does not give rise to a permanent 

establishment of the first-mentioned enterprise. The maintenance 

of a fixed place of business solely for the purpose of purchasing 

goods or merchandise, or for collecting information, for the enterprise, or for other activities that have a preparatory or auxiliary 

character for the enterprise, such as advertising, or the supply of 

information, do not constitute a permanent establishment of the 

enterprise. Moreover, subparagraph 4(f) provides that a combination of the activities described in the other subparagraphs of paragraph 4 will not give rise to a permanent establishment if the combination results in an overall activity that is of a preparatory or 

auxiliary character. 

Paragraph 5 

Paragraphs 5 and 6 specify when activities carried on by an 

agent or other person acting on behalf of an enterprise create a 

permanent establishment of that enterprise. Under paragraph 5, a 

person is deemed to create a permanent establishment of the enterprise if that person has and habitually exercises an authority to 

conclude contracts in the name of the enterprise. If, however, for 

example, his activities are limited to those activities specified in 

paragraph 4 which would not constitute a permanent establishment if carried on by the enterprise through a fixed place of business, the person does not create a permanent establishment of the 

enterprise. 

The Convention adopts the OECD Model language ‘‘in the name 

of the enterprise ‘‘rather than the U.S. Model language ‘‘binding on 

the enterprise.’’ This difference in language is not intended to be 

a substantive difference. As indicated in paragraph 32 to the 

OECD Commentaries on Article 5, paragraph 5 is intended to encompass persons who have ‘‘sufficient authority to bind the enterprise’s participation in the business activity in the State concerned.’’ 

The contracts referred to in paragraph 5 are those relating to the 

essential business operations of the enterprise, rather than ancillary activities. For example, if the person has no authority to conclude contracts in the name of the enterprise with its customers 

for, say, the sale of the goods produced by the enterprise, but it can 

enter into service contracts in the name of the enterprise for the 

enterprise’s business equipment, this contracting authority would 

not fall within the scope of the paragraph, even if exercised regularly. 

Paragraph 6 

Under paragraph 6, an enterprise is not deemed to have a permanent establishment in a Contracting State merely because it 

carries on business in that State through an independent agent, including a broker or general commission agent, if the agent is acting 

in the ordinary course of his business as an independent agent. 

Thus, there are two conditions that must be satisfied: the agent 

24 

must be both legally and economically independent of the enterprise, and the agent must be acting in the ordinary course of its 

business in carrying out activities on behalf of the enterprise. 

Whether the agent and the enterprise are independent is a factual determination. Among the questions to be considered are the 

extent to which the agent operates on the basis of instructions from 

the enterprise. An agent that is subject to detailed instructions regarding the conduct of its operations or comprehensive control by 

the enterprise is not legally independent. 

In determining whether the agent is economically independent, 

a relevant factor is the extent to which the agent bears business 

risk. Business risk refers primarily to risk of loss. An independent 

agent typically bears risk of loss from its own activities. In the absence of other factors that would establish dependence, an agent 

that shares business risk with the enterprise, or has its own business risk, is economically independent because its business activities are not integrated with those of the principal. Conversely, an 

agent that bears little or no risk from the activities it performs is 

not economically independent and therefore is not described in 

paragraph 6. 

Another relevant factor in determining whether an agent is economically independent is whether the agent acts exclusively or 

nearly exclusively for the principal. Such a relationship may indicate that the principal has economic control over the agent. A number of principals acting in concert also may have economic control 

over an agent. The limited scope of the agent’s activities and the 

agent’s dependence on a single source of income may indicate that 

the agent lacks economic independence. It should be borne in mind, 

however, that exclusivity is not in itself a conclusive test; an agent 

may be economically independent notwithstanding an exclusive relationship with the principal if it has the capacity to diversify and 

acquire other clients without substantial modifications to its current business and without substantial harm to its business profits. 

Thus, exclusivity should be viewed merely as a pointer to further 

investigation of the relationship between the principal and the 

agent. Each case must be addressed on the basis of its own facts 

and circumstances. 

Paragraph 7 

This paragraph clarifies that a company that is a resident of a 

Contracting State is not deemed to have a permanent establishment in the other Contracting State merely because it controls, or 

is controlled by, a company that is a resident of that other Contracting State, or that carries on business in that other Contracting 

State. The determination whether a permanent establishment exists is made solely on the basis of the factors described in paragraphs 1 through 6 of the Article. Whether a company is a permanent establishment of a related company, therefore, is based solely 

on those factors and not on the ownership or control relationship 

between the companies. 

ARTICLE 6 (INCOME FROM IMMOVABLE PROPERTY (REAL PROPERTY))

This Article deals with the taxation of income from immovable 

property (real property) situated in a Contracting State (the ‘‘situs 

State’’). The Article does not grant an exclusive taxing right to the 

25 

situs State; the situs State is merely given the primary right to 

tax. The Article does not impose any limitation in terms of rate or 

form of tax imposed by the situs State. 

Paragraph 1 

The first paragraph of Article 6 states the general rule that income of a resident of a Contracting State derived from real property situated in the other Contracting State may be taxed in the 

Contracting State in which the property is situated. The paragraph 

specifies that income from real property includes income from agriculture and forestry. 

Paragraph 2 

The term ‘‘real property’’ is defined in paragraph 2 by reference 

to the internal law definition in the situs State. In the case of the 

United States, the term has the meaning given to it by Reg. 

§ 1.897–1(b). In addition to the statutory definitions in the two Contracting States, the paragraph specifies certain additional classes of 

property that, regardless of internal law definitions, are within the 

scope of the term for purposes of the Convention. This expanded 

definition conforms to that in the OECD Model. The definition of 

‘‘real property’’ for purposes of Article 6 is more limited than the 

expansive definition of ‘‘real property’’ in paragraph 1 of Article 13 

(Capital Gains). The Article 13 term includes not only real property 

as defined in Article 6 but certain other interests in real property. 

Paragraph 3 

Paragraph 3 makes clear that all forms of income derived from 

the exploitation of real property are taxable in the Contracting 

State in which the property is situated. This includes income from 

any use of real property, including, but not limited to, income from 

direct use by the owner (in which case income may be imputed to 

the owner for tax purposes) and rental income from the letting of 

real property. In the case of a net lease of real property, if any elections to be taxed on a net basis as may be provided under the laws 

of the situs State have not been made, the gross rental payment 

(before deductible expenses incurred by the lessee) is treated as income from the property. 

Other income closely associated with real property is covered by 

other Articles of the Convention, however, and not Article 6. For 

example, income from the disposition of an interest in real property 

is not considered ‘‘derived’’ from real property; taxation of that income is addressed in Article 13. Interest paid on a mortgage on 

real property would be covered by Article 11 (Interest). Distributions by a U.S. Real Estate Investment Trust or certain regulated 

investment companies would fall under Article 13 in the case of 

distributions of U.S. real property gain or Article 10 (Dividends) in 

the case of distributions treated as dividends. Finally, distributions 

from a United States Real Property Holding Corporation are not 

considered to be income from the exploitation of real property; such 

payments would fall under Article 10 or 13. 

Paragraph 4 

This paragraph specifies that the basic rule of paragraph 1 (as 

elaborated in paragraph 3) applies to income from real property of 

26 

an enterprise. This clarifies that the situs country may tax the real 

property income (including rental income) of a resident of the other 

Contracting State in the absence of attribution to a permanent establishment in the situs State. This provision represents an exception to the general rule under Articles 7 (Business Profits) that income must be attributable to a permanent establishment in order 

to be taxable in the situs State. 

ARTICLE 7 (BUSINESS PROFITS)

This Article provides rules for the taxation by a Contracting 

State of the business profits of an enterprise of the other Contracting State. 

Paragraph 1 

Paragraph 1 states the general rule that business profits of an 

enterprise of one Contracting State may not be taxed by the other 

Contracting State unless the enterprise carries on business in that 

other Contracting State through a permanent establishment (as defined in Article 5 (Permanent Establishment)) situated there. When 

that condition is met, the State in which the permanent establishment is situated may tax the enterprise on the income that is attributable to the permanent establishment. 

Although the Convention does not include a definition of ‘‘business profits,’’ the term is intended to cover income derived from 

any trade or business. In accordance with this broad definition, the 

term ‘‘business profits’’ includes income attributable to notional 

principal contracts and other financial instruments to the extent 

that the income is attributable to a trade or business of dealing in 

such instruments or is otherwise related to a trade or business (as 

in the case of a notional principal contract entered into for the purpose of hedging currency risk arising from an active trade or business). Any other income derived from such instruments is, unless 

specifically covered in another article, dealt with under Article 20 

(Other Income). 

The term ‘‘business profits’’ also includes income derived by an 

enterprise from the rental of tangible personal property (unless 

such tangible personal property consists of aircraft, ships or containers, income from which is addressed by Article 8 (Shipping and 

Air Transport)). The inclusion of income derived by an enterprise 

from the rental of tangible personal property in business profits 

means that such income earned by a resident of a Contracting 

State can be taxed by the other Contracting State only if the income is attributable to a permanent establishment maintained by 

the resident in that other State, and, if the income is taxable, it 

can be taxed only on a net basis. Income from the rental of tangible 

personal property that is not derived in connection with a trade or 

business is dealt with in Article 20. 

In addition, as a result of the definitions of ‘‘enterprise’’ and 

‘‘business’’ in Article 3 (General Definitions), the term includes income derived from the furnishing of personal services. Thus, a consulting firm resident in one State whose employees or partners perform services in the other State through a permanent establishment may be taxed in that other State on a net basis under Article 

7, and not under Article 14 (Income from Employment), which applies only to income of employees. With respect to the enterprise’s 

27 

employees themselves, however, their salary remains subject to Article 14. 

Because this Article applies to income earned by an enterprise 

from the furnishing of personal services, the Article also applies to 

income derived by a partner resident in a Contracting State that 

is attributable to personal services performed in the other Contracting State through a partnership with a permanent establishment in that other State. Income which may be taxed under this 

Article includes all income attributable to the permanent establishment in respect of the performance of the personal services carried 

on by the partnership (whether by the partner himself, other partners in the partnership, or by employees assisting the partners) 

and any income from activities ancillary to the performance of 

those services (e.g., charges for facsimile services). 

The application of Article 7 to a service partnership may be illustrated by the following example: a partnership has five partners 

(who agree to split profits equally), four of whom are resident and 

perform personal services only in Iceland at Office A, and one of 

whom performs personal services at Office B, a permanent establishment in the United States. In this case, the four partners of the 

partnership resident in Iceland may be taxed in the United States 

in respect of their share of the income attributable to the permanent establishment, Office B. The services giving rise to income 

which may be attributed to the permanent establishment would include not only the services performed by the one resident partner, 

but also, for example, if one of the four other partners came to the 

United States and worked on an Office B matter there, the income 

in respect of those services. Income from the services performed by 

the visiting partner would be subject to tax in the United States 

regardless of whether the visiting partner actually visited or used 

Office B while performing services in the United States. 

Paragraph 2 

Paragraph 2 provides rules for the attribution of business profits 

to a permanent establishment. The Contracting States will attribute to a permanent establishment the profits that it would have 

earned had it been a distinct and separate enterprise engaged in 

the same or similar activities under the same or similar conditions 

and dealing wholly independently with the enterprise of which it 

is a permanent establishment. 

The ‘‘attributable to’’ concept of paragraph 2 provides an alternative to the analogous but somewhat different ‘‘effectively connected’’ concept in Code section 864(c). Depending on the circumstances, the amount of income ‘‘attributable to’’ a permanent 

establishment under Article 7 may be greater or less than the 

amount of income that would be treated as ‘‘effectively connected’’ 

to a U.S. trade or business under Code section 864. In particular, 

in the case of financial institutions, the use of internal dealings to 

allocate income within an enterprise may produce results under Article 7 that are significantly different than the results under the effectively connected income rules. For example, income from interbranch notional principal contracts may be taken into account 

under Article 7, notwithstanding that such transactions may be ignored for purposes of U.S. domestic law. 

28 

The profits attributable to a permanent establishment may be 

from sources within or without a Contracting State. However, the 

business profits attributable to a permanent establishment include 

only those profits derived from the assets used, risks assumed, and 

activities performed by the permanent establishment. 

Paragraph 2 of the Protocol confirms that the arm’s length method of paragraphs 2 and 3 consists of applying the OECD Transfer 

Pricing Guidelines, but taking into account the different economic 

and legal circumstances of a single legal entity (as opposed to separate but associated enterprises). Thus, any of the methods used in 

the Transfer Pricing Guidelines, including profits methods, may be 

used as appropriate and in accordance with the Transfer Pricing 

Guidelines. 

However, the use of the Transfer Pricing Guidelines applies only 

for purposes of attributing profits within the legal entity. It does 

not create legal obligations or other tax consequences that would 

result from transactions having independent legal significance. 

One example of the different circumstances of a single legal entity is that an entity that operates through branches rather than 

separate subsidiaries generally will have lower capital requirements because all of the assets of the entity are available to support all of the entity’s liabilities (with some exceptions attributable 

to local regulatory restrictions). This is the reason that most commercial banks and some insurance companies operate through 

branches rather than subsidiaries. The benefit that comes from 

such lower capital costs must be allocated among the branches in 

an appropriate manner. This issue does not arise in the case of an 

enterprise that operates through separate entities, since each entity will have to be separately capitalized or will have to compensate 

another entity for providing capital (usually through a guarantee). 

Under U.S. domestic regulations, internal ‘‘transactions’’ generally are not recognized because they do not have legal significance. In contrast, the Convention provides that such internal dealings may be used to attribute income to a permanent establishment 

in cases where the dealings accurately reflect the allocation of risk 

within the enterprise. One example is that of global trading in securities. In many cases, banks use internal swap transactions to 

transfer risk from one branch to a central location where traders 

have the expertise to manage that particular type of risk. Under 

the Convention, such a bank may also use such swap transactions 

as a means of attributing income between the branches, if use of 

that method is the ‘‘best method’’ within the meaning of regulation 

section 1.482–1(c). The books of a branch will not be respected, 

however, when the results are inconsistent with a functional analysis. So, for example, income from a transaction that is booked in 

a particular branch (or home office) will not be treated as attributable to that location if the sales and risk management functions 

that generate the income are performed in another location. 

Because the use of profits methods is permissible under paragraph 2, it is not necessary for the Convention to include a provision corresponding to paragraph 4 of Article 7 of the OECD Model. 

Paragraph 3 

Paragraph 3 provides that in determining the business profits of 

a permanent establishment, deductions shall be allowed for the exVerDate Aug 31 2005 15:57 Sep 15, 2008 Jkt 000000 PO 00000 Frm 00028 Fmt 6659 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-17.TXT sfrela2 PsN: MIKEB
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penses incurred for the purposes of the permanent establishment, 

ensuring that business profits will be taxed on a net basis. This 

rule is not limited to expenses incurred exclusively for the purposes 

of the permanent establishment, but includes expenses incurred for 

the purposes of the enterprise as a whole, or that part of the enterprise that includes the permanent establishment. Deductions are to 

be allowed regardless of which accounting unit of the enterprise 

books the expenses, so long as they are incurred for the purposes 

of the permanent establishment. For example, a portion of the interest expense recorded on the books of the home office in one State 

may be deducted by a permanent establishment in the other. The 

amount of the expense that must be allowed as a deduction is determined by applying the arm’s length principle. And, as noted 

above with respect to paragraph 2 of Article 1 (General Scope), if 

a deduction would be allowed under the Code in computing the 

U.S. taxable income, the deduction also is allowed in computing 

taxable income under the Convention. However, except where the 

Convention provides for more favorable treatment, a taxpayer cannot take deductions for expenses in computing taxable income 

under the Convention to a greater extent than would be allowed 

under the Code where doing so would be inconsistent with the intent of the Code. For example, assume that a Bulgarian taxpayer 

with a permanent establishment in the United States borrows $100 

to purchase U.S. tax exempt bonds, and that the $100 of tax-exempt bonds and the $100 of related debt would be treated as assets 

and liabilities of the permanent establishment. For purposes of 

computing the profits attributable to the permanent establishment 

under the Convention, both the tax exempt interest from the bonds 

and the interest expense from the related debt would be excluded. 

As noted above, paragraph the Convention provides that the 

OECD Transfer Pricing Guidelines apply, by analogy, in determining the profits attributable to a permanent establishment. Accordingly, a permanent establishment may deduct payments made 

to its head office or another branch in compensation for services 

performed for the benefit of the branch. The method to be used in 

calculating that amount will depend on the terms of the arrangements between the branches and head office. For example, the enterprise could have a policy, expressed in writing, under which 

each business unit could use the services of lawyers employed by 

the head office. At the end of each year, the costs of employing the 

lawyers would be charged to each business unit according to the 

amount of services used by that business unit during the year. 

Since this appears to be a kind of cost-sharing arrangement and 

the allocation of costs is based on the benefits received by each 

business unit, such a cost allocation would be an acceptable means 

of determining a permanent establishment’s deduction for legal expenses. Alternatively, the head office could agree to employ lawyers 

at its own risk, and to charge an arm’s length price for legal services performed for a particular business unit. If the lawyers were 

under-utilized, and the ‘‘fees’’ received from the business units were 

less than the cost of employing the lawyers, then the head office 

would bear the excess cost. If the ‘‘fees’’ exceeded the cost of employing the lawyers, then the head office would keep the excess to 

compensate it for assuming the risk of employing the lawyers. If 

the enterprise acted in accordance with this agreement, this methVerDate Aug 31 2005 15:57 Sep 15, 2008 Jkt 000000 PO 00000 Frm 00029 Fmt 6659 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-17.TXT sfrela2 PsN: MIKEB
30 

od would be an acceptable alternative method for calculating a permanent establishment’s deduction for legal expenses. 

A permanent establishment cannot be funded entirely with debt, 

but must have sufficient capital to carry on its activities as if it 

were a distinct and separate enterprise. To the extent that the permanent establishment has not been attributed capital for profit attribution purposes, a Contracting State may attribute such capital 

to the permanent establishment, in accordance with the arm’s 

length principle, and deny an interest deduction to the extent necessary to reflect that capital attribution. The method prescribed by 

U.S. domestic law for making this attribution is found in Treas. 

Reg. section 1.882–5. Both section 1.882–5 and the method prescribed the Convention start from the premise that all of the capital of the enterprise supports all of the assets and risks of the enterprise, and therefore the entire capital of the enterprise must be 

allocated to its various businesses and offices. 

However, section 1.882–5 does not take into account the fact that 

some assets create more risk for the enterprise than do other assets. An independent enterprise would need less capital to support 

a perfectly-hedged U.S. Treasury security than it would need to 

support an equity security or other asset with significant market 

and/or credit risk. Accordingly, in some cases section 1.882–5 would 

require a taxpayer to allocate more capital to the United States, 

and therefore would reduce the taxpayer’s interest deduction more, 

than is appropriate. To address these cases, the Convention allows 

a taxpayer to apply a more flexible approach that takes into account the relative risk of its assets in the various jurisdictions in 

which it does business. In particular, in the case of financial institutions other than insurance companies, the amount of capital attributable to a permanent establishment is determined by allocating the institution’s total equity between its various offices on 

the basis of the proportion of the financial institution’s risk-weighted assets attributable to each of them. This recognizes the fact that 

financial institutions are in many cases required to risk-weight 

their assets for regulatory purposes and, in other cases, will do so 

for business reasons even if not required to do so by regulators. 

However, risk-weighting is more complicated than the method prescribed by section 1.882–5. Accordingly, to ease this administrative 

burden, taxpayers may choose to apply the principles of Treas. Reg. 

section 1.882–5(c) to determine the amount of capital allocable to 

its U.S. permanent establishment, in lieu of determining its allocable capital under the risk-weighted capital allocation method provided by the Convention, even if it has otherwise chosen the principles of Article 7 rather than the effectively connected income 

rules of U.S. domestic law. 

Paragraph 4 

Paragraph 4 provides that no business profits can be attributed 

to a permanent establishment merely because it purchases goods or 

merchandise for the enterprise of which it is a part. This paragraph is essentially identical to paragraph 5 of Article 7 of the 

OECD Model. This rule applies only to an office that performs 

functions for the enterprise in addition to purchasing. The income 

attribution issue does not arise if the sole activity of the office is 

the purchase of goods or merchandise because such activity does 

31 

not give rise to a permanent establishment under Article 5 (Permanent Establishment). A common situation in which paragraph 4 is 

relevant is one in which a permanent establishment purchases raw 

materials for the enterprise’s manufacturing operation conducted 

outside the United States and sells the manufactured product. 

While business profits may be attributable to the permanent establishment with respect to its sales activities, no profits are attributable to it with respect to its purchasing activities. 

Paragraph 5 

Paragraph 5 provides that profits shall be determined by the 

same method each year, unless there is good reason to change the 

method used. This rule assures consistent tax treatment over time 

for permanent establishments. It limits the ability of both the Contracting State and the enterprise to change accounting methods to 

be applied to the permanent establishment. It does not, however, 

restrict a Contracting State from imposing additional requirements, such as the rules under Code section 481, to prevent 

amounts from being duplicated or omitted following a change in accounting method. Such adjustments may be necessary, for example, 

if the taxpayer switches from using the domestic rules under section 864 in one year to using the rules of Article 7 in the next. Also, 

if the taxpayer switches from Convention-based rules to U.S. domestic rules, it may need to meet certain deadlines for making 

elections that are not necessary when applying the rules of the 

Convention. 

Paragraph 6 

Paragraph 6 coordinates the provisions of Article 7 and other 

provisions of the Convention. Under this paragraph, when business 

profits include items of income that are dealt with separately under 

other articles of the Convention, the provisions of those articles 

will, except when they specifically provide to the contrary, take 

precedence over the provisions of Article 7. For example, the taxation of dividends will be determined by the rules of Article 10 

(Dividends), and not by Article 7, except where, as provided in 

paragraph 6 of Article 10, the dividend is attributable to a permanent establishment. In the latter case the provisions of Article 7 

apply. Thus, an enterprise of one State deriving dividends from the 

other State may not rely on Article 7 to exempt those dividends 

from tax at source if they are not attributable to a permanent establishment of the enterprise in the other State. By the same 

token, if the dividends are attributable to a permanent establishment in the other State, the dividends may be taxed on a net income basis at the source State full corporate tax rate, rather than 

on a gross basis under Article 10. 

As provided in Article 8 (Shipping and Air Transport), income derived from shipping and air transport activities in international 

traffic described in that Article is taxable only in the country of 

residence of the enterprise regardless of whether it is attributable 

to a permanent establishment situated in the source State. 

Paragraph 7 

Paragraph 7 incorporates into the Convention the rule of Code 

section 864(c)(6). Like the Code section on which it is based, paraVerDate Aug 31 2005 15:57 Sep 15, 2008 Jkt 000000 PO 00000 Frm 00031 Fmt 6659 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-17.TXT sfrela2 PsN: MIKEB
32 

graph 7 provides that any income or gain attributable to a permanent establishment during its existence is taxable in the Contracting State where the permanent establishment is situated, even 

if the payment of that income or gain is deferred until after the 

permanent establishment ceases to exist. This rule applies with respect to paragraphs 1 and 2 of Article 7 (Business Profits), paragraph 6 of Article 10, paragraph 4 of Article 11 (Interest), paragraph 3 of Articles 12 (Royalties) and 13 (Capital Gains) and paragraph 2 of Article 20 (Other Income). 

The effect of this rule can be illustrated by the following example. Assume a company that is a resident of Iceland and that maintains a permanent establishment in the United States winds up the 

permanent establishment’s business and sells the permanent establishment’s inventory and assets to a U.S. buyer at the end of year 

1 in exchange for an interest-bearing installment obligation payable in full at the end of year 3. Despite the fact that Article 13’s 

threshold requirement for U.S. taxation is not met in year 3 because the company has no permanent establishment in the United 

States, the United States may tax the deferred income payment 

recognized by the company in year 3. 

Relationship to Other Articles 

This Article is subject to the saving clause of paragraph 4 of Article 1 (General Scope) of the Model. Thus, if a citizen of the United 

States who is a resident of Iceland under the treaty derives business profits from the United States that are not attributable to a 

permanent establishment in the United States, the United States 

may, subject to the special foreign tax credit rules of paragraph 4 

of Article 22 (Relief from Double Taxation), tax those profits, notwithstanding the provision of paragraph 1 of this Article which 

would exempt the income from U.S. tax. 

The benefits of this Article are also subject to Article 21 (Limitation on Benefits). Thus, an enterprise of Iceland that derives income effectively connected with a U.S. trade or business may not 

claim the benefits of Article 7 unless the resident carrying on the 

enterprise qualifies for such benefits under Article 21. 

As provided in paragraph 3 of the Protocol, Articles 7 and 23 

(Non-Discrimination) shall not prevent Iceland from continuing to 

tax permanent establishments of United States insurance companies in accordance with Article 70, paragraph 2, section 3 of the 

Icelandic Tax Code, nor shall it prevent the United States from 

continuing to tax permanent establishments of Icelandic insurance 

companies in accordance with section 842(b) of the Code. 

ARTICLE 8 (SHIPPING AND AIR TRANSPORT)

This Article governs the taxation of profits from the operation of 

ships and aircraft in international traffic. The term ‘‘international 

traffic’’ is defined in subparagraph 1(h) of Article 3 (General Definitions). 

Paragraph 1 

Paragraph 1 provides that profits derived by an enterprise of a 

Contracting State from the operation in international traffic of 

ships or aircraft are taxable only in that Contracting State. Because paragraph 6 of Article 7 (Business Profits) defers to Article 

33 

8 with respect to shipping income, such income derived by a resident of one of the Contracting States may not be taxed in the other 

State even if the enterprise has a permanent establishment in that 

other State. Thus, if a U.S. airline has a ticket office in Iceland, 

Iceland may not tax the airline’s profits attributable to that office 

under Article 7. Since entities engaged in international transportation activities normally will have many permanent establishments in a number of countries, the rule avoids difficulties that 

would be encountered in attributing income to multiple permanent 

establishments if the income were covered by Article 7. 

Paragraph 2 

The income from the operation of ships or aircraft in international traffic that is exempt from tax under paragraph 1 is defined in paragraph 2. 

In addition to income derived directly from the operation of ships 

and aircraft in international traffic, this definition also includes 

certain items of rental income. First, income of an enterprise of a 

Contracting State from the rental of ships or aircraft on a full basis 

(i.e., with crew) is income of the lessor from the operation of ships 

and aircraft in international traffic and, therefore, is exempt from 

tax in the other Contracting State under paragraph 1. Also, paragraph 2 encompasses income from the lease of ships or aircraft on 

a bareboat basis (i.e., without crew), either when the income is incidental to other income of the lessor from the operation of ships or 

aircraft in international traffic, or when the ships or aircraft are 

operated in international traffic by the lessee. If neither of those 

two conditions apply, income from the bareboat rentals would constitute business profits. The coverage of Article 8 is therefore 

broader than that of Article 8 of the OECD Model, which covers 

bareboat leasing only when it is incidental to other income of the 

lessor from the operation of ships of aircraft in international traffic. 

Paragraph 2 also clarifies, consistent with the Commentary to 

Article 8 of the OECD Model, that income earned by an enterprise 

from the inland transport of property or passengers within either 

Contracting State falls within Article 8 if the transport is undertaken as part of the international transport of property or passengers by the enterprise. Thus, if a U.S. shipping company contracts to carry property from Iceland to a U.S. city and, as part of 

that contract, it transports the property by truck from its point of 

origin to an airport in Iceland (or it contracts with a trucking company to carry the property to the airport) the income earned by the 

U.S. shipping company from the overland leg of the journey would 

be taxable only in the United States. Similarly, Article 8 also would 

apply to all of the income derived from a contract for the international transport of goods, even if the goods were transported to 

the port by a lighter, not by the vessel that carried the goods in 

international waters. 

Finally, certain non-transport activities that are an integral part 

of the services performed by a transport company, or are ancillary 

to the enterprise’s operation of ships or aircraft in international 

traffic, are understood to be covered in paragraph 1, though they 

are not specified in paragraph 2. These include, for example, the 

provision of goods and services by engineers, ground and equipment maintenance and staff, cargo handlers, catering staff and cusVerDate Aug 31 2005 15:57 Sep 15, 2008 Jkt 000000 PO 00000 Frm 00033 Fmt 6659 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-17.TXT sfrela2 PsN: MIKEB
34 

tomer services personnel. Where the enterprise provides such goods 

to, or performs services for, other enterprises and such activities 

are directly connected with or ancillary to the enterprise’s operation of ships or aircraft in international traffic, the profits from 

the provision of such goods and services to other enterprises will 

fall under this paragraph. 

For example, enterprises engaged in the operation of ships or aircraft in international traffic may enter into pooling arrangements 

for the purposes of reducing the costs of maintaining facilities 

needed for the operation of their ships or aircraft in other countries. For instance, where an airline enterprise agrees (for example, 

under an International Airlines Technical Pool agreement) to provide spare parts or maintenance services to other airlines landing 

at a particular location (which allows it to benefit from these services at other locations), activities carried on pursuant to that agreement will be ancillary to the operation of aircraft in international 

traffic by the enterprise. 

Also, advertising that the enterprise may do for other enterprises 

in magazines offered aboard ships or aircraft that it operates in 

international traffic or at its business locations, such as ticket offices, is ancillary to its operation of these ships or aircraft. Profits 

generated by such advertising fall within this paragraph. Income 

earned by concessionaires, however, is not covered by Article 8. 

These interpretations of paragraph 1 also are consistent with the 

Commen≥tary to Article 8 of the OECD Model. 

Paragraph 3 

Under this paragraph, profits of an enterprise of a Contracting 

State from the use, maintenance or rental of containers (including 

equipment for their transport) used in international traffic are exempt from tax in the other Contracting State. This result obtains 

under paragraph 3 regardless of whether the recipient of the income is engaged in the operation of ships or aircraft in international traffic, and regardless of whether the enterprise has a permanent establishment in the other Contracting State. Only income 

from the use, maintenance or rental of containers that is incidental 

to other income from international traffic is covered by Article 8 of 

the OECD Model. 

Paragraph 4 

This paragraph clarifies that the provisions of paragraphs 1 and 

3 also apply to profits derived by an enterprise of a Contracting 

State from participation in a pool, joint business or international 

operating agency. This refers to various arrangements for international cooperation by carriers in shipping and air transport. For 

example, airlines from two countries may agree to share the transport of passengers between the two countries. They each will fly 

the same number of flights per week and share the revenues from 

that route equally, regardless of the number of passengers that 

each airline actually transports. Paragraph 4 makes clear that with 

respect to each carrier the income dealt with in the Article is that 

carrier’s share of the total transport, not the income derived from 

the passengers actually carried by the airline. This paragraph corresponds to paragraph 4 of Article 8 of the OECD Model. 

35 

Relationship to Other Articles 

The taxation of gains from the alienation of ships, aircraft or containers is not dealt with in this Article but in paragraph 4 of Article 13 (Capital Gains). 

As with other benefits of the Convention, the benefit of exclusive 

residence country taxation under Article 8 is available to an enterprise only if it is entitled to benefits under Article 21 (Limitation 

on Benefits). 

This Article also is subject to the saving clause of paragraph 4 

of Article 1 (General Scope) of the Model. Thus, if a citizen of the 

United States who is a resident of Iceland derives profits from the 

operation of ships or aircraft in international traffic, notwithstanding the exclusive residence country taxation in paragraph 1 

of Article 8, the United States may, subject to the special foreign 

tax credit rules of paragraph 4 of Article 22 (Relief from Double 

Taxation), tax those profits as part of the worldwide income of the 

citizen. (This is an unlikely situation, however, because non-tax 

considerations (e.g., insurance) generally result in shipping activities being carried on in corporate form.) 

ARTICLE 9 (ASSOCIATED ENTERPRISES)

This Article incorporates in the Convention the arm’s-length 

principle reflected in the U.S. domestic transfer pricing provisions, 

particularly Code section 482. It provides that when related enterprises engage in a transaction on terms that are not arm’s-length, 

the Contracting States may make appropriate adjustments to the 

taxable income and tax liability of such related enterprises to reflect what the income and tax of these enterprises with respect to 

the transaction would have been had there been an arm’s-length 

relationship between them. 

Paragraph 1 

This paragraph is essentially the same as its counterpart in the 

U.S. and OECD Models. It addresses the situation where an enterprise of a Contracting State is related to an enterprise of the other 

Contracting State, and there are arrangements or conditions imposed between the enterprises in their commercial or financial relations that are different from those that would have existed in the 

absence of the relationship. Under these circumstances, the Contracting States may adjust the income (or loss) of the enterprise to 

reflect what it would have been in the absence of such a relationship. 

The paragraph identifies the relationships between enterprises 

that serve as a prerequisite to application of the Article. As the 

Commentary to the OECD Model makes clear, the necessary element in these relationships is effective control, which is also the 

standard for purposes of section 482. Thus, the Article applies if an 

enterprise of one State participates directly or indirectly in the 

management, control, or capital of the enterprise of the other State. 

Also, the Article applies if any third person or persons participate 

directly or indirectly in the management, control, or capital of enterprises of different States. For this purpose, all types of control 

are included, i.e., whether or not legally enforceable and however 

exercised or exercisable. 

36 

The fact that a transaction is entered into between such related 

enterprises does not, in and of itself, mean that a Contracting State 

may adjust the income (or loss) of one or both of the enterprises 

under the provisions of this Article. If the conditions of the transaction are consistent with those that would be made between independent persons, the income arising from that trans-action should 

not be subject to adjustment under this Article. 

Similarly, the fact that associated enterprises may have concluded arrangements, such as cost sharing arrangements or general services agreements, is not in itself an indication that the two 

enterprises have entered into a non-arm’s-length transaction that 

should give rise to an adjustment under paragraph 1. Both related 

and unrelated parties enter into such arrangements (e.g., joint venturers may share some development costs). As with any other kind 

of transaction, when related parties enter into an arrangement, the 

specific arrangement must be examined to see whether or not it 

meets the arm’s-length standard. In the event that it does not, an 

appropriate adjustment may be made, which may include modifying the terms of the agreement or re-characterizing the transaction to reflect its substance. 

It is understood that the ‘‘commensurate with income’’ standard 

for determining appropriate transfer prices for intangibles, added 

to Code section 482 by the Tax Reform Act of 1986, was designed 

to operate consistently with the arm’s-length standard. The implementation of this standard in the section 482 regulations is in accordance with the general principles of paragraph 1 of Article 9 of 

the Convention, as interpreted by the OECD Transfer Pricing 

Guidelines. 

This Article also permits tax authorities to deal with thin capitalization issues. They may, in the context of Article 9, scrutinize 

more than the rate of interest charged on a loan between related 

persons. They also may examine the capital structure of an enterprise, whether a payment in respect of that loan should be treated 

as interest, and, if it is treated as interest, under what circumstances interest deductions should be allowed to the payor. 

Paragraph 2 of the Commentary to Article 9 of the OECD Model, 

together with the U.S. observation set forth in paragraph 15, sets 

forth a similar understanding of the scope of Article 9 in the context of thin capitalization. 

Paragraph 2 

When a Contracting State has made an adjustment that is consistent with the provisions of paragraph 1, and the other Contracting State agrees that the adjustment was appropriate to reflect arm’s-length conditions, that other Contracting State is obligated to make a correlative adjustment (sometimes referred to as 

a ‘‘corresponding adjustment’’) to the tax liability of the related person in that other Contracting State. Although the OECD Model 

does not specify that the other Contracting State must agree with 

the initial adjustment before it is obligated to make the correlative 

adjustment, the Commentary makes clear that the paragraph is to 

be read that way. 

As explained in the Commentary to Article 9 of the OECD Model, 

Article 9 leaves the treatment of ‘‘secondary adjustments’’ to the 

laws of the Contracting States. When an adjustment under Article 

37 

9 has been made, one of the parties will have in its possession 

funds that it would not have had at arm’s length. The question 

arises as to how to treat these funds. In the United States the general practice is to treat such funds as a dividend or contribution to 

capital, depending on the relationship between the parties. Under 

certain circumstances, the parties may be permitted to restore the 

funds to the party that would have the funds had the transactions 

been entered into on arm’s length terms, and to establish an account payable pending restoration of the funds. See Rev. Proc. 99– 

32, 1999–2 C.B. 296. 

The Contracting State making a secondary adjustment will take 

the other provisions of the Convention, where relevant, into account. For example, if the effect of a secondary adjustment is to 

treat a U.S. corporation as having made a distribution of profits to 

its parent corporation in the other Contracting State, the provisions of Article 10 (Dividends) will apply, and the United States 

may impose a 5 percent withholding tax on the dividend. Also, if 

under Article 22 (Relief from Double Taxation) the other State generally gives a credit for taxes paid with respect to such dividends, 

it would also be required to do so in this case. 

The competent authorities are authorized by paragraph 3 of Article 24 (Mutual Agreement Procedure) to consult, if necessary, to resolve any differences in the application of these provisions. For example, there may be a disagreement over whether an adjustment 

made by a Contracting State under paragraph 1 was appropriate. 

If a correlative adjustment is made under paragraph 2, it is to 

be implemented, pursuant to paragraph 2 of Article 24, notwithstanding any time limits or other procedural limitations in the law 

of the Contracting State making the adjustment. If a taxpayer has 

entered a closing agreement (or other written settlement) with the 

United States prior to bringing a case to the competent authorities, 

the U.S. competent authority will endeavor only to obtain a correlative adjustment from Iceland. See Rev. Proc. 2006–54, 2006–49 

I.R.B.1035, Section 7.05. 

Relationship to Other Articles 

The saving clause of paragraph 4 of Article 1 (General Scope) 

does not apply to paragraph 2 of Article 9 by virtue of an exception 

to the saving clause in subparagraph 5(a) of Article 1. Thus, even 

if the statute of limitations has run, a refund of tax can be made 

in order to implement a correlative adjustment. Statutory or procedural limitations, however, cannot be overridden to impose additional tax, because paragraph 2 of Article 1 provides that the Convention cannot restrict any statutory benefit. 

ARTICLE 10 (DIVIDENDS)

Article 10 provides rules for the taxation of dividends paid by a 

company that is a resident of one Contracting State to a beneficial 

owner that is a resident of the other Contracting State. The Article 

provides for full residence State taxation of such dividends and a 

limited source-State right to tax. Article 10 also provides rules for 

the imposition of a tax on branch profits by the State of source. Finally, the article prohibits a State from imposing taxes on a company resident in the other Contracting State, other than a branch 

profits tax, on undistributed earnings. 

38 

Paragraph 1 

The right of a shareholder’s country of residence to tax dividends 

arising in the source country is preserved by paragraph 1, which 

permits a Contracting State to tax its residents on dividends paid 

to them by a company that is a resident of the other Contracting 

State. For dividends from any other source paid to a resident, Article 20 (Other Income) grants the residence country exclusive taxing 

jurisdiction (other than for dividends attributable to a permanent 

establishment in the other State). 

Paragraph 2 

The State of source also may tax dividends beneficially owned by 

a resident of the other State, subject to the limitations of paragraphs 2 and 3. Paragraph 2 generally limits the rate of withholding tax in the State of source on dividends paid by a company 

resident in that State to 15 percent of the gross amount of the dividend. If, however, the beneficial owner of the dividend is a company resident in the other State and owns directly shares representing at least 10 percent of the share capital, as represented 

as voting power of the company paying the dividend, then the rate 

of withholding tax in the State of source is limited to 5 percent of 

the gross amount of the dividend. Shares are considered voting 

shares if they provide the power to elect, appoint or replace any 

person vested with the powers ordinarily exercised by the board of 

directors of a U.S. corporation. 

The benefits of paragraph 2 may be granted at the time of payment by means of reduced rate of withholding tax at source. It also 

is consistent with the paragraph for tax to be withheld at the time 

of payment at full statutory rates, and the treaty benefit to be 

granted by means of a subsequent refund so long as such procedures are applied in a reasonable manner. 

The determination of whether the ownership threshold for subparagraph 2(a) is met for purposes of the 5 percent maximum rate 

of withholding tax is made on the date on which entitlement to the 

dividend is determined. Thus, in the case of a dividend from a U.S. 

company, the determination of whether the ownership threshold is 

met generally would be made on the dividend record date. 

Paragraph 2 does not affect the taxation of the profits out of 

which the dividends are paid. The taxation by a Contracting State 

of the income of its resident companies is governed by the internal 

law of the Contracting State, subject to the provisions of paragraph 

4 of Article 23 (Non-Discrimination). 

The term ‘‘beneficial owner’’ is not defined in the Convention, 

and is, therefore, defined as under the internal law of the country 

imposing tax (i.e., the source country). The beneficial owner of the 

dividend for purposes of Article 10 is the person to which the dividend income is attributable for tax purposes under the laws of the 

source State. Thus, if a dividend paid by a corporation that is a 

resident of one of the States (as determined under Article 4 (Resident)) is received by a nominee or agent that is a resident of the 

other State on behalf of a person that is not a resident of that other 

State, the dividend is not entitled to the benefits of this Article. 

However, a dividend received by a nominee on behalf of a resident 

of that other State would be entitled to benefits. These limitations 

39 

are confirmed by paragraph 12 of the Commentary to Article 10 of 

the OECD Model. 

Special rules, however, apply to shares that are held through fiscally transparent entities. In that case, the rules of paragraph 6 of 

Article 1 (General Scope) will apply to determine whether the dividends should be treated as having been derived by a resident of a 

Contracting State. Residence State principles shall be used to determine who derives the dividend, to assure that the dividends for 

which the source State grants benefits of the Convention will be 

taken into account for tax purposes by a resident of the residence 

State. Source State principles of beneficial ownership shall then 

apply to determine whether the person who derives the dividends, 

or another resident of the other Contracting State, is the beneficial 

owner of the dividend. The source State may conclude that the person who derives the dividend in the residence State is a mere 

nominee, agent, conduit, etc., for a third country resident and deny 

benefits of the Convention. If the person who derives the dividend 

under paragraph 6 of Article 1 would not be treated under the 

source State’s principles for determining beneficial ownership as a 

nominee, agent, custodian, conduit, etc., that person will be treated 

as the beneficial owner of the income, profits or gains for purposes 

of the Convention. 

Assume, for instance, that a company resident in Iceland pays a 

dividend to LLC, an entity which is treated as fiscally transparent 

for U.S. tax purposes but is treated as a company for Icelandic tax 

purposes. USCo, a company incorporated in the United States, is 

the sole interest holder in LLC. Paragraph 6 of Article 1 provides 

that USCo derives the dividend. Iceland’s principles of beneficial 

ownership shall then be applied to USCo. If under the laws of Iceland USCo is found not to be the beneficial owner of the dividend, 

USCo will not be entitled to the benefits of Article 10 with respect 

to such dividend. The payment may be entitled to benefits, however, if USCo is found to be a nominee, agent, custodian or conduit 

for a person who is a resident of the United States. 

Beyond identifying the person to whom the principles of beneficial ownership shall be applied, the principles of paragraph 6 of 

Article 1 will also apply when determining whether other requirements, such as the ownership threshold of subparagraph 2(a) have 

been satisfied. 

For example, assume that IceCo, a company that is a resident of 

Iceland, owns all of the outstanding shares in ThirdDE, an entity 

that is disregarded for U.S. tax purposes that is resident in a third 

country. ThirdDE owns 100% of the stock of USCo. Iceland views 

ThirdDE as fiscally transparent under its domestic law, and taxes 

IceCo currently on the income derived by ThirdDE. In this case, 

IceCo is treated as deriving the dividends paid by USCo under 

paragraph 6 of Article 1. Moreover, IceCo is treated as owning the 

shares of USCo directly. The Convention does not address what 

constitutes direct ownership for purposes of Article 10. As a result, 

whether ownership is direct is determined under the internal law 

of the country imposing tax (i.e., the source country) unless the 

context otherwise requires. Accordingly, a company that holds stock 

through such an entity will generally be considered to directly own 

such stock for purposes of Article 10. 

40 

This result may change, however, if ThirdDE is regarded as nonfiscally transparent under the laws of Iceland. Assuming that 

ThirdDE is treated as non-fiscally transparent by Iceland, the income will not be treated as derived by a resident of Iceland for purposes of the Convention. However, ThirdDE may still be entitled to 

the benefits of the U.S. tax treaty, if any, with its country of residence. 

The same principles would apply in determining whether companies holding shares through fiscally transparent entities such as 

partnerships, trusts, and estates would qualify for benefits. As a result, companies holding shares through such entities may be able 

to claim the benefits of subparagraph 2(a) under certain circumstances. The lower rate applies when the company’s proportionate share of the shares held by the intermediate entity meets 

the 10 percent threshold, and the company meets the requirements 

of Article 1(6) (i.e., the company’s country of residence treats the 

intermediate entity as fiscally transparent) with respect to the dividend. Whether this ownership threshold is satisfied may be difficult to determine and often will require an analysis of the partnership or trust agreement. 

Paragraph 3 

Paragraph 3 imposes limitations on the rate reductions provided 

by paragraphs 2 and 3 in the case of dividends paid by RIC or a 

REIT. 

The first sentence of subparagraph 3(a) provides that dividends 

paid by a RIC or REIT are not eligible for the 5 percent rate of 

withholding tax of subparagraph 2(a). 

The second sentence of subparagraph 3(a) provides that the 15 

percent maximum rate of withholding tax of subparagraph 2(b) applies to dividends paid by RICs. 

The third sentence of subparagraph 3(a) provides that the 15 

percent rate of withholding tax also applies to dividends paid by a 

REIT provided that one of the three following conditions is met. 

First, the beneficial owner of the dividend is an individual or a 

pension fund, in either case holding an interest of not more than 

10 percent in the REIT. Second, the dividend is paid with respect 

to a class of stock that is publicly traded and the beneficial owner 

of the dividend is a person holding an interest of not more than 5 

percent of any class of the REIT’s shares. Third, the beneficial 

owner of the dividend holds an interest in the REIT of not more 

than 10 percent and the REIT is ‘‘diversified.’’ A REIT is diversified 

if the gross value of no single interest in real property held by the 

REIT exceeds 10 percent of the gross value of the REIT’s total interest in real property. Foreclosure property is not considered an 

interest in real property, and a REIT holding a partnership interest is treated as owning its proportionate share of any interest in 

real property held by the partnership. 

The restrictions set out above are intended to prevent the use of 

these entities to gain inappropriate U.S. tax benefits. For example, 

a company resident in Iceland that wishes to hold a diversified 

portfolio of U.S. corporate shares could hold the portfolio directly 

and would bear a U.S. withholding tax of 15 percent on all of the 

dividends that it receives. Alternatively, it could hold the same diversified portfolio by purchasing 10 percent or more of the interests 

41 

in a RIC. If the RIC is a pure conduit, there may be no U.S. tax 

cost to interposing the RIC in the chain of ownership. Absent the 

special rule in paragraph 3, such use of the RIC could transform 

portfolio dividends, taxable in the United States under the Convention at a 15 percent maximum rate of withholding tax, into direct 

investment dividends taxable at a 5 percent maximum rate of withholding tax or eligible for the elimination of source-country withholding tax on dividends paid to pension funds as provided in paragraph 4. 

Similarly, a resident of Iceland directly holding U.S. real property would pay U.S. tax upon the sale of the property either at a 

30 percent rate of withholding tax on the gross income or at graduated rates on the net income. As in the preceding example, by 

placing the real property in a REIT, the investor could, absent a 

special rule, transform income from the sale of real estate into dividend income from the REIT, taxable at the rates provided in Article 10, significantly reducing the U.S. tax that otherwise would be 

imposed. Paragraph 3 prevents this result and thereby avoids a 

disparity between the taxation of direct real estate investments 

and real estate investments made through REIT conduits. In the 

cases in which paragraph 3 allows a dividend from a REIT to be 

eligible for the 15 percent rate of withholding tax, the holding in 

the REIT is not considered the equivalent of a direct holding in the 

underlying real property. 

Paragraph 4 

Paragraph 4 provides that dividends beneficially owned by a pension scheme or employee benefits organization may not be taxed in 

the Contracting State of which the company paying the tax is a 

resident. However, the exemption provided in paragraph 4 shall 

not apply if the dividends are derived from the carrying on of a 

business, directly or indirectly, by the pension scheme or employee 

benefits organization. For these purposes, the term ‘‘pension 

scheme’’ is defined in subparagraph 1(l) of Article 3 (General Definitions). 

The exemption is provided because pension schemes and employee benefits organizations normally do not pay tax (either 

through a general exemption or because reserves for future pension 

liabilities effectively offset all of the fund’s income), and therefore 

cannot benefit from a foreign tax credit. Moreover, distributions 

from a pension fund generally do not maintain the character of the 

underlying income, so the beneficiaries of the pension are not in a 

position to claim a foreign tax credit when they finally receive the 

pension, in many cases years after the withholding tax has been 

paid. Accordingly, in the absence of this rule, the dividends would 

almost certainly be subject to unrelieved double taxation. 

Paragraph 5 

Paragraph 5 defines the term dividends broadly and flexibly. The 

definition is intended to cover all arrangements that yield a return 

on an equity investment in a corporation as determined under the 

tax law of the state of source, as well as arrangements that might 

be developed in the future. 

The term includes income from shares, or other corporate rights 

that are not treated as debt under the law of the source State, that 

42 

participate in the profits of the company. The term also includes 

income that is subjected to the same tax treatment as income from 

shares by the law of the State of source. Thus, a constructive dividend that results from a non-arm’s length transaction between a 

corporation and a related party is a dividend. In the case of the 

United States the term dividend includes amounts treated as a dividend under U.S. law upon the sale or redemption of shares or 

upon a transfer of shares in a reorganization. See, e.g., Rev. Rul. 

92–85, 1992–2 C.B. 69 (sale of foreign subsidiary’s stock to U.S. sister company is a deemed dividend to extent of the subsidiary’s and 

sister company’s earnings and profits). Further, a distribution from 

a U.S. publicly traded limited partnership, which is taxed as a corporation under U.S. law, is a dividend for purposes of Article 10. 

However, a distribution by a limited liability company is not taxable by the United States under Article 10, provided the limited liability company is not characterized as an association taxable as a 

corporation under U.S. law. 

Finally, a payment denominated as interest that is made by a 

thinly capitalized corporation may be treated as a dividend to the 

extent that the debt is recharacterized as equity under the laws of 

the source State. 

Paragraph 6 

Paragraph 6 provides a rule for taxing dividends paid with respect to holdings that form part of the business property of a permanent establishment. In such case, the rules of Article 7 (Business Profits) shall apply. Accordingly, the dividends will be taxed 

on a net basis using the rates and rules of taxation generally applicable to residents of the State in which the permanent establishment is located, as such rules may be modified by the Convention. 

An example of dividends paid with respect to the business property 

of a permanent establishment would be dividends derived by a 

dealer in stock or securities from stock or securities that the dealer 

held for sale to customers. 

Paragraph 7 

The right of a Contracting State to tax dividends paid by a company that is a resident of the other Contracting State is restricted 

by paragraph 7 to cases in which the dividends are paid to a resident of that Contracting State or are attributable to a permanent 

establishment or fixed base in that Contracting State. Thus, a Contracting State may not impose a ‘‘secondary’’ withholding tax on 

dividends paid by a nonresident company out of earnings and profits from that Contracting State 

The paragraph also restricts the right of a Contracting State to 

impose corporate level taxes on undistributed profits, other than a 

branch profits tax. The paragraph does not restrict a State’s right 

to tax its resident shareholders on undistributed earnings of a corporation resident in the other State. Thus, the authority of the 

United States to impose taxes on subpart F income and on earnings deemed invested in U.S. property, and its tax on income of a 

passive foreign investment company that is a qualified electing 

fund is in no way restricted by this provision. 

43 

Paragraph 8 

Paragraph 8 permits a Contracting State to impose a branch 

profits tax on a company resident in the other Contracting State. 

The tax is in addition to other taxes permitted by the Convention. 

The term ‘‘company’’ is defined in subparagraph 1(d) of Article 3 

(General Definitions). 

A Contracting State may impose a branch profits tax on a company if the company has income attributable to a permanent establishment in that Contracting State, derives income from real property in that Contracting State that is taxed on a net basis under 

Article 6 (Income from Immovable Property (Real Property)), or realizes gains taxable in that State under paragraph 1 of Article 13 

(Capital Gains). In the case of the United States, the imposition of 

such tax is limited, however, to the portion of the aforementioned 

items of income that represents the amount of such income that is 

the ‘‘dividend equivalent amount.’’ This is consistent with the relevant rules under the U.S. branch profits tax, and the term dividend equivalent amount is defined in paragraph 4 of the Protocol 

as that portion of the income mentioned in paragraph 7 of Article 

10 that is comparable to the amount that would be distributed as 

a dividend if such income were earned by a subsidiary incorporated 

in the United States. For any year, a foreign corporation’s dividend 

equivalent amount is equal to the after-tax earnings attributable to 

the foreign corporation’s (i) income attributable to a permanent establishment in the United States, (ii) income from real property in 

the United States that is taxed on a net basis under Article 6 (Income from Immovable Property (Real Property)), and (iii) gain from 

a real property interest taxable by the United States under paragraph 1 of Article 13 (Capital Gains), reduced by any increase in 

the foreign corporation’s net investment in U.S. assets or increased 

by any reduction in the foreign corporation’s net investment in U.S. 

assets. 

The dividend equivalent amount for any year approximates the 

dividend that a U.S. branch office would have paid during the year 

if the branch had been operated as a separate U.S. subsidiary company. If Iceland also imposes a branch profits tax, the base of its 

tax must be limited to an amount that is analogous to the dividend 

equivalent amount. 

As discussed in the Technical Explanations to Articles 1(2) and 

7(2), consistency principles require that a taxpayer may not mix 

and match the rules of the Code and the Convention in an inconsistent manner. In the context of the branch profits tax, the consistency requirement means that an enterprise that uses the principles of Article 7 to determine its net taxable income also must use 

the principles in determining the dividend equivalent amount. 

Similarly, an enterprise that uses U.S. domestic law to determine 

its net taxable income must also use U.S. domestic law in complying with the branch profits tax. As in the case of Article 7, if 

an enterprise switches between domestic law and treaty principles 

from year to year, it will need to make appropriate adjustments or 

recapture amounts that otherwise might go untaxed. 

44 

Paragraph 9 

Paragraph 9 provides that the branch profits tax shall not be imposed at a rate exceeding the direct investment dividend withholding rate of five percent. 

Relationship to Other Articles 

Notwithstanding the foregoing limitations on source country taxation of dividends, the saving clause of paragraph 4 of Article 1 

permits the United States to tax dividends received by its residents 

and citizens, subject to the special foreign tax credit rules of paragraph 4 of Article 22 (Relief from Double Taxation), as if the Convention had not come into effect. 

The benefits of this Article are also subject to the provisions of 

Article 21 (Limitation on Benefits). Thus, if a resident of the other 

Contracting State is the beneficial owner of dividends paid by a 

U.S. corporation, the shareholder must qualify for treaty benefits 

under at least one of the tests of Article 21 in order to receive the 

benefits of this Article. 

ARTICLE 11 (INTEREST)

Article 11 specifies the taxing jurisdictions over interest income 

of the States of source and residence and defines the terms necessary to apply the Article. 

Paragraph 1 

Paragraph 1 generally grants to the State of residence the exclusive right to tax interest beneficially owned by its residents and 

arising in the other Contracting State. 

The term ‘‘beneficial owner’’ is not defined in the Convention, 

and is, therefore, defined under the internal law of the State of 

source. The beneficial owner of the interest for purposes of 

Article 11 is the person to which the income is attributable under 

the laws of the source State. Thus, if interest arising in a Contracting State is received by a nominee or agent that is a resident 

of the other State on behalf of a person that is not a resident of 

that other State, the interest is not entitled to the benefits of Article 11. However, interest received by a nominee on behalf of a resident of that other State would be entitled to benefits. These limitations are confirmed by paragraph 9 of the OECD Commentary to 

Article 11. 

Paragraph 2 

The term ‘‘interest’’ as used in Article 11 is defined in paragraph 

2 to include, inter alia, income from debt claims of every kind, 

whether or not secured by a mortgage. Penalty charges for late 

payment are excluded from the definition of interest. Interest that 

is paid or accrued subject to a contingency is within the ambit of 

Article 11. This includes income from a debt obligation carrying the 

right to participate in profits. The term does not, however, include 

amounts that are treated as dividends under Article 10 (Dividends). 

The term interest also includes amounts subject to the same tax 

treatment as income from money lent under the law of the State 

in which the income arises. Thus, for purposes of the Convention, 

45 

amounts that the United States will treat as interest include (i) the 

difference between the issue price and the stated redemption price 

at maturity of a debt instrument (i.e., original issue discount 

(‘‘OID’’)), which may be wholly or partially realized on the disposition of a debt instrument (section 1273), (ii) amounts that are imputed interest on a deferred sales contract (section 483), (iii) 

amounts treated as interest or OID under the stripped bond rules 

(section 1286), (iv) amounts treated as original issue discount 

under the below-market interest rate rules (section 7872), (v) a 

partner’s distributive share of a partnership’s interest income (section 702), (vi) the interest portion of periodic payments made under 

a ‘‘finance lease’’ or similar contractual arrangement that in substance is a borrowing by the nominal lessee to finance the acquisition of property, (vii) amounts included in the income of a holder 

of a residual interest in a REMIC (section 860E), because these 

amounts generally are subject to the same taxation treatment as 

interest under U.S. tax law, and (viii) interest with respect to notional principal contracts that are re-characterized as loans because 

of a ‘‘substantial non-periodic payment.’’ 

Paragraph 3 

Paragraph 3 provides an exception to the exclusive residence taxation rule of paragraph 1 and the source-country gross taxation 

rule of paragraph 5 in cases where the beneficial owner of the interest carries on business through a permanent establishment in 

the State of source situated in that State and the interest is attributable to that permanent establishment. In such cases the provisions of Article 7 (Business Profits) will apply and the State of 

source will retain the right to impose tax on such interest income. 

In the case of a permanent establishment that once existed in 

the State but that no longer exists, the provisions of paragraph 3 

also apply, by virtue of paragraph 7 of Article 7, to interest that 

would be attributable to such a permanent establishment or fixed 

base if it did exist in the year of payment or accrual. See the Technical Explanation of paragraph 7 of Article 7. 

Paragraph 4 

Paragraph 4 provides that in cases involving special relationships between the payor and the beneficial owner of interest income, Article 11 applies only to that portion of the total interest 

payments that would have been made absent such special relationships (i.e., an arm’s length interest payment). Any excess amount 

of interest paid remains taxable according to the laws of the United 

States and Iceland, respectively, with due regard to the other provisions of the Convention. Thus, if the excess amount would be 

treated under the source country’s law as a distribution of profits 

by a corporation, such amount could be taxed as a dividend rather 

than as interest, but the tax would be subject, if appropriate, to the 

rate limitations of paragraph 2 of Article 10. 

The term ‘‘special relationship’’ is not defined in the Convention. 

In applying this paragraph the United States considers the term to 

include the relationships described in Article 9, which in turn corresponds to the definition of ‘‘control’’ for purposes of section 482 

of the Code. 

46 

This paragraph does not address cases where, owing to a special 

relationship between the payer and the beneficial owner or between 

both of them and some other person, the amount of the interest is 

less than an arm’s-length amount. In those cases a transaction may 

be characterized to reflect its substance and interest may be imputed consistent with the definition of interest in paragraph 3. The 

United States would apply section 482 or 7872 of the Code to determine the amount of imputed interest in those cases. 

Paragraph 5 

Paragraph 5 provides anti-abuse exceptions to the source-country 

exemption in paragraph 1 for two classes of interest payments. 

The first class of interest, dealt with in subparagraph 5(a) is socalled ‘‘contingent interest.’’ Under this provision, interest arising 

in a Contracting State that is determined by reference to the receipts, sales, income, profits or other cash flow of the debtor or a 

related person, to any change in the value of any property of the 

debtor or a related person or to any dividend, partnership distribution or similar payment made by the debtor or a related person, 

and paid to a resident of the other State may also be taxed in the 

Contracting State. Any such interest may be taxed in that Contracting State according to the laws of that State. However, if the 

beneficial owner is a resident of the other Contracting State, the 

gross amount of the interest may be taxed at a rate not exceeding 

15 percent. 

The second class of interest is dealt with in subparagraph 5(b). 

This exception is consistent with the policy of Code sections 

860E(e) and 860G(b) that excess inclusions with respect to a real 

estate mortgage investment conduit (REMIC) should bear full U.S. 

tax in all cases. Without a full tax at source foreign purchasers of 

residual interests would have a competitive advantage over U.S. 

purchasers at the time these interests are initially offered. Also, 

absent this rule, the U.S. fisc would suffer a revenue loss with respect to mortgages held in a REMIC because of opportunities for 

tax avoidance created by differences in the timing of taxable and 

economic income produced by these interests. 

Relationship to Other Articles 

Notwithstanding the foregoing limitations on source country taxation of interest, the saving clause of paragraph 4 of Article 1 (General Scope) permits the United States to tax its residents and citizens, subject to the special foreign tax credit rules of paragraph 4 

of Article 22 (Relief from Double Taxation), as if the Convention 

had not come into force. 

As with other benefits of the Convention, the benefits of Article 

11 are available to a resident of the other State only if that resident is entitled to those benefits under the provisions of Article 21 

(Limitation on Benefits). 

ARTICLE 12 (ROYALTIES)

Article 12 provides rules for the taxation of royalties arising in 

one Contracting State and paid to a beneficial owner that is a resident of the other Contracting State. 

47 

Paragraph 1 

Paragraph 1 generally grants to the State of residence the exclusive right to tax royalties beneficially owned by its residents and 

arising in the other Contracting State. 

The term ‘‘beneficial owner’’ is not defined in the Convention, 

and is, therefore, defined under the internal law of the State of 

source. The beneficial owner of the royalty for purposes of Article 

12 is the person to which the income is attributable under the laws 

of the source State. Thus, if a royalty arising in a Contracting 

State is received by a nominee or agent that is a resident of the 

other State on behalf of a person that is not a resident of that other 

State, the royalty is not entitled to the benefits of Article 12. However, a royalty received by a nominee on behalf of a resident of that 

other State would be entitled to benefits. These limitations are confirmed by paragraph 4 of the OECD Commentary to Article 12. 

Paragraph 2 

Paragraph 2 provides that notwithstanding the provisions of 

paragraph 1, the following royalties may be taxed in the Contracting State in which they arise: royalties paid in consideration 

for the use of, or the right to use a trademark and any information 

concerning industrial, commercial or scientific experience provided 

in connection with a rental or franchise agreement that includes 

rights to use a trademark, and royalties paid in consideration for 

the use of or the right to use a motion picture film or work on film 

or videotape or other means of reproduction for use in connection 

with television. If, however, the beneficial owner of the royalty is 

a resident of the other Contracting State, the tax may not exceed 

5 percent of the gross amount of the royalties. 

Paragraph 3 

Paragraph 2 defines the term ‘‘royalties,’’ as used in Article 12, 

to include any consideration for the use of, or the right to use, any 

copyright of literary, artistic, scientific or other work (such as computer software and cinematographic films), any patent, trademark, 

design or model, plan, secret formula or process, or for information 

concerning industrial, commercial, or scientific experience. The 

term ‘‘royalties,’’ however, does not include income from leasing 

personal property. 

The term royalties is defined in the Convention and therefore is 

generally independent of domestic law. Certain terms used in the 

definition are not defined in the Convention, but these may be defined under domestic tax law. For example, the term ‘‘secret process or formulas’’ is found in the Code, and its meaning has been 

elaborated in the context of sections 351 and 367. See Rev. Rul. 55– 

17, 1955–1 C.B. 388; Rev. Rul. 64–56, 1964–1 C.B. 133; Rev. Proc. 

69–19, 1969–2 C.B. 301. 

Consideration for the use or right to use cinematographic films, 

or works on film, tape, or other means of reproduction in radio or 

television broadcasting is specifically included in the definition of 

royalties. It is intended that, with respect to any subsequent technological advances in the field of radio or television broadcasting, 

consideration received for the use of such technology will also be 

included in the definition of royalties. 

48 

If an artist who is resident in one Contracting State records a 

performance in the other Contracting State, retains a copyrighted 

interest in a recording, and receives payments for the right to use 

the recording based on the sale or public playing of the recording, 

then the right of such other Contracting State to tax those payments is governed by Article 12. See Boulez v. Commissioner, 83 

T.C. 584 (1984), aff’d, 810 F.2d 209 (D.C. Cir. 1986). By contrast, 

if the artist earns in the other Contracting State income covered 

by Article 16 (Entertainers and Sportsmen), for example, endorsement income from the artist’s attendance at a film screening, and 

if such income also is attributable to one of the rights described in 

Article 12 (e.g., the use of the artist’s photograph in promoting the 

screening), Article 16 and not Article 12 is applicable to such income. 

Computer software generally is protected by copyright laws 

around the world. Under the Convention, consideration received for 

the use, or the right to use, computer software is treated either as 

royalties or as business profits, depending on the facts and circumstances of the transaction giving rise to the payment. 

The primary factor in determining whether consideration received for the use, or the right to use, computer software is treated 

as royalties or as business profits is the nature of the rights transferred. See Treas. Reg. section 1.861–18. The fact that the transaction is characterized as a license for copyright law purposes is 

not dispositive. For example, a typical retail sale of ‘‘shrink wrap’’ 

software generally will not be considered to give rise to royalty income, even though for copyright law purposes it may be characterized as a license. 

The means by which the computer software is transferred are not 

relevant for purposes of the analysis. Consequently, if software is 

electronically transferred but the rights obtained by the transferee 

are substantially equivalent to rights in a program copy, the payment will be considered business profits. 

The term ‘‘industrial, commercial, or scientific experience’’ (sometimes referred to as ‘‘know-how’’) has the meaning ascribed to it in 

paragraph 11 et seq. of the Commentary to Article 12 of the OECD 

Model. Consistent with that meaning, the term may include information that is ancillary to a right otherwise giving rise to royalties, 

such as a patent or secret process. 

Know-how also may include, in limited cases, technical information that is conveyed through technical or consultancy services. It 

does not include general educational training of the user’s employees, nor does it include information developed especially for the 

user, such as a technical plan or design developed according to the 

user’s specifications. Thus, as provided in paragraph 11.3 of the 

Commentary to Article 12 of the OECD Model, the term ‘‘royalties’’ 

does not include payments received as consideration for after-sales 

service, for services rendered by a seller to a purchaser under a 

warranty, or for pure technical assistance. 

The term ‘‘royalties’’ also does not include payments for professional services (such as architectural, engineering, legal, managerial, medical, software development services). For example, income 

from the design of a refinery by an engineer (even if the engineer 

employed know-how in the process of rendering the design) or the 

production of a legal brief by a lawyer is not income from the transVerDate Aug 31 2005 15:57 Sep 15, 2008 Jkt 000000 PO 00000 Frm 00048 Fmt 6659 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-17.TXT sfrela2 PsN: MIKEB
49 

fer of know-how taxable under Article 12, but is income from services taxable under either Article 7 (Business Profits) or Article 14 

(Income from Employment). Professional services may be embodied 

in property that gives rise to royalties, however. Thus, if a professional contracts to develop patentable property and retains rights 

in the resulting property under the development contract, subsequent license payments made for those rights would be royalties. 

Paragraph 4 

This paragraph provides an exception in cases where the beneficial owner of the royalties carries on business through a permanent establishment in the state of source and the royalties are attributable to that permanent establishment. In such cases the provisions of Article 7 will apply. 

The provisions of paragraph 7 of Article 7 apply to this paragraph. For example, royalty income that is attributable to a permanent establishment and that accrues during the existence of the 

permanent establishment, but is received after the permanent establishment no longer exists, remains taxable under the provisions 

of Article 7, and not under this Article. 

Paragraph 5 

Paragraph 5 contains the source rule for royalties. Under paragraph 5, royalties are treated as arising in a Contracting State if 

paid by a resident of that State. As an exception, royalties that are 

attributable to a permanent establishment in a Contracting State 

and borne by the permanent establishment are considered to arise 

in that State. Where, however, the payor of the royalties is not a 

resident of either Contracting State, and the royalties are not 

borne by a permanent establishment in either Contracting State, 

but the royalties are for the use of, or the right to use, in one of 

the Contracting States, any property or right described in paragraph 3, the royalties are deemed to arise in that State. 

Paragraph 6 

Paragraph 6 provides that in cases involving special relationships between the payor and beneficial owner of royalties, Article 

12 applies only to the extent the royalties would have been paid 

absent such special relationships (i.e., an arm’s-length royalty). 

Any excess amount of royalties paid remains taxable according to 

the laws of the two Contracting States, with due regard to the 

other provisions of the Convention. If, for example, the excess 

amount is treated as a distribution of corporate profits under domestic law, such excess amount will be taxed as a dividend rather 

than as royalties, but the tax imposed on the dividend payment 

will be subject to the rate limitations of paragraph 2 of Article 10 

(Dividends). 

1Relationship to Other Articles 

Notwithstanding the foregoing limitations on source country taxation of royalties, the saving clause of paragraph 4 of Article 1 

(General Scope) permits the United States to tax its residents and 

citizens, subject to the special foreign tax credit rules of paragraph 

4 of Article 22 (Relief from Double Taxation), as if the Convention 

had not come into force. 

50 

As with other benefits of the Convention, the benefits of Article 

12 are available to a resident of the other State only if that resident is entitled to those benefits under Article 21 (Limitation on 

Benefits). 

ARTICLE 13 (CAPITAL GAINS)

Article 13 assigns either primary or exclusive taxing jurisdiction 

over gains from the alienation of property to the State of residence 

or the State of source. 

Paragraph 1 

Paragraph 1 of Article 13 preserves the non-exclusive right of the 

State of source to tax from the alienation of immovable property 

(real property) situated in that State. For purposes of paragraph 1, 

in all events the term ‘‘immovable property (real property) situated 

in the other State’’ includes a United States real property interest 

in the United States, as that term is defined in the Internal Revenue Code on the date of signature of the Convention, and as 

amended (without changing the general principles of paragraph 1). 

Thus, the United States preserves its right to collect the tax imposed by section 897 of the Code on gains derived by foreign persons from the disposition of United States real property interests, 

including gains arising from indirect dispositions described in section 897(h). 

Paragraph 2 

This paragraph defines the term ‘‘immovable property (real property) situated in the other Contracting State.’’ The term includes 

real property referred to in Article 6 (i.e., an interest in the real 

property itself), rights to assets to be produced by the exploration 

or exploitation of the seabed and subsoil of that other State and 

their natural resources, including rights to interests in or the benefit of such assets, a ‘‘United States real property interest’’ (when 

the United States is the other Contracting State under paragraph 

1), and, as specified in subparagraph 2(d), an equivalent interest 

in immovable property (real property) situated in Iceland. 

Under section 897(c) of the Code the term ‘‘United States real 

property interest’’ includes shares in a U.S. corporation that owns 

sufficient U.S. real property interests to satisfy an asset-ratio test 

on certain testing dates. The term also includes certain foreign corporations that have elected to be treated as U.S. corporations for 

this purpose. Section 897(i). 

Paragraph 3 

Paragraph 3 of Article 13 deals with the taxation of certain gains 

from the alienation of movable property forming part of the business property of a permanent establishment that an enterprise of 

a Contracting State has in the other Contracting State. This also 

includes gains from the alienation of such a permanent establishment (alone or with the whole enterprise). Such gains may be taxed 

in the State in which the permanent establishment is located. 

A resident of Iceland that is a partner in a partnership doing 

business in the United States generally will have a permanent establishment in the United States as a result of the activities of the 

partnership, assuming that the activities of the partnership rise to 

51 

the level of a permanent establishment. Rev. Rul. 91–32, 1991–1 

C.B. 107. Further, under paragraph 3, the United States generally 

may tax a partner’s distributive share of income realized by a partnership on the disposition of movable property forming part of the 

business property of the partnership in the United States. 

The gains subject to paragraph 3 may be taxed in the State in 

which the permanent establishment is located, regardless of whether the permanent establishment exists at the time of the alienation. This rule incorporates the rule of section 864(c)(6) of the 

Code. Accordingly, income that is attributable to a permanent establishment, but that is deferred and received after the permanent 

establishment no longer exists, may nevertheless be taxed by the 

State in which the permanent establishment was located. 

Paragraph 4 

This paragraph limits the taxing jurisdiction of the State of 

source with respect to gains from the alienation of ships, aircraft 

or containers operated in international traffic by the enterprise 

alienating the ship or aircraft and from property (other than real 

property) pertaining to the operation or use of such ships, aircraft, 

or containers. 

Under paragraph 4, such income is taxable only in the Contracting State in which the alienator is resident. Notwithstanding 

paragraph 3, the rules of this paragraph apply even if the income 

is attributable to a permanent establishment maintained by the enterprise in the other Contracting State. This result is consistent 

with the allocation of taxing rights under Article 8 (Shipping and 

Air Transport). 

Paragraph 5 

Paragraph 5 grants to the State of residence of the alienator the 

exclusive right to tax gains from the alienation of property other 

than property referred to in paragraphs 1 through 4. For example, 

gain derived from shares, other than shares described in paragraphs 2 or 3, debt instruments and various financial instruments, 

may be taxed only in the State of residence, to the extent such income is not otherwise characterized as income taxable under another article (e.g., Article 10 (Dividends) or Article 11 (Interest)). 

Similarly gain derived from the alienation of tangible personal 

property, other than tangible personal property described in paragraph 3, may be taxed only in the State of residence of the alienator. 

Gains derived by a resident of a Contracting State from real 

property located in a third state are not taxable in the other Contracting State, even if the sale is attributable to a permanent establishment located in the other Contracting State. 

Paragraph 6 

Paragraph 6 sets forth a rule which permits the imposition of 

certain expatriation taxes. This rule provides that notwithstanding 

paragraph 5 a Contracting State may tax gains from the alienation 

of shares or rights in a company, the capital of which is wholly or 

partly divided into shares, and that is a resident of that State, if 

the person alienating the shares or rights is an individual resident 

in the other Contracting State, but only if such individual was a 

52 

resident of the first-mentioned State at any time during the fiveyear period preceding the alienation. 

Relationship to Other Articles 

Notwithstanding the foregoing limitations on taxation of certain 

gains by the State of source, the saving clause of paragraph 4 of 

Article 1 (General Scope) permits the United States to tax its citizens and residents as if the Convention had not come into effect. 

Thus, any limitation in this Article on the right of the United 

States to tax gains does not apply to gains of a U.S. citizen or resident. 

The benefits of this Article are also subject to the provisions of 

Article 21 (Limitation on Benefits). Thus, only a resident of a Contracting State that satisfies one of the conditions in Article 21 is 

entitled to the benefits of this Article. 

Additionally, the provisions of paragraph 6 shall be applied in 

conjunction with subparagraph 2(b) of Article 22 (Relief from Double Taxation). 

ARTICLE 14 (INCOME FROM EMPLOYMENT)

Article 14 apportions taxing jurisdiction over remuneration derived by a resident of a Contracting State as an employee between 

the States of source and residence. 

Paragraph 1 

The general rule of Article 14 is contained in paragraph 1. Remuneration derived by a resident of a Contracting State as an employee may be taxed by the State of residence, and the remuneration also may be taxed by the other Contracting State to the extent 

derived from employment exercised (i.e., services performed) in 

that other Contracting State. Paragraph 1 also provides that the 

more specific rules of Articles 15 (Directors’ Fees), 17 (Pensions, Social Security, and Annuities), and 19 (Government Service) apply 

in the case of employment income described in one of those articles. 

Thus, even though the State of source has a right to tax employment income under Article 14, it may not have the right to tax that 

income under the Convention if the income is described, for example, in Article 17 (Pensions, Social Security, and Annuities) and is 

not taxable in the State of source under the provisions of that article. 

Article 14 applies to any form of compensation for employment, 

including payments in kind. Paragraph 1.1 of the Commentary to 

Article 16 of the OECD Model now confirms that interpretation. 

Consistent with section 864(c)(6) of the Code, Article 14 also applies regardless of the timing of actual payment for services. Consequently, a person who receives the right to a future payment in 

consideration for services rendered in a Contracting State would be 

taxable in that State even if the payment is received at a time 

when the recipient is a resident of the other Contracting State. 

Thus, a bonus paid to a resident of a Contracting State with respect to services performed in the other Contracting State with respect to a particular taxable year would be subject to Article 14 for 

that year even if it was paid after the close of the year. An annuity 

received for services performed in a taxable year could be subject 

to Article 14 despite the fact that it was paid in subsequent years. 

53 

In that case, it would be necessary to determine whether the payment constitutes deferred compensation, taxable under Article 14, 

or a qualified pension subject to the rules of Article 17 (Pensions, 

Social Security, and Annuities). Article 14 also applies to income 

derived from the exercise of stock options granted with respect to 

services performed in the host State, even if those stock options are 

exercised after the employee has left the source country. If Article 

14 is found to apply, whether such payments were taxable in the 

State where the employment was exercised would depend on 

whether the tests of paragraph 2 were satisfied in the year in 

which the services to which the payment relates were performed. 

Paragraph 2 

Paragraph 2 sets forth an exception to the general rule that employment income may be taxed in the State where it is exercised. 

Under paragraph 2, the State where the employment is exercised 

may not tax the income from the employment if three conditions 

are satisfied: (a) the individual is present in the other Contracting 

State for a period or periods not exceeding 183 days in any 12- 

month period that begins or ends during the relevant taxable year 

(i.e., in the United States, the calendar year in which the services 

are performed); (b) the remuneration is paid by, or on behalf of, an 

employer who is not a resident of that other Contracting State; and 

(c) the remuneration is not borne as a deductible expense by a permanent establishment that the employer has in that other State. 

In order for the remuneration to be exempt from tax in the source 

State, all three conditions must be satisfied. This exception is identical to that set forth in the OECD Model. 

The 183-day period in condition (a) is to be measured using the 

‘‘days of physical presence’’ method. Under this method, the days 

that are counted include any day in which a part of the day is 

spent in the host country. (Rev. Rul. 56–24, 1956–1 C.B. 851.) 

Thus, days that are counted include the days of arrival and departure; weekends and holidays on which the employee does not work 

but is present within the country; vacation days spent in the country before, during or after the employment period, unless the individual’s presence before or after the employment can be shown to 

be independent of his presence there for employment purposes; and 

time during periods of sickness, training periods, strikes, etc., when 

the individual is present but not working. If illness prevented the 

individual from leaving the country in sufficient time to qualify for 

the benefit, those days will not count. Also, any part of a day spent 

in the host country while in transit between two points outside the 

host country is not counted. If the individual is a resident of the 

host country for part of the taxable year concerned and a nonresident for the remainder of the year, the individual’s days of 

presence as a resident do not count for purposes of determining 

whether the 183-day period is exceeded. 

Conditions (b) and (c) are intended to ensure that a Contracting 

State will not be required to allow a deduction to the payor for 

compensation paid and at the same time to exempt the employee 

on the amount received. Accordingly, if a foreign person pays the 

salary of an employee who is employed in the host State, but a host 

State corporation or permanent establishment reimburses the 

payor with a payment that can be identified as a reimbursement, 

54 

neither condition (b) nor (c), as the case may be, will be considered 

to have been fulfilled. 

The reference to remuneration ‘‘borne by’’ a permanent establishment is understood to encompass all expenses that economically 

are incurred and not merely expenses that are currently deductible 

for tax purposes. Accordingly, the expenses referred to include expenses that are capitalizable as well as those that are currently deductible. Further, salaries paid by residents that are exempt from 

income taxation may be considered to be borne by a permanent establishment notwithstanding the fact that the expenses will be neither deductible nor capitalizable since the payor is exempt from 

tax. 

Paragraph 3 

Paragraph 3 contains a special rule applicable to remuneration 

for services performed by a resident of a Contracting State as an 

employee aboard a ship or aircraft operated in international traffic. 

Such remuneration may be taxed only in the State of residence of 

the employee if the services are performed as a member of the regular complement of the ship or aircraft. The ‘‘regular complement’’ 

includes the crew. In the case of a cruise ship, for example, it may 

also include others, such as entertainers, lecturers, etc., employed 

by the shipping company to serve on the ship throughout its voyage. The use of the term ‘‘regular complement’’ is intended to clarify that a person who exercises his employment as, for example, an 

insurance salesman while aboard a ship or aircraft is not covered 

by this paragraph. 

If a U.S. citizen who is resident in Iceland performs services as 

an employee in the United States and meets the conditions of paragraph 2 for source country exemption, he nevertheless is taxable in 

the United States by virtue of the saving clause of paragraph 4 of 

Article 1 (General Scope), subject to the special foreign tax credit 

rule of paragraph 4 of Article 22 (Relief from Double Taxation). 

ARTICLE 15 (DIRECTORS’ FEES)

This Article provides that a Contracting State may tax the fees 

and other compensation paid by a company that is a resident of 

that State for services performed by a resident of the other Contracting State in his capacity as a director of the company. This 

rule is an exception to the more general rules of Articles 7 (Business Profits) and 14 (Income from Employment). Thus, for example, 

in determining whether a director’s fee paid to a non-employee director is subject to tax in the country of residence of the corporation, it is not relevant to establish whether the fee is attributable 

to a permanent establishment in that State. 

Under this Article, a resident of one Contracting State who is a 

director of a corporation that is resident in the other Contracting 

State is subject to tax in that other State in respect of his directors’ 

fees regardless of where the services are performed. Under U.S. 

law, however, services performed by a nonresident may not be 

taxed unless they are performed in the United States (unless that 

nonresident is a U.S. citizen, and therefore subject to the saving 

clause of paragraph 4 of Article 1 (General Scope)). 

55 

ARTICLE 16 (ENTERTAINERS AND SPORTSMEN)

This Article deals with the taxation in a Contracting State of entertainers and sportsmen resident in the other Contracting State 

from the performance of their services as such. The Article applies 

both to the income of an entertainer or sportsman who performs 

services on his own behalf and one who performs services on behalf 

of another person, either as an employee of that person, or pursuant to any other arrangement. The rules of this Article take precedence, in some circumstances, over those of Articles 7 (Business 

Profits) and 14 (Income from Employment). 

This Article applies only with respect to the income of entertainers and sportsmen. Others involved in a performance or athletic event, such as producers, directors, technicians, managers, 

coaches, etc., remain subject to the provisions of Articles 7 and 14. 

In addition, except as provided in paragraph 2, income earned by 

juridical persons is not covered by Article 16. 

Paragraph 1 

Paragraph 1 describes the circumstances in which a Contracting 

State may tax the performance income of an entertainer or sportsman who is a resident of the other Contracting State. Under the 

paragraph, income derived by an individual resident of a Contracting State from activities as an entertainer or sportsman exercised in the other Contracting State may be taxed in that other 

State if the amount of the gross receipts derived by the performer 

exceeds $20,000 (or its equivalent in Icelandic kronur) for the taxable year. The $20,000 includes expenses reimbursed to the individual or borne on his behalf. If the gross receipts exceed $20,000, 

the full amount, not just the excess, may be taxed in the State of 

performance. 

The Convention introduces the monetary threshold to distinguish 

between two groups of entertainers and athletes—those who are 

paid relatively large sums of money for very short periods of service, and who would, therefore, normally be exempt from host country tax under the standard personal services income rules, and 

those who earn relatively modest amounts and are, therefore, not 

easily distinguishable from those who earn other types of personal 

service income. 

Tax may be imposed under paragraph 1 even if the performer 

would have been exempt from tax under Article 7 or 14. On the 

other hand. if the performer would be exempt from host-country 

tax under Article 16, but would be taxable under either Article 7 

or 14, tax may be imposed under either of those Articles. Thus, for 

example, if a performer derives remuneration from his activities in 

an independent capacity, and the performer does not have a permanent establishment in the host State, he may be taxed by the host 

State in accordance with Article 16 if his remuneration exceeds 

$20,000 annually, despite the fact that he generally would be exempt from host State taxation under Article 7. However, a performer who receives less than the $20,000 threshold amount and 

therefore is not taxable under Article 16 nevertheless may be subject to tax in the host country under Article 7 or 14 if the tests for 

host-country taxability under the relevant Article are met. For example, if an entertainer who is an independent contractor earns 

56 

$14,000 of income in a State for the calendar year, but the income 

is attributable to his permanent establishment in the State of performance, that State may tax his income under Article 7. 

Nothing shall preclude a Contracting State from withholding tax 

from such payments according to its domestic laws. However, if according to the provisions of this Article, such remuneration or income may only be taxed in the other Contracting State, the firstmentioned Contracting State shall make a refund of the tax so 

withheld upon a duly filed claim. Such claim must be filed with the 

tax authorities that have collected the withholding tax within five 

years after the close of the calendar year in which the tax was 

withheld. 

As explained in paragraph 9 of the Commentary to Article 17 of 

the OECD Model, Article 16 of the Convention applies to all income 

connected with a performance by the entertainer, such as appearance fees, award or prize money, and a share of the gate receipts. 

Income derived from a Contracting State by a performer who is a 

resident of the other Contracting State from other than actual performance, such as royalties from record sales and payments for 

product endorsements, is not covered by this Article, but by other 

articles of the Convention, such as Article 12 (Royalties) or Article 

7. For example, if an entertainer receives royalty income from the 

sale of live recordings, the royalty income would be subject to the 

provisions of Article 12, even if the performance was conducted in 

the source country, although the entertainer could be taxed in the 

source country with respect to income from the performance itself 

under Article 16 if the dollar threshold is exceeded. 

In determining whether income falls under Article 16 or another 

article, the controlling factor will be whether the income in question is predominantly attributable to the performance itself or to 

other activities or property rights. For instance, a fee paid to a performer for endorsement of a performance in which the performer 

will participate would be considered to be so closely associated with 

the performance itself that it normally would fall within Article 16. 

Similarly, a sponsorship fee paid by a business in return for the 

right to attach its name to the performance would be so closely associated with the performance that it would fall under Article 16 

as well. As indicated in paragraph 9 of the Commentary to Article 

17 of the OECD Model, however, a cancellation fee would not be 

considered to fall within Article 16 but would be dealt with under 

Article 7 or 14. 

As indicated in paragraph 4 of the Commentary to Article 17 of 

the OECD Model, where an individual fulfills a dual role as performer and non-performer (such as a player-coach or an actor-director), but his role in one of the two capacities is negligible, the predominant character of the individual’s activities should control the 

characterization of those activities. In other cases there should be 

an apportionment between the performance-related compensation 

and other compensation. 

Consistent with Article 14, Article 16 also applies regardless of 

the timing of actual payment for services. Thus, a bonus paid to 

a resident of a Contracting State with respect to a performance in 

the other Contracting State during a particular taxable year would 

be subject to Article 16 for that year even if it was paid after the 

close of the year. The determination as to whether the $20,000 

57 

threshold has been exceeded is determined separately with respect 

to each year of payment. Accordingly, if an actor who is a resident 

of one Contracting State receives residual payments over time with 

respect to a movie that was filmed in the other Contracting State, 

the payments do not have to be aggregated from one year to another to determine whether the total payments have finally exceeded $20,000. Otherwise, residual payments received many years 

later could retroactively subject all earlier payments to tax by the 

other Contracting State. Paragraph 2 

Paragraph 2 is intended to address the potential for circumvention of the rule in paragraph 1 when a performer’s income does not 

accrue directly to the performer himself, but to another person. 

Foreign performers frequently perform in the United States as employees of, or under contract with, a company or other person. 

The relationship may truly be one of employee and employer, 

with no circumvention of paragraph 1 either intended or realized. 

On the other hand, the ‘‘employer’’ may, for example, be a company 

established and owned by the performer, which is merely acting as 

the nominal income recipient in respect of the remuneration for the 

performance (a ‘‘star company’’). The performer may act as an ‘‘employee,’’ receive a modest salary, and arrange to receive the remainder of the income from his performance from the company in 

another form or at a later time. In such case, absent the provisions 

of paragraph 2, the income arguably could escape host-country tax 

because the company earns business profits but has no permanent 

establishment in that country. The performer may largely or entirely escape host-country tax by receiving only a small salary, perhaps small enough to place him below the dollar threshold in paragraph 1. The performer might arrange to receive further payments 

in a later year, when he is not subject to host-country tax, perhaps 

as dividends or liquidating distributions. 

Paragraph 2 seeks to prevent this type of abuse while at the 

same time protecting the taxpayers’ rights to the benefits of the 

Convention when there is a legitimate employee-employer relationship between the performer and the person providing his services. 

Under paragraph 2, when the income accrues to a person other 

than the performer, and the performer or related persons participate, directly or indirectly, in the receipts or profits of that other 

person, the income may be taxed in the Contracting State where 

the performer’s services are exercised, without regard to the provisions of the Convention concerning business profits or income from 

employment (Article 14). In cases where paragraph 2 is applicable, 

the income of the ‘‘employer’’ may be subject to tax in the host Contracting State even if it has no permanent establishment in the 

host country. Taxation under paragraph 2 is on the person providing the services of the performer. This paragraph does not affect 

the rules of paragraph 1, which applyto the performer himself. The 

income taxable by virtue of paragraph 2 is reduced to the extent 

of salary payments to the performer, which fall under paragraph 

1. 

For purposes of paragraph 2, income is deemed to accrue to another person (i.e., the person providing the services of the performer) if that other person has control over, or the right to receive, 

gross income in respect of the services of the performer. Direct or 

indirect participation in the profits of a person may include, but is 

58 

not limited to, the accrual or receipt of deferred remuneration, bonuses, fees, dividends, partnership income or other income or distributions. 

Paragraph 2 does not apply if it is established that neither the 

performer nor any persons related to the performer participate directly or indirectly in the receipts or profits of the person providing 

the services of the performer. Assume, for example, that a circus 

owned by a U.S. corporation performs in the other Contracting 

State, and promoters of the performance in the other State pay the 

circus, which, in turn, pays salaries to the circus performers. The 

circus is determined to have no permanent establishment in that 

State. Since the circus performers do not participate in the profits 

of the circus, but merely receive their salaries out of the circus’ 

gross receipts, the circus is protected by Article 7 and its income 

is not subject to host-country tax. Whether the salaries of the circus performers are subject to host-country tax under this Article 

depends on whether they exceed the $20,000 threshold in paragraph 1. 

Since pursuant to Article 1 (General Scope) the Convention only 

applies to persons who are residents of one of the Contracting 

States, income of the star company would not be eligible for benefits of the Convention if the company is not a resident of one of the 

Contracting States. 

Relationship to Other Articles 

This Article is subject to the provisions of the saving clause of 

paragraph 4 of Article 1 (General Scope). Thus, if an entertainer 

or a sportsman who is resident in the other Contracting State is 

a citizen of the United States, the United States may tax all of his 

income from performances in the United States without regard to 

the provisions of this Article, subject, however, to the special foreign tax credit provisions of paragraph 4 of Article 22 (Relief From 

Double Taxation). In addition, benefits of this Article are subject to 

the provisions of Article 21 (Limitation On Benefits). 

ARTICLE 17 (PENSIONS, SOCIAL SECURITY, AND ANNUITIES)

This Article deals with the taxation of private (i.e., non-government service) pensions, social security benefits, and annuities. 

Paragraph 1 

Paragraph 1 provides that distributions from pensions and other 

similar remuneration paid to a resident of a Contracting State in 

consideration of past employment are taxable only in the State of 

residence of the beneficiary. The term ‘‘pensions and other similar 

remuneration’’ includes both periodic and single sum payments. 

The phrase ‘‘pensions and other similar remuneration’’ is intended to encompass payments made by qualified private retirement plans. In the United States, the plans encompassed by Paragraph 1 include: qualified plans under section 401(a), individual retirement plans (including individual retirement plans that are part 

of a simplified employee pension plan that satisfies section 408(k), 

individual retirement accounts and section 408(p) accounts), section 

403(a) qualified annuity plans, and section 403(b) plans. Distributions from section 457 plans may also fall under Paragraph 1 if 

they are not paid with respect to government services covered by 

59 

Article 19. In Iceland, the term pension applies to any pension fund 

or pension plan qualified under the Pension Act or any identical or 

substantially similar schemes which are created under any law enacted after the signature of the Convention. The competent authorities may agree that distributions from other plans that generally meet similar criteria to those applicable to the listed plans 

also qualify for the benefits of Paragraph 1. 

Pensions in respect of government services covered by Article 18 

are not covered by this paragraph. They are covered either by paragraph 2 of this Article, if they are in the form of social security 

benefits, or by paragraph 2 of Article 18 (Government Service). 

Thus, Article 18 generally covers section 457(g), 401(a), 403(a), and 

403(b) plans established for government employees, including the 

Thrift Savings Plan (section 7701(j)). 

Paragraph 2 

The treatment of social security benefits is dealt with in paragraph 2. This paragraph provides that, notwithstanding the provision of paragraph 1 under which private pensions are taxable exclusively in the State of residence of the beneficial owner, payments made by one of the Contracting States under the provisions 

of its social security or similar legislation to a resident of Iceland 

or to a citizen of the United States will be taxable only in the Contracting State making the payment. The reference to U.S. citizens 

is necessary to ensure that a social security payment by Iceland to 

a U.S. citizen who is not resident in the United States will not be 

taxable by the United States. 

This paragraph applies to social security beneficiaries whether 

they have contributed to the system as private sector or Government employees. The phrase ‘‘similar legislation’’ is intended to 

refer to United States tier 1 Railroad Retirement benefits. 

Paragraph 3 

Under paragraph 3, annuities that are derived and beneficially 

owned by a resident of a Contracting State are taxable only in that 

State. An annuity, as the term is used in this paragraph, means 

a stated sum paid periodically at stated times during a specified 

number of years, under an obligation to make the payment in return for adequate and full consideration (other than for services 

rendered). An annuity received in consideration for services rendered would be treated as either deferred compensation that is taxable in accordance with Article 14 (Income from Employment) or a 

pension that is subject to the rules of paragraph 1. 

Paragraph 4 

Paragraph 4 provides that, if a resident of a Contracting State 

participates in a pension fund established in the other Contracting 

State, the State of residence will not tax the income of the pension 

fund with respect to that resident until a distribution is made from 

the pension fund. Thus, for example, if a U.S. citizen contributes 

to a U.S. qualified plan while working in the United States and 

then establishes residence in Iceland, paragraph 1 prevents Iceland 

from taxing currently the plan’s earnings and accretions with respect to that individual. When the resident receives a distribution 

60 

from the pension fund, that distribution may be subject to tax in 

the State of residence, subject to paragraph 1. 

Relationship to Other Articles 

Paragraphs 1 and 3 of Article 17 are subject to the saving clause 

of paragraph 4 of Article 1 (General Scope). Thus, a U.S. citizen 

who is resident in the other Contracting State, and receives either 

a pension, annuity or alimony payment from the United States, 

may be subject to U.S. tax on the payment, notwithstanding the 

rules in those three paragraphs that give the State of residence of 

the recipient the exclusive taxing right. Paragraphs 2 and 4 are excepted from the saving clause by virtue of subparagraph 5(a) of Article 1. Thus, the United States will not tax U.S. citizens and residents on the income described in those paragraphs even if such 

amounts otherwise would be subject to tax under U.S. law. 

ARTICLE 18 (GOVERNMENT SERVICE)

Paragraph 1 

Subparagraphs 1(a) and 1(b) deal with the taxation of government compensation (other than a pension addressed in paragraph 

2). Subparagraph 1(a) provides that remuneration paid from the 

public funds of a Contracting State or its political subdivisions or 

local authorities to any individual who is rendering services to that 

State, political subdivision or local authority,which are in the discharge of governmental functions, is exempt from tax by the other 

State. Under subparagraph 1(b), such payments are, however, taxable exclusively in the other State (i.e., the host State) if the services are rendered in that other State and the individual is a resident of that State who is either a national of that State or a person 

who did not become resident of that State solely for purposes of 

rendering the services. The paragraph applies to anyone performing services for a government, whether as a government employee, an independent contractor, or an employee of an independent contractor. 

Paragraph 2 

Paragraph 2 deals with the taxation of pensions paid by, or out 

of funds created by, one of the States, or a political subdivision or 

a local authority thereof, to an individual in respect of services rendered in the discharge of functions of a governmental nature to 

that State or subdivision or authority. Subparagraph 1(a) provides 

that such pensions are taxable only in that State. Subparagraph 

1(b) provides an exception under which such pensions are taxable 

only in the other State if the individual is a resident of, and a national of, that other State. 

Pensions paid to retired civilian and military employees of a Government of either State are intended to be covered under paragraph 2. When benefits paid by a State in respect of services rendered to that State or a subdivision or authority are in the form 

of social security benefits, however, those payments are covered by 

paragraph 2 of Article 17 (Pensions, Social Security, Annuities, Alimony, and Child Support). As a general matter, the result will be 

the same whether Article 17 or 19 applies, since social security 

benefits are taxable exclusively by the source country and so are 

61 

government pensions. The result will differ only when the payment 

is made to a citizen and resident of the other Contracting State, 

who is not also a citizen of the paying State. In such a case, social 

security benefits continue to be taxable at source while government 

pensions become taxable only in the residence country. 

Paragraph 3 

Paragraph 3 provides that the remuneration described in paragraph 1 will be subject to the rules of Articles 14 (Income from Employment), 15 (Directors’ Fees), 16 (Entertainers and Sportsmen) or 

17 if the recipient of the income is employed by a business conducted by a government. 

Relationship to Other Articles 

Under subparagraph 5(b) of Article 1 (General Scope), the saving 

clause (paragraph 4 of Article 1) does not apply to the benefits conferred by one of the States under Article 18 if the recipient of the 

benefits is neither a citizen of that State, nor a person who has 

been admitted for permanent residence there (i.e., in the United 

States, a ‘‘green card’’ holder). Thus, a resident of a Contracting 

State who in the course of performing functions of a governmental 

nature becomes a resident of the other State (but not a permanent 

resident), would be entitled to the benefits of this Article. Similarly, 

an individual who receives a pension paid by the Government of 

Iceland in respect of services rendered to the Government of Iceland shall be taxable on this pension only in Iceland unless the individual is a U.S. citizen or acquires a U.S. green card. 

ARTICLE 19 (STUDENTS AND TRAINEES)

This Article provides rules for host-country taxation of visiting 

students and business trainees. Persons who meet the tests of the 

Article will be exempt from tax in the State that they are visiting 

with respect to designated classes of income. Several conditions 

must be satisfied in order for an individual to be entitled to the 

benefits of this Article. 

Paragraph 1 

Paragraph 1 provides that an individual who is a resident of one 

Contracting State at the time he becomes temporarily present in 

the other Contracting State and who is temporarily present therein 

for the primary purpose of studying at a university or other recognized educational institution in that other Contracting State, securing training required to qualify him to practice a profession or professional specialty, or studying or doing research as a recipient of 

a grant, allowance, or award from a governmental, religious, charitable, scientific, literary, or educational organization, will be exempt from tax by that other Contracting State for a period not exceeding five taxable years from the date of his arrival in that other 

Contracting State on: 

(1) Gifts from abroad for the purpose of his maintenance, 

education, study, research or training; 

(2) The grant, allowance, or award; and 

62 

(3) Income from personal services performed in the other Contracting State not in excess of $9,000 or its equivalent in 

Icelandic kronur for any taxable year. 

Paragraph 2 

Under paragraph 2, an individual who is a resident of one Contracting State at the time he becomes temporarily present in the 

other Contracting State and who is temporarily present therein as 

an employee of, or under contract with, a resident of the first-mentioned Contracting State, for the primary purpose of acquiring 

technical, professional, or business experience from a person other 

than that resident of the first-mentioned Contracting State or other 

than a person related to such resident, or studying at a university 

or other recognized educational institution in that other Contracting State, will be exempt from tax by that other Contracting 

State for a period of twelve consecutive months on income from 

personal services not in excess of $9,000 or its equivalent in Icelandic kronur. 

Paragraph 3 

Paragraph 3 provides an exemption for residents of one Contracting State who become temporarily present in the other Contracting State for purposes of training, research or study in a program sponsored by the other Contracting State. The exemption is 

available to an individual who is a resident of one Contracting 

State at the time he becomes temporarily present in the other Contracting State and who is temporarily present in that other Contracting State for a period not exceeding one year, as a participant 

in a program sponsored by the other Contracting State, for the primary purpose of training, research, or study. A person meeting 

these requirements will be exempt from tax by the other Contracting State with respect to his income from personal services in 

respect of such training, research, or study performed in that other 

Contracting State in an aggregate amount not in excess of $9,000 

or its equivalent in Icelandic kronur. 

Relationship to Other Articles 

The saving clause of paragraph 4 of Article 1 (General Scope) 

does not apply to this Article with respect to an individual who is 

neither a citizen of the host State nor an individual who has been 

admitted for permanent residence there. The saving clause, however, does apply with respect to citizens and permanent residents 

of the host State. Thus, a U.S. citizen who is a resident of Iceland 

and who visits the United States as a full-time student at an accredited university will not be exempt from U.S. tax on remittances 

from abroad that otherwise constitute U.S. taxable income. An individual, however, who is not a U.S. citizen, and who visits the 

United States as a student and remains long enough to become a 

resident under U.S. law, but does not become a permanent resident 

(i.e., does not acquire a green card), will be entitled to the full benefits of the Article. 

ARTICLE 20 (OTHER INCOME)

Article 20 generally assigns taxing jurisdiction over income not 

dealt with in the other articles (Articles 6 (Income from Immovable 

63 

Property (Real Property)) through 19 (Students and Trainees)) of 

the Convention to the State of residence of the beneficial owner of 

the income. In order for an item of income to be ‘‘dealt with’’ in another article it must be the type of income described in the article 

and, in most cases, it must have its source in a Contracting State. 

For example, all royalty income that arises in a Contracting State 

and that is beneficially owned by a resident of the other Contracting State is ‘‘dealt with’’ in Article 12 (Royalties). However, 

profits derived in the conduct of a business are ‘‘dealt with’’ in Article 7 (Business Profits) whether or not they have their source in 

one of the Contracting States. 

Examples of items of income covered by Article 20 include income 

from gambling, punitive (but not compensatory) damages and covenants not to compete. The article would also apply to income from 

a variety of financial transactions, where such income does not 

arise in the course of the conduct of a trade or business. For example, income from notional principal contracts and other derivatives 

would fall within Article 20 if derived by persons not engaged in 

the trade or business of dealing in such instruments, unless such 

instruments were being used to hedge risks arising in a trade or 

business. It would also apply to securities lending fees derived by 

an institutional investor. Further, in most cases guarantee fees 

paid within an intercompany group would be covered by Article 20, 

unless the guarantor were engaged in the business of providing 

such guarantees to unrelated parties. 

Article 20 also applies to items of income that are not dealt with 

in the other articles because of their source or some other characteristic. For example, Article 11 (Interest) addresses only the taxation of interest arising in a Contracting State. Interest arising in 

a third State that is not attributable to a permanent establishment, therefore, is subject to Article 20. 

Distributions from partnerships are not generally dealt with 

under Article 20 because partnership distributions generally do not 

constitute income. Under the Code, partners include in income 

their distributive share of partnership income annually, and partnership distributions themselves generally do not give rise to income. This would also be the case under U.S. law with respect to 

distributions from trusts. Trust income and distributions that, 

under the Code, have the character of the associated distributable 

net income would generally be covered by another article of the 

Convention. See Code section 641 et seq. 

Paragraph 1 

The general rule of Article 20 is contained in paragraph 1. Items 

of income not dealt with in other articles and beneficially owned by 

a resident of a Contracting State will be taxable only in the State 

of residence. This exclusive right of taxation applies whether or not 

the residence State exercises its right to tax the income covered by 

the Article. 

The reference in this paragraph to ‘‘items of income beneficially 

owned by a resident of a Contracting State’’ rather than simply 

‘‘items of income of a resident of a Contracting State,’’ as in the 

OECD Model, is intended merely to make explicit the implicit understanding in other treaties that the exclusive residence taxation 

provided by paragraph 1 applies only when a resident of a ConVerDate Aug 31 2005 15:57 Sep 15, 2008 Jkt 000000 PO 00000 Frm 00063 Fmt 6659 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-17.TXT sfrela2 PsN: MIKEB
64 

tracting State is the beneficial owner of the income. Thus, source 

taxation of income not dealt with in other articles of the Convention is not limited by paragraph 1 if it is nominally paid to a resident of the other Contracting State, but is beneficially owned by a 

resident of a third State. However, income received by a nominee 

on behalf of a resident of that other State would be entitled to benefits. 

The term ‘‘beneficially owned’’ is not defined in the Convention, 

and is, therefore, defined as under the internal law of the country 

imposing tax (i.e., the source country). The person who beneficially 

owns the income for purposes of Article 20 is the person to which 

the income is attributable for tax purposes under the laws of the 

source State. 

Paragraph 2 

This paragraph provides an exception to the general rule of paragraph 1 for income that is attributable to a permanent establishment maintained in a Contracting State by a resident of the other 

Contracting State. The taxation of such income is governed by the 

provisions of Article 7 (Business Profits). Therefore, income arising 

outside the United States that is paid in respect of a right or property that is effectively connected with a permanent establishment 

maintained in the United States by a resident of Iceland generally 

would be taxable by the United States under the provisions of Article 7. This would be true even if the income is sourced in a third 

state. 

Relationship to Other Articles 

This Article is subject to the saving clause of paragraph 4 of Article 1 (General Scope). Thus, the United States may tax the income 

of a resident of Iceland that is not dealt with elsewhere in the Convention, if that resident is a citizen of the United States. The Article is also subject to the provisions of Article 21 (Limitation On 

Benefits). Thus, if a resident of Iceland earns income that falls 

within the scope of paragraph 1 of Article 21, but that is taxable 

by the United States under U.S. law, the income would be exempt 

from U.S. tax under the provisions of Article 20 only if the resident 

satisfies one of the tests of Article 21 for entitlement to benefits. 

ARTICLE 21 (LIMITATION ON BENEFITS)

Article 21 contains anti-treaty-shopping provisions that are intended to prevent residents of third countries from benefiting from 

what is intended to be a reciprocal agreement between two countries. In general, the provision does not rely on a determination of 

purpose or intention but instead sets forth a series of objective 

tests. A resident of a Contracting State that satisfies one of the 

tests will receive benefits regardless of its motivations in choosing 

its particular business structure. 

The structure of the Article is as follows: Paragraph 1 states the 

general rule that residents are entitled to benefits otherwise accorded to residents only to the extent provided in the Article. Paragraph 2 lists a series of attributes of a resident of a Contracting 

State, the presence of any one of which will entitle that person to 

all the benefits of the Convention. Paragraph 3 provides a so-called 

‘‘derivative benefits’’ test under which certain categories of income 

65 

may qualify for benefits. Paragraph 4 provides that, regardless of 

whether a person qualifies for benefits under paragraph 2, benefits 

may be granted to that person with regard to certain income 

earned in the conduct of an active trade or business. Paragraph 5 

provides special rules for so-called ‘‘triangular cases’’ notwithstanding the other provisions of Article 21. Paragraph 6 provides 

special rules for income from so-called ‘‘disproportionate shares’’ 

notwithstanding the other provisions of Article 21. Paragraph 7 

provides that benefits also may be granted if the competent authority of the State from which benefits are claimed determines that it 

is appropriate to provide benefits in that case. Paragraph 8 defines 

certain terms used in the Article. 

Paragraph 1 

Paragraph 1 provides that a resident of a Contracting State will 

be entitled to the benefits otherwise accorded to residents of a Contracting State under the Convention only to the extent provided in 

the Article. The benefits otherwise accorded to residents under the 

Convention include all limitations on source-based taxation under 

Articles 6 (Income from Immovable Property (Real Property) 

through 20 (Other Income), the treaty-based relief from double taxation provided by Article 22 (Relief from Double Taxation), and the 

protection afforded to residents of a Contracting State under Article 23 (Non-Discrimination). Some provisions do not require that a 

person be a resident in order to enjoy the benefits of those provisions. Article 24 (Mutual Agreement Procedure) is not limited to 

residents of the Contracting States, and Article 26 (Members of 

Diplomatic Missions and Consular Posts) applies to diplomatic 

agents or consular officials regardless of residence. Article 21 accordingly does not limit the availability of treaty benefits under 

these provisions. 

Article 21 and the anti-abuse provisions of domestic law complement each other, as Article 21 effectively determines whether an 

entity has a sufficient nexus to the Contracting State to be treated 

as a resident for treaty purposes, while domestic anti-abuse provisions (e.g., business purpose, substance-over-form, step transaction 

or conduit principles) determine whether a particular transaction 

should be recast in accordance with its substance. Thus, internal 

law principles of the source Contracting State may be applied to 

identify the beneficial owner of an item of income, and Article 21 

then will be applied to the beneficial owner to determine if that 

person is entitled to the benefits of the Convention with respect to 

such income. 

Paragraph 2 

Paragraph 2 has five subparagraphs, each of which describes a 

category of residents that are entitled to all benefits of the Convention. 

It is intended that the provisions of paragraph 2 will be self executing. Unlike the provisions of paragraph 7, discussed below, 

claiming benefits under paragraph 2 does not require advance competent authority ruling or approval. The tax authorities may, of 

course, on review, determine that the taxpayer has improperly interpreted the paragraph and is not entitled to the benefits claimed. 

66 

Individuals—Subparagraph 2(a) 

Subparagraph 2(a) provides that individual residents of a Contracting State will be entitled to all treaty benefits. If such an individual receives income as a nominee on behalf of a third country 

resident, benefits may be denied under the respective articles of 

the Convention by the requirement that the beneficial owner of the 

income be a resident of a Contracting State. 

Governments—Subparagraph 2(b) 

Subparagraph 2(b) provides that the Contracting States and any 

political subdivision or local authority thereof will be entitled to all 

benefits of the Convention. 

Publicly-Traded Corporations—Subparagraph 2(c)(i) 

Subparagraph 2(c) applies to two categories of companies: publicly traded companies and subsidiaries of publicly traded companies. A company resident in a Contracting State is entitled to all 

the benefits of the Convention under clause (i) of subparagraph 2(c) 

if the principal class of its shares is regularly traded on one or 

more recognized stock exchanges and the company satisfies at least 

one of the following additional requirements: first, the company’s 

principal class of shares is primarily traded on one or more recognized stock exchanges located in the Contracting State of which the 

company is a resident; or, second, the company’s primary place of 

management and control is in its State of residence. 

The term ‘‘recognized stock exchange’’ is defined in subparagraph 

8(b). It includes (i) the NASDAQ System and any stock exchange 

registered with the Securities and Exchange Commission as a national securities exchange for purposes of the Securities Exchange 

Act of 1934; (ii) the Icelandic Stock Exchange; (iii) the stock exchanges of Amsterdam, Brussels, Copenhagen, Frankfurt, Hamburg, Helsinki, London, Oslo, Paris, Stockholm, Sydney, Tokyo, and 

Toronto; and (iv) any other stock exchange agreed upon by the competent authorities of the Contracting States. 

If a company has only one class of shares, it is only necessary 

to consider whether the shares of that class meet the relevant trading requirements. If the company has more than one class of 

shares, it is necessary as an initial matter to determine which class 

or classes constitute the ‘‘principal class of shares’’. The term ‘‘principal class of shares’’ is defined in subparagraph 8(a) to mean the 

ordinary or common shares of the company representing the majority of the aggregate voting power and value of the company. If the 

company does not have a class of ordinary or common shares representing the majority of the aggregate voting power and value of 

the company, then the ‘‘principal class of shares’’ is that class or 

any combination of classes of shares that represents, in the aggregate, a majority of the voting power and value of the company. Although in a particular case involving a company with several classes of shares it is conceivable that more than one group of classes 

could be identified that account for more than 50% of the shares, 

it is only necessary for one such group to satisfy the requirements 

of this subparagraph in order for the company to be entitled to benefits. Benefits would not be denied to the company even if a second, 

non-qualifying, group of shares with more than half of the company’s voting power and value could be identified. 

67 

The term ‘‘regularly traded’’ is not defined in the Convention. In 

accordance with paragraph 2 of Article 3 (General Definitions), this 

term will be defined by reference to the domestic tax laws of the 

State from which treaty benefits are sought, generally the source 

State. In the case of the United States, this term is understood to 

have the meaning it has under Treas. Reg. section 1. 884– 

5(d)(4)(i)(B), relating to the branch tax provisions of the Code. 

Under these regulations, a class of shares is considered to be ‘‘regularly traded’’ if two requirements are met: trades in the class of 

shares are made in more than de minimis quantities on at least 60 

days during the taxable year, and the aggregate number of shares 

in the class traded during the year is at least 10 percent of the average number of shares outstanding during the year. Sections 

1.884–5(d)(4)(i)(A), (ii) and (iii) will not be taken into account for 

purposes of defining the term ‘‘regularly traded’’ under the Convention. 

The regular trading requirement can be met by trading on any 

recognized exchange or exchanges located in either State. Trading 

on one or more recognized stock exchanges may be aggregated for 

purposes of this requirement. Thus, a U.S. company could satisfy 

the regularly traded requirement through trading, in whole or in 

part, on a recognized stock exchange located in Iceland. Authorized 

but unissued shares are not considered for purposes of this test. 

The term ‘‘primarily traded’’ is not defined in the Convention. In 

accordance with paragraph 2 of Article 3, this term will have the 

meaning it has under the laws of the State concerning the taxes 

to which the Convention applies, generally the source State. In the 

case of the United States, this term is understood to have the 

meaning it has under Treas. Reg. section 1.884–5(d)(3), relating to 

the branch tax provisions of the Code. Accordingly, stock of a corporation is ‘‘primarily traded’’ if the number of shares in the company’s principal class of shares that are traded during the taxable 

year on all recognized stock exchanges in the Contracting State of 

which the company is a resident exceeds the number of shares in 

the company’s principal class of shares that are traded during that 

year on established securities markets in any other single foreign 

country. 

A company whose principal class of shares is regularly traded on 

a recognized exchange but cannot meet the primarily traded test 

may claim treaty benefits if its primary place of management and 

control is in its country of residence. This test should be distinguished from the ‘‘place of effective management’’ test which is 

used in the OECD Model and by many other countries to establish 

residence. In some cases, the place of effective management test 

has been interpreted to mean the place where the board of directors meets. By contrast, the primary place of management and control test looks to where day-to-day responsibility for the management of the company (and its subsidiaries) is exercised. The company’s primary place of management and control will be located in 

the State in which the company is a resident only if the executive 

officers and senior management employees exercise day-to-day responsibility for more of the strategic, financial and operational policy decision making for the company (including direct and indirect 

subsidiaries) in that State than in the other State or any third 

state, and the staff that support the management in making those 

68 

decisions are also based in that State. Thus, the test looks to the 

overall activities of the relevant persons to see where those activities are conducted. In most cases, it will be a necessary, but not 

a sufficient, condition that the headquarters of the company (that 

is, the place at which the Chief Executive Officer and other top executives normally are based) be located in the Contracting State of 

which the company is a resident. 

To apply the test, it will be necessary to determine which persons 

are to be considered ‘‘executive officers and senior management employees’’. In most cases, it will not be necessary to look beyond the 

executives who are members of the Board of Directors (the ‘‘inside 

directors’’) in the case of a U.S. company. That will not always be 

the case, however; in fact, the relevant persons may be employees 

of subsidiaries if those persons make the strategic, financial and 

operational policy decisions. Moreover, it would be necessary to 

take into account any special voting arrangements that result in 

certain board members making certain decisions without the participation of other board members. 

Subsidiaries of Publicly-Traded Corporations—Subparagraph 2(c)(ii) 

A company resident in a Contracting State is entitled to all the 

benefits of the Convention under clause (ii) of subparagraph 2(c) if 

five or fewer publicly traded companies described in clause (i) are 

the direct or indirect owners of at least 50 percent of the aggregate 

vote and value of the company’s shares. If the publicly-traded companies are indirect owners, however, each of the intermediate companies must be a resident of one of the Contracting States. 

Thus, for example, a company that is a resident of Iceland, all 

the shares of which are owned by another company that is a resident of Iceland, would qualify for benefits under the Convention if 

the principal class of shares of the parent company are regularly 

and primarily traded on a recognized stock exchange in Iceland. 

However, such a subsidiary would not qualify for benefits under 

clause (ii) if the publicly traded parent company were a resident of 

a third state, for example, and not a resident of the United States 

or Iceland. Furthermore, if a parent company in Iceland indirectly 

owned the bottom-tier company through a chain of subsidiaries, 

each such subsidiary in the chain, as an intermediate owner, must 

be a resident of the United States or Iceland in order for the subsidiary to meet the test in clause (ii). 

Tax Exempt Organizations—Subparagraph 2(d) 

Subparagraph 2(d) provides rules by which the tax exempt organizations described in paragraph 2 of Article 4 (Resident) will be 

entitled to all the benefits of the Convention. A pension scheme described in paragraph 2(a) of Article 4 or an employee benefits plan 

described in paragraph 2(b) of Article 4 will qualify for benefits if 

more than fifty percent of the beneficiaries, members or participants of the organization are individuals resident in either Contracting State. For purposes of this provision, the term ‘‘beneficiaries’’ should be understood to refer to the persons receiving 

benefits from the organization. On the other hand, an organization 

resident in a Contracting State that is established exclusively for 

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69 

poses automatically qualifies for benefits, without regard to the residence of its beneficiaries or members. 

Ownership/Base Erosion—Subparagraph 2(e) 

Subparagraph 2(e) provides an additional method to qualify for 

treaty benefits that applies to any form of legal entity that is a 

resident of a Contracting State. The test provided in subparagraph 

2(e), the so-called ownership and base erosion test, is a two-part 

test. Both prongs of the test must be satisfied for the resident to 

be entitled to treaty benefits under subparagraph 2(e). 

The ownership prong of the test, under clause (i), requires that 

50 percent or more of each class of shares or other beneficial interests in the person is owned, directly or indirectly, on at least half 

the days of the person’s taxable year by persons who are residents 

of the Contracting State of which that person is a resident and that 

are themselves entitled to treaty benefits under subparagraphs 

2(a), 2(b), 2(d) or clause (i) of subparagraph 2(c). In the case of indirect owners, however, each of the intermediate owners must be a 

resident of that Contracting State. 

Trusts may be entitled to benefits under this provision if they 

are treated as residents under Article 4 and they otherwise satisfy 

the requirements of this subparagraph. For purposes of this subparagraph, the beneficial interests in a trust will be considered to 

be owned by its beneficiaries in proportion to each beneficiary’s actuarial interest in the trust. The interest of a remainder beneficiary will be equal to 100 percent less the aggregate percentages 

held by income beneficiaries. A beneficiary’s interest in a trust will 

not be considered to be owned by a person entitled to benefits 

under subparagraphs 2(a), 2(b), 2(d) or clause (i) of subparagraph 

2(c) if it is not possible to determine the beneficiary’s actuarial interest. Consequently, if it is not possible to determine the actuarial 

interest of the beneficiaries in a trust, the ownership test under 

clause i) cannot be satisfied, unless all possible beneficiaries are 

persons entitled to benefits under subparagraphs 2(a), 2(b), 2(d) or 

clause (i) of subparagraph 2(c) . 

The base erosion prong of clause (ii) of subparagraph 2(e) is satisfied with respect to a person if less than 50 percent of the person’s gross income for the taxable year, as determined under the 

tax law in the person’s State of residence, is paid or accrued, directly or indirectly, to persons who are not residents of either Contracting State entitled to benefits under subparagraphs 2(a), 2(b), 

2(d) or clause (i) of subparagraph 2(c), in the form of payments deductible for tax purposes in the payer’s State of residence. These 

amounts do not include arm’s-length payments in the ordinary 

course of business for services or tangible property, or payments in 

respect of financial obligations to a bank, provided that where such 

a bank is not a resident of a Contracting State, such payment is 

attributable to a permanent establishment of that bank located in 

one of the Contracting States. To the extent they are deductible 

from the taxable base, trust distributions are deductible payments. 

However, depreciation and amortization deductions, which do not 

represent payments or accruals to other persons, are disregarded 

for this purpose. 

70 

Paragraph 3 

Paragraph 3 sets forth a derivative benefits test that is potentially applicable to all treaty benefits, although the test is applied 

to individual items of income. In general, a derivative benefits test 

entitles the resident of a Contracting State to treaty benefits if the 

owner of the resident would have been entitled to the same benefit 

had the income in question flowed directly to that owner. To qualify under this paragraph, the company must meet an ownership 

test and a base erosion test. 

Clause (i) of subparagraph 3(a) sets forth the ownership test. 

Under this test, at least 95 percent of the aggregate voting power 

and value of the shares of the company must be owned by seven 

or fewer persons that are residents of Member States of the European Union, or of the European Economic Area, or parties to the 

North American Free Trade Agreement or the European Free 

Trade Agreement. Ownership may be direct or indirect. To be considered a resident of Member States of the European Union, or of 

the European Economic Area, or parties to the North American 

Free Trade Agreement or the European Free Trade Agreement for 

purposes of paragraph 3, a person must meet the requirements of 

subparagraph 3(b). These requirements may be met in two alternative ways. 

Under one alternative, a person may be treated as a resident of 

Member States of the European Union, or of the European Economic Area, or parties to the North American Free Trade Agreement or the European Free Trade Agreement because it is entitled 

to equivalent benefits under a treaty between the country of source 

and the country in which the person is a resident. To satisfy this 

requirement, the person must be entitled to all the benefits of a 

comprehensive income tax convention in force between the Contracting State from which benefits of the Convention are claimed 

and a qualifying state under provisions that are analogous to the 

rules in subparagraphs 2(a), 2(b), 2(d) and clause (i) of subparagraph 2(c). If the treaty in question does not have a comprehensive 

limitation on benefits article, this requirement is met only if the 

person would be entitled to treaty benefits under the tests in subparagraphs 2(a), 2(b), 2(d) and clause (i) of subparagraph 2(c) of 

this Article if the person were a resident of one of the Contracting 

States. 

In order to satisfy this alternative with respect to dividends, interest, royalties or branch tax, the person must be entitled to a rate 

of tax that is at least as low as the tax rate that would apply under 

the Convention to such income. Thus, the rates to be compared are: 

(1) the rate of tax that the source State would have imposed if a 

qualified resident of the other Contracting State was the beneficial 

owner of the income; and (2) the rate of tax that the source State 

would have imposed if the third State resident received the income 

directly from the source State. For example, USCo is a wholly 

owned subsidiary of IceCo, a company resident in Iceland. IceCo is 

wholly owned by CanCo, a corporation resident in Canada. Assuming IceCo satisfies the requirements of paragraph 2 of Article 10 

(Dividends), IceCo would be eligible for a dividend withholding tax 

rate of 5 percent. The dividend withholding tax rate in the treaty 

between the United States and Canada is also 5 percent. Thus, if 

CanCo received the dividend directly from USCo, CanCo would 

71 

have been subject to a 5 percent rate of withholding tax on the dividend. Because CanCo would be entitled to a rate of withholding 

tax that is at least as low as the rate that would apply under the 

Convention to such income, CanCo is treated as a resident of Member States of the European Union, or of the European Economic 

Area, or parties to the North American Free Trade Agreement or 

the European Free Trade Agreement with respect to the elimination of withholding tax on dividends. 

The requirement that a person be entitled to ‘‘all the benefits’’ of 

a comprehensive tax treaty eliminates those persons that qualify 

for benefits with respect to only certain types of income. Accordingly, the fact that a Canadian parent of an Icelandic company is 

engaged in the active conduct of a trade or business in Canada and 

therefore would be entitled to the benefits of the U. S.-Canada treaty if it received dividends directly from a U.S. subsidiary of the Icelandic company is not sufficient for purposes of this paragraph. 

Further, the Canadian company cannot be an equivalent beneficiary if it qualifies for benefits only with respect to certain income 

as a result of a ‘‘derivative benefits’’ provision in the U.S.-Canada 

treaty. 

However, it would be possible to look through the Canadian company to its parent company to determine whether the parent company is an equivalent beneficiary. 

The second alternative requirement for treatment as a resident 

of Member States of the European Union, or of the European Economic Area, or parties to the North American Free Trade Agreement or the European Free Trade Agreement is available only to 

residents of one of the two Contracting States. U.S. or Icelandic 

residents who are eligible for treaty benefits by reason of subparagraphs 2(a), 2(b), 2(d) or clause (i) of subparagraph 2(c) are treated 

as residents of Member States of the European Union, or of the European Economic Area, or parties to the North American Free 

Trade Agreement or the European Free Trade Agreement under 

the second alternative. Thus, an Icelandic individual will qualify 

without regard to whether the individual would have been entitled 

to receive the same benefits if it received the income directly. A 

resident of a third country cannot qualify for treaty benefits under 

any of those subparagraphs or any other rule of the treaty, and 

therefore does not qualify under this alternative. Thus, a resident 

of a third country will be treated as a resident of Member States 

of the European Union, or of the European Economic Area, or parties to the North American Free Trade Agreement or the European 

Free Trade Agreement only if it would have been entitled to equivalent benefits had it received the income directly. 

The second alternative was included in order to clarify that ownership by certain residents of a Contracting State would not disqualify a U.S. or Icelandic company under this paragraph. Thus, 

for example, if 90 percent of an Icelandic company is owned by five 

companies that are resident in member states of the European 

Union who satisfy the requirements of clause (ii), and 10 percent 

of the Icelandic company is owned by a U.S. or Icelandic individual, 

then the Icelandic company still can satisfy the requirements of 

subparagraph 3(b). 

Clause (ii) of subparagraph 3(a) sets forth the base erosion test. 

A company meets this base erosion test if less than 50 percent of 

72 

its gross income (as determined in the company’s State of residence) for the taxable period is paid or accrued, directly or indirectly, to a person or persons who are not residents of Member 

States of the European Union, or of the European Economic Area, 

or parties to the North American Free Trade Agreement or the European Free Trade Agreement in the form of payments deductible 

for tax purposes in company’s State of residence. 

Paragraph 4 

Paragraph 4 sets forth an alternative test under which a resident 

of a Contracting State may receive treaty benefits with respect to 

certain items of income that are connected to an active trade or 

business conducted in its State of residence. A resident of a Contracting State may qualify for benefits under paragraph 4 whether 

or not it also qualifies under paragraph 2 or 3. 

Subparagraph 4(a) sets forth the general rule that a resident of 

a Contracting State engaged in the active conduct of a trade or 

business in that State may obtain the benefits of the Convention 

with respect to an item of income derived in the other Contracting 

State. The item of income, however, must be derived in connection 

with or incidental to that trade or business. 

The term ‘‘trade or business’’ is not defined in the Convention. 

Pursuant to paragraph 2 of Article 3 (General Definitions), when 

determining whether a resident of Iceland is entitled to the benefits of the Convention under paragraph 3 of this Article with respect to an item of income derived from sources within the United 

States, the United States will ascribe to this term the meaning 

that it has under the law of the United States. Accordingly, the 

U.S. competent authority will refer to the regulations issued under 

section 3 67(a) for the definition of the term ‘‘trade or business.’’ 

In general, therefore, a trade or business will be considered to be 

a specific unified group of activities that constitute or could constitute an independent economic enterprise carried on for profit. 

Furthermore, a corporation generally will be considered to carry on 

a trade or business only if the officers and employees of the corporation conduct substantial managerial and operational activities. 

The business of making or managing investments for the resident’s own account will be considered to be a trade or business only 

when part of banking, insurance or securities activities conducted 

by a bank, an insurance company, or a registered securities dealer. 

Such activities conducted by a person other than a bank, insurance 

company or registered securities dealer will not be considered to be 

the conduct of an active trade or business, nor would they be considered to be the conduct of an active trade or business if conducted 

by a bank, insurance company or registered securities dealer but 

not as part of the company’s banking, insurance or dealer business. 

Because a headquarters operation is in the business of managing 

investments, a company that functions solely as a headquarters 

company will not be considered to be engaged in an active trade or 

business for purposes of paragraph 3. 

An item of income is derived in connection with a trade or business if the income-producing activity in the State of source is a line 

of business that ‘‘forms a part of’’ or is ‘‘complementary’’ to the 

trade or business conducted in the State of residence by the income 

recipient. 

73 

A business activity generally will be considered to form part of 

a business activity conducted in the State of source if the two activities involve the design, manufacture or sale of the same products or type of products, or the provision of similar services. The 

line of business in the State of residence may be upstream, downstream, or parallel to the activity conducted in the State of source. 

Thus, the line of business may provide inputs for a manufacturing 

process that occurs in the State of source, may sell the output of 

that manufacturing process, or simply may sell the same sorts of 

products that are being sold by the trade or business carried on in 

the State of source. 

Example 1. USCo is a corporation resident in the United States. 

USCo is engaged in an active manufacturing business in the 

United States. USCo owns 100 percent of the shares of ICo, a corporation resident in Iceland. ICo distributes USCo products in Iceland. Since the business activities conducted by the two corporations involve the same products, ICo’s distribution business is considered to form a part of USCo’s manufacturing business. 

Example 2. The facts are the same as in Example 1, except that 

USCo does not manufacture. Rather, USCo operates a large research and development facility in the United States that licenses 

intellectual property to affiliates worldwide, including ICo. ICo and 

other USCo affiliates then manufacture and market the USCo-designed products in their respective markets. Since the activities 

conducted by ICo and USCo involve the same product lines, these 

activities are considered to form a part of the same trade or business. 

For two activities to be considered to be ‘‘complementary,’’ the activities need not relate to the same types of products or services, 

but they should be part of the same overall industry and be related 

in the sense that the success or failure of one activity will tend to 

result in success or failure for the other. Where more than one 

trade or business is conducted in the State of source and only one 

of the trades or businesses forms a part of or is complementary to 

a trade or business conducted in the State of residence, it is necessary to identify the trade or business to which an item of income 

is attributable. Royalties generally will be considered to be derived 

in connection with the trade or business to which the underlying 

intangible property is attributable. Dividends will be deemed to be 

derived first out of earnings and profits of the treaty-benefited 

trade or business, and then out of other earnings and profits. Interest income may be allocated under any reasonable method consistently applied. A method that conforms to U.S. principles for expense allocation will be considered a reasonable method. 

Example 3. Americair is a corporation resident in the United 

States that operates an international airline. IceSub is a whollyowned subsidiary of Americair resident in Iceland. IceSub operates 

a chain of hotels in Iceland that are located near airports served 

by Americair flights. Americair frequently sells tour packages that 

include air travel to Iceland and lodging at Ice Sub hotels. Although both companies are engaged in the active conduct of a trade 

or business, the businesses of operating a chain of hotels and operating an airline are distinct trades or businesses. Therefore 

IceSub’s business does not form a part of Americair’s business. 

74 

However, IceSub’s business is considered to be complementary to 

Americair’s business because they are part of the same overall industry (travel) and the links between their operations tend to make 

them interdependent. 

Example 4. The facts are the same as in Example 3, except that 

IceSub owns an office building in Iceland instead of a hotel chain. 

No part of Americair’s business is conducted through the office 

building. IceSub’s business is not considered to form a part of or 

to be complementary to Americair’s business. They are engaged in 

distinct trades or businesses in separate industries, and there is no 

economic dependence between the two operations. 

Example 5. USFlower is a corporation resident in the United 

States. USFlower produces and sells flowers in the United States 

and other countries. USFlower owns all the shares of IceHolding, 

a corporation resident in Iceland. IceHolding is a holding company 

that is not engaged in a trade or business. IceHolding owns all the 

shares of three corporations that are resident in Iceland: IceFlower, 

IceLawn, and IceFish. IceFlower distributes USFlower flowers 

under the USFlower trademark in Iceland. IceLawn markets a line 

of lawn care products in Iceland under the USFlower trademark. 

In addition to being sold under the same trademark, IceLawn and 

IceFlower products are sold in the same stores and sales of each 

company’s products tend to generate increased sales of the other’s 

products. IceFish imports fish from the United States and distributes it to fish wholesalers in Iceland. For purposes of paragraph 3, 

the business of IceFlower forms a part of the business of USFlower, 

the business of IceLawn is complementary to the business of 

USFlower, and the business of IceFish is neither part of nor complementary to that of USFlower. 

An item of income derived from the State of source is ‘‘incidental 

to’’ the trade or business carried on in the State of residence if production of the item facilitates the conduct of the trade or business 

in the State of residence. An example of incidental income is the 

temporary investment of working capital of a person in the State 

of residence in securities issued by persons in the State of source. 

Subparagraph 4(b) states a further condition to the general rule 

in subparagraph 4(a) in cases where the trade or business generating the item of income in question is carried on either by the person deriving the income or by any associated enterprises. Subparagraph 4(b) states that the trade or business carried on in the State 

of residence, under these circumstances, must be substantial in relation to the activity in the State of source. The substantiality requirement is intended to prevent a narrow case of treaty-shopping 

abuses in which a company attempts to qualify for benefits by engaging in de minimis connected business activities in the treaty 

country in which it is resident (i.e., activities that have little economic cost or effect with respect to the company business as a 

whole). 

The determination of substantiality is made based upon all the 

facts and circumstances and takes into account the comparative 

sizes of the trades or businesses in each Contracting State the nature of the activities performed in each Contracting State, and the 

relative contributions made to that trade or business in each Contracting State. 

75 

The determination in subparagraph 4(b) also is made separately 

for each item of income derived from the State of source. It therefore is possible that a person would be entitled to the benefits of 

the Convention with respect to one item of income but not with respect to another. If a resident of a Contracting State is entitled to 

treaty benefits with respect to a particular item of income under 

paragraph 3, the resident is entitled to all benefits of the Convention insofar as they affect the taxation of that item of income in 

the State of source. 

Subparagraph 4(c) provides special attribution rules for purposes 

of applying the substantive rules of subparagraph 4(a). Thus, these 

rules apply for purposes of determining whether a person meets 

the requirement in subparagraph 4(a) that it be engaged in the active conduct of a trade or business and that the item of income is 

derived in connection with that active trade or business. Subparagraph 4(c) attributes to a person activities conducted by a partnership in which that person is a partner and activities conducted by 

persons ‘‘connected’’ to such person. A person (‘‘X’’) is connected to 

another person (‘‘Y’’) if X possesses 50 percent or more of the beneficial interest in Y (or if Y possesses 50 percent or more of the beneficial interest in X). For this purpose, X is connected to a company 

if X owns shares representing fifty percent or more of the aggregate 

voting power and value of the company or fifty percent or more of 

the beneficial equity interest in the company. X also is connected 

to Y if a third person possesses, directly or indirectly, fifty percent 

or more of the beneficial interest in both X and Y. For this purpose, 

if X or Y is a company, the threshold relationship with respect to 

such company or companies is fifty percent or more of the aggregate voting power and value or fifty percent or more of the beneficial equity interest. Finally, X is connected to Y if, based upon all 

the facts and circumstances, X controls Y, Y controls X, or X and 

Y are controlled by the same person or persons. 

Paragraph 5 

Paragraph 5 deals with the treatment of income in the context 

of a so-called ‘‘triangular case.’’ 

The term ‘‘triangular case’’ refers to the use of the following 

structure by a resident of Iceland to earn, in this case, interest income from the United States. The resident of Iceland, who is assumed to qualify for benefits under one or more of the provisions 

of Article 16 (Limitation on Benefits), sets up a permanent establishment in a third jurisdiction that imposes only a low rate of tax 

on the income of the permanent establishment. The Icelandic resident lends funds into the United States through the permanent establishment. The permanent establishment, despite its third-jurisdiction location, is an integral part of a Icelandic resident. Therefore the income that it earns on those loans, absent the provisions 

of paragraph 5, is entitled to exemption from U.S. withholding tax 

under the Convention. Under a current Icelandic income tax treaty 

with the host jurisdiction of the permanent establishment, the income of the permanent establishment is exempt from Icelandic tax 

(alternatively, Iceland may choose to exempt the income of the permanent establishment from Icelandic income tax). Thus, the interest income is exempt from U.S. tax, is subject to little tax in the 

76 

host jurisdiction of the permanent establishment, and is exempt 

from Icelandic tax. 

Paragraph 5 applies reciprocally. However, the United States 

does not exempt the profits of a third-jurisdiction permanent establishment of a U.S. resident from U.S. tax, either by statute or by 

treaty. 

Paragraph 5 provides that the tax benefits that would otherwise 

apply under the Convention will not apply to any item of income 

if the combined tax actually paid in the residence State and the 

third state is less than 60 percent of the tax that would have been 

payable in the residence State if the income were earned in that 

State by the enterprise and were not attributable to the permanent 

establishment in the third state. In the case of dividends, interest 

and royalties to which this paragraph applies, the withholding tax 

rates under the Convention are replaced with a 15 percent withholding tax. Any other income to which the provisions of paragraph 

5 apply is subject to tax under the domestic law of the source 

State, notwithstanding any other provisions of the Convention. 

In general, the principles employed under Code section 954(b) (4) 

will be employed to determine whether the profits are subject to an 

effective rate of taxation that is above the specified threshold. 

Notwithstanding the level of tax on interest and royalty income 

of the permanent establishment, paragraph 5 will not apply under 

certain circumstances. In the case of royalties, paragraph 5 will not 

apply if the royalties are received as compensation for the use of, 

or the right to use, intangible property produced or developed by 

the permanent establishment itself. In the case of any other income, paragraph 5 will not apply if that income is derived in connection with, or is incidental to, the active conduct of a trade or 

business carried on by the permanent establishment in the third 

state. The business of making, managing or simply holding investments is not considered to be an active trade or business, unless 

these are banking or securities activities carried on by a bank or 

registered securities dealer. 

Paragraph 6 

Paragraph 6 provides a special rule where a company resident in 

a Contracting State, or a company that controls such a company directly or indirectly, has a class of shares that is subject to terms 

or other arrangements that entitle the holder to a larger portion 

of the company’s income than the portion the holders would receive 

absent such terms or arrangements (‘‘the disproportionate part of 

the income’’). Where 50 percent or more of such a class of shares 

is owned by persons who are not entitled to benefits under paragraph 2, the benefits of the Convention shall not apply with respect 

to the disproportionate part of the income of the Company. 

The following example illustrates this result. 

Example. IceCo is a corporation resident in Iceland. IceCo has 

two classes of shares: Common and Preferred. The Common shares 

are listed and regularly traded on the Icelandic Stock Exchange. 

The Preferred shares have no voting rights and are entitled to receive dividends equal in amount to interest payments that IceCo 

receives from unrelated borrowers in the United States. The Preferred shares are owned entirely by a single investor that is a resident of a third country. The Common shares account for more than 

77 

50 percent of the value of IceCo and for 100 percent of the voting 

power. Because the owner of the Preferred shares is entitled to receive payments corresponding to the U.S. source interest income 

earned by IceCo, the Preferred shares are a disproportionate class 

of shares. Because the Preferred shares are not owned by persons 

entitled to benefits under paragraph 2, the benefits of the Convention shall not apply with respect to IceCo’s U.S.-source interest income. 

Paragraph 7 

Paragraph 7 provides that a resident of one of the States that is 

not entitled to the benefits of the Convention as a result of paragraphs 1 through 5 still shall be granted benefits under the Convention if the competent authority of the State from which benefits 

are claimed determines that the establishment, acquisition, or 

maintenance of the person seeking benefits under the Convention, 

or the conduct of such person’s operations, has or had as one of its 

principal purposes the obtaining of benefits under the Convention. 

Benefits will not be granted, however, solely because a company 

was established prior to the effective date of a treaty or protocol. 

In that case a company would still be required to establish, to the 

satisfaction of the competent authority, clear non-tax business reasons for its formation in a Contracting State, or that the allowance 

of benefits would not otherwise be contrary to the purposes of the 

treaty. Thus, persons that establish operations in one of the States 

with a principal purpose of obtaining the benefits of the Convention 

ordinarily will not be granted relief under paragraph 7. 

The competent authority’s discretion is quite broad. It may grant 

all of the benefits of the Convention to the taxpayer making the request, or it may grant only certain benefits. For instance, it may 

grant benefits only with respect to a particular item of income in 

a manner similar to paragraph 3. Further, the competent authority 

may establish conditions, such as setting time limits on the duration of any relief granted. 

For purposes of implementing paragraph 7, a taxpayer will be 

permitted to present his case to the relevant competent authority 

for an advance determination based on the facts. In these circumstances, it is also expected that, if the competent authority determines that benefits are to be allowed, they will be allowed retroactively to the time of entry into force of the relevant treaty provision or the establishment of the structure in question, whichever 

is later. 

Finally, there may be cases in which a resident of a Contracting 

State may apply for discretionary relief to the competent authority 

of his State of residence. This would arise, for example, if the benefit it is claiming is provided by the residence country, and not by 

the source country. So, for example, if a company that is a resident 

of the United States would like to claim the benefit of the resourcing rule of subparagraph 2(a) of Article 22, but it does not 

meet any of the objective tests of paragraphs 2 through 5, it may 

apply to the U.S. competent authority for discretionary relief. 

78 

Paragraph 8 

Paragraph 8 defines several key terms for purposes of Article 22. 

Each of the defined terms is discussed above in the context in 

which it is used. 

ARTICLE 22 (RELIEF FROM DOUBLE TAXATION)

This Article describes the manner in which each Contracting 

State undertakes to relieve double taxation. The United States 

uses the foreign tax credit method under its internal law, and by 

treaty. 

Paragraph 1 

The United States agrees, in paragraph 1, to allow to its citizens 

and residents a credit against U.S. tax for income taxes paid or accrued to Iceland. Paragraph 1 also provides that Iceland’s covered 

taxes are income taxes for U.S. purposes. This provision is based 

on the Treasury Department’s review of Iceland’s laws. 

Subparagraph 1(b) provides for a deemed-paid credit, consistent 

with section 902 of the Code, to a U.S. corporation in respect of 

dividends received from a corporation resident in Iceland of which 

the U.S. corporation owns at least 10 percent of the voting stock. 

This credit is for the tax paid by the corporation to Iceland on the 

profits out of which the dividends are considered paid. 

The credits allowed under paragraph 1 are allowed in accordance 

with the provisions and subject to the limitations of U.S. law, as 

that law may be amended over time, so long as the general principle of the Article, that is, the allowance of a credit, is retained. 

Thus, although the Convention provides for a foreign tax credit, the 

terms of the credit are determined by the provisions, at the time 

a credit is given, of the U.S. statutory credit. 

Therefore, the U.S. credit under the Convention is subject to the 

various limitations of U.S. law (see, e.g., Code sections 901–908). 

For example, the credit against U.S. tax generally is limited to the 

amount of U.S. tax due with respect to net foreign source income 

within the relevant foreign tax credit limitation category (see Code 

section 904(a) and (d)), and the dollar amount of the credit is determined in accordance with U.S. currency translation rules (see, e.g., 

Code section 986). Similarly, U.S. law applies to determine carryover periods for excess credits and other inter-year adjustments. 

Paragraph 2 

Paragraph 2 provides a re-sourcing rule for gross income covered 

by paragraph 1. Subparagraph 2(a) is intended to ensure that a 

U.S. resident can obtain an appropriate amount of U.S. foreign tax 

credit for income taxes paid to Iceland when the Convention assigns to Iceland primary taxing rights over an item of gross income. 

Accordingly, if the Convention allows Iceland to tax an item of 

gross income (as defined under U.S. law) derived by a resident of 

the United States, the United States will treat that item of gross 

income as gross income from sources within Iceland for U.S. foreign 

tax credit purposes. In the case of a U.S.-owned foreign corporation, however, section 904(g)(10) may apply for purposes of determining the U.S. foreign tax credit with respect to income subject 

to this re-sourcing rule. Section 904(g)(10) generally applies the forVerDate Aug 31 2005 15:57 Sep 15, 2008 Jkt 000000 PO 00000 Frm 00078 Fmt 6659 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-17.TXT sfrela2 PsN: MIKEB
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eign tax credit limitation separately to re-sourced income. Furthermore, the subparagraph 2(a) re-sourcing rule applies to gross income, not net income. Accordingly, U.S. expense allocation and apportionment rules, see, e.g., Treas. Reg. section 1.861–9, continue to 

apply to income resourced under subparagraph 2(a). 

Subparagraph 2(b) provides that gains derived by an individual 

who was a resident of the United States that are taxed by the 

United States in accordance with the Convention, and that may 

also be taxed in Iceland solely by reason of Article 13 (Capital 

Gains) , shall be deemed to be gains from sources in the United 

States. The provisions of subparagraph 2(b) ensure that the United 

States does not bear, from a foreign tax credit standpoint, the cost 

of Iceland’s expatriation tax. 

Paragraph 3 

Specific rules are provided in paragraph 3 under which Iceland, 

in imposing tax on its residents, provides relief for U.S. taxes paid 

by those residents. Subparagraph 3(a) provides that when a resident of Iceland derives income that, in accordance with the provisions of the Convention, may be taxed in the United States, Iceland 

shall allow as a credit against Icelandic income taxes an amount 

equal to those taxes paid to the United States. 

Subparagraph 3(b) limits the credits against Icelandic taxes to 

those taxes that are attributable to the income that has been taxed 

by the United States. 

Subparagraph 3(c) provides that when a resident of Iceland derives income that, in accordance with the provisions of the Convention, may be taxed by the United States, Iceland shall allow the 

credit against Icelandic tax described in subparagraph 3(b). However, subparagraph 3(c) also permits Iceland to include the income 

corresponding to the U.S. tax in the resident’s tax base for purposes of determining the Icelandic tax. This rule is a variation of 

the ‘‘exemption with progression rule,’’ adapted to accommodate 

Iceland’s credit system. It is also similar to U.S. domestic law, 

which permits credits for foreign taxes paid, while at the same 

time taxing residents on worldwide income. Finally, subparagraph 

3(c) provides that for purposes of this Article, the U.S. taxes referred to in subparagraph 3(b) and paragraph 4 of Article 2 (Taxes 

Covered) are considered to be income taxes and are allowed as 

credits against Icelandic tax on income, subject to all of the provisions and limitations of this paragraph. 

Paragraph 4 

Paragraph 4 provides special rules for the tax treatment in both 

States of certain types of income derived from U.S. sources by U.S. 

citizens who are residents of Iceland. Since U.S. citizens, regardless 

of residence, are subject to United States tax at ordinary progressive rates on their worldwide income, the U.S. tax on the U.S. 

source income of a U.S. citizen resident in Iceland may exceed the 

U.S. tax that may be imposed under the Convention on an item of 

U.S. source income derived by a resident of Iceland who is not a 

U.S. citizen. The provisions of paragraph 4 ensure that Iceland 

does not bear the cost of U.S. taxation of its citizens who are residents of Iceland. 

80 

Subparagraph 4(a) provides, with respect to items of income from 

sources within the United States, special credit rules for Iceland. 

These rules apply to items of U. S.-source income that would be either exempt from U.S. tax or subject to reduced rates of U.S. tax 

under the provisions of the Convention if they had been received 

by a resident of Iceland who is not a U.S. citizen. The tax credit 

allowed under paragraph 4 with respect to such items need not exceed the U.S. tax that may be imposed under the Convention, other 

than tax imposed solely by reason of the U.S. citizenship of the taxpayer under the provisions of the saving clause of paragraph 4 of 

Article 1 (General Scope). 

For example, if a U.S. citizen resident in Iceland receives portfolio dividends from sources within the United States, the foreign 

tax credit granted by Iceland would be limited to 15 percent of the 

dividend - the U.S. tax that may be imposed under subparagraph 

2(b) of Article 10 (Dividends) - even if the shareholder is subject to 

U.S. net income tax because of his U.S. citizenship. With respect 

to interest income, Iceland would allow no foreign tax credit, because its residents are exempt from U.S. tax on interest income 

under the provisions of Articles 11 (Interest). 

Subparagraph 4(b) eliminates the potential for double taxation 

that can arise because subparagraph 4(a) provides that Iceland 

need not provide full relief for the U.S. tax imposed on its citizens 

resident in Iceland. The subparagraph provides that the United 

States will credit the income tax paid or accrued to Iceland, after 

the application of subparagraph 4(a). It further provides that in allowing the credit, the United States will not reduce its tax below 

the amount that is taken into account in Iceland in applying subparagraph 4(a). 

Since the income described in subparagraph 4(a) generally will 

be U.S. source income, special rules are required to re-source some 

of the income to Iceland in order for the United States to be able 

to credit the tax paid to Iceland. This re-sourcing is provided for 

in subparagraph 4(c), which deems the items of income referred to 

in subparagraph 4(a) to be from foreign sources to the extent necessary to avoid double taxation under subparagraph 4(b). Clause 

(iii) of subparagraph 3(c) of Article 24 (Mutual Agreement Procedure) provides a mechanism by which the competent authorities 

can resolve any disputes regarding whether income is from sources 

within the United States. 

The following two examples illustrate the application of paragraph 4 in the case of a U. S.-source portfolio dividend received by 

a U.S. citizen resident in Iceland. In both examples, the U.S. rate 

of tax on residents of Iceland, under subparagraph 2(b) of Article 

10 (Dividends) of the Convention, is 15 percent. In both examples, 

the U.S. income tax rate on the U.S. citizen is 35 percent. In example 1, the rate of income tax imposed in Iceland on its resident (the 

U.S. citizen) is 25 percent (below the U.S. rate), and in example 2, 

the rate imposed on its resident is 40 percent (above the U.S. rate). 

Example 1 Example 2 

Subparagraph (a) 

U.S. dividend declared ....................... $100.00 $100.00 

81 

Example 1 Example 2 

Notional U.S. withholding tax (Article 10(2)(b)) ...................................... 15.00 15.00 

Taxable income in Iceland ................. 100.00 100.00 

Icelandic tax before credit ................. 25.00 40.00 

Less: tax credit for notional U.S. 

withholding tax ............................... 15.00 15.00 

Net post-credit tax paid to Iceland ... 10.00 25.00 

Subparagraphs (b) and (c) 

U.S. pre-tax income ............................ $100.00 $100.00 

U.S. pre-credit citizenship tax ........... 35.00 35.00 

Notional U.S. withholding tax .......... 15.00 15.00 

U.S. tax eligible to be offset by credit 20.00 20.00 

Tax paid to Iceland ............................ 10.00 25.00 

Income re-sourced from U.S. to foreign source (see below) ................... 28.57 57.14 

U.S. pre-credit tax on re-sourced income ................................................. 10.00 20.00 

U.S. credit for tax paid to Iceland .... 10.00 20.00 

Net post-credit U.S. tax ..................... 10.00 0.00 

Total U.S. tax ..................................... 25.00 15.00 

In both examples, in the application of subparagraph 4(a), Iceland credits a 15 percent U.S. tax against its residence tax on the 

U.S. citizen. In the first example, the net tax paid to Iceland after 

the foreign tax credit is $10.00; in the second example, it is $25.00. 

In the application of subparagraphs 4(b) and 4(c), from the U.S. tax 

due before credit of $35.00, the United States subtracts the amount 

of the U.S. source tax of $15.00, against which no U.S. foreign tax 

credit is allowed. This subtraction ensures that the United States 

collects the tax that it is due under the Convention as the State 

of source. 

In both examples, given the 35 percent U.S. tax rate, the maximum amount of U.S. tax against which credit for the tax paid to 

Iceland may be claimed is $20 ($35 U.S. tax minus $15 U.S. withholding tax). Initially, all of the income in both examples was from 

sources within the United States. For a U.S. foreign tax credit to 

be allowed for the full amount of the tax paid to Iceland, an appropriate amount of the income must be re-sourced to Iceland under 

subparagraph 4(c). 

The amount that must be re-sourced depends on the amount of 

tax for which the U.S. citizen is claiming a U.S. foreign tax credit. 

In example 1, the tax paid to Iceland was $10. For this amount to 

be creditable against U.S. tax, $28.57 ($10 tax divided by 35 percent U.S. tax rate) must be resourced to Iceland. When the tax is 

credited against the $10 of U.S. tax on this resourced income, there 

is a net U.S. tax of $10 due after credit ($20 U.S. tax eligible to 

be offset by credit, minus $10 tax paid to Iceland). Thus, in example 1, there is a total of $25 in U.S. tax ($15 U.S. withholding tax 

plus $10 residual U.S. tax). 

82 

In example 2, the tax paid to Iceland was $25, but, because the United States subtracts the U.S. withholding tax of $15 from the 

total U.S. tax of $35, only $20 of U.S. taxes may be offset by taxes 

paid to Iceland. Accordingly, the amount that must be resourced to 

Iceland is limited to the amount necessary to ensure a U.S. foreign 

tax credit for $20 of tax paid to Iceland, or $57.14 ($20 tax paid 

to Iceland divided by 35 percent U.S. tax rate). When the tax paid 

to Iceland is credited against the U.S. tax on this re-sourced income, there is no residual U.S. tax ($20 U.S. tax minus $25 tax 

paid to Iceland, subject to the U.S. limit of $20). Thus, in example 

2, there is a total of $15 in U.S. tax ($15 U.S. withholding tax plus 

$0 residual U.S. tax). Because the tax paid to Iceland was $25 and 

the U.S. tax eligible to be offset by credit was $20, there is $5 of 

excess foreign tax credit available for carryover. 

Relationship to Other Articles 

By virtue of subparagraph 5(a) of Article 1 (General Scope), Article 22 is not subject to the saving clause of paragraph 4 of Article 

1. Thus, the United States will allow a credit to its citizens and 

residents in accordance with the Article, even if such credit were 

to provide a benefit not available under the Code (such as the resourcing provided by paragraph 2 and subparagraph 4(c)). 

ARTICLE 23 (NON-DISCRIMINATION)

This Article ensures that nationals of a Contracting State, in the 

case of paragraph 1, and residents of a Contracting State, in the 

case of paragraphs 2 through 4, will not be subject, directly or indirectly, to discriminatory taxation in the other Contracting State. 

Not all differences in tax treatment, either as between nationals of 

the two States, or between residents of the two States, are violations of the prohibition against discrimination. Rather, the non-discrimination obligations of this Article apply only if the nationals or 

residents of the two States are comparably situated. 

Each of the relevant paragraphs of the Article provides that two 

persons that arecomparably situated must be treated similarly. Although the actual words differ from paragraph to paragraph (e.g., 

paragraph 1 refers to two nationals ‘‘in the same circumstances,’’ 

paragraph 2 refers to two enterprises ‘‘carrying on the same activities’’ and paragraph 4 refers to two enterprises that are ‘‘similar’’), 

the common underlying premise is that if the difference in treatment is directly related to a tax-relevant difference in the situations of the domestic and foreign persons being compared, that difference is not to be treated as discriminatory (i.e., if one person is 

taxable in a Contracting State on worldwide income and the other 

is not, or tax may be collectible from one person at a later stage, 

but not from the other, distinctions in treatment would be justified 

under paragraph 1). Other examples of such factors that can lead 

to non-discriminatory differences in treatment are noted in the discussions of each paragraph. 

The operative paragraphs of the Article also use different language to identify the kinds of differences in taxation treatment that 

will be considered discriminatory. For example, paragraphs 1 and 

4 speak of ‘‘any taxation or any requirement connected therewith 

that is more burdensome,’’ while paragraph 2 specifies that a tax 

‘‘shall not be less favorably levied.’’ Regardless of these differences 

83 

in language, only differences in tax treatment that materially disadvantage the foreign person relative to the domestic person are 

properly the subject of the Article. 

Paragraph 1 

Paragraph 1 provides that a national of one Contracting State 

may not be subject to taxation or connected requirements in the 

other Contracting State that are different from or more burdensome than the taxes and connected requirements imposed upon a 

national of that other State in the same circumstances. 

The term ‘‘national’’ in relation to a Contracting State is defined 

in subparagraph 1(j) of Article 3 (General Definitions). The term includes both individuals and juridical persons. 

A national of a Contracting State is afforded protection under 

this paragraph even if the national is not a resident of either Contracting State. Thus, a U.S. citizen who is resident in a third country is entitled, under this paragraph, to the same treatment in Iceland as a national of Iceland who is in similar circumstances (i.e., 

presumably one who is resident in a third State). 

As noted above, whether or not the two persons are both taxable 

on worldwide income is a significant circumstance for this purpose. 

For this reason, paragraph 1 specifically states that the United 

States is not obligated to apply the same taxing regime to a national of Iceland who is not resident in the United States as it applies to a U.S. national who is not resident in the United States. 

United States citizens who are not residents of the United States 

but who are, nevertheless, subject to United States tax on their 

worldwide income are not in the same circumstances with respect 

to United States taxation as citizens of Iceland who are not United 

States residents. Thus, for example, Article 23 would not entitle a 

national of Iceland resident in a third country to taxation at graduated rates on U.S. source dividends or other investment income 

that applies to a U.S. citizen resident in the same third country. 

Paragraph 2 

Paragraph 2 of the Article, provides that a Contracting State 

may not tax a permanent establishment of an enterprise of the 

other Contracting State less favorably than an enterprise of that 

first-mentioned State that is carrying on the same activities. 

The fact that a U.S. permanent establishment of an enterprise 

of Iceland is subject to U.S. tax only on income that is attributable 

to the permanent establishment, while a U.S. corporation engaged 

in the same activities is taxable on its worldwide income is not, in 

itself, a sufficient difference to provide different treatment for the 

permanent establishment. There are cases, however, where the two 

enterprises would not be similarly situated and differences in treatment may be warranted. For instance, it would not be a violation 

of the non-discrimination protection of paragraph 2 to require the 

foreign enterprise to provide information in a reasonable manner 

that may be different from the information requirements imposed 

on a resident enterprise, because information may not be as readily 

available to the Internal Revenue Service from a foreign as from 

a domestic enterprise. Similarly, it would not be a violation of paragraph 2 to impose penalties on persons who fail to comply with 

such a requirement (see, e.g., sections 874(a) and 882(c)(2)). FurVerDate Aug 31 2005 15:57 Sep 15, 2008 Jkt 000000 PO 00000 Frm 00083 Fmt 6659 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-17.TXT sfrela2 PsN: MIKEB
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ther, a determination that income and expenses have been attributed or allocated to a permanent establishment in conformity with 

the principles of Article 7 (Business Profits) implies that the attribution or allocation was not discriminatory. 

Section 1446 of the Code imposes on any partnership with income that is effectively connected with a U.S. trade or business the 

obligation to withhold tax on amounts allocable to a foreign partner. In the context of the Convention, this obligation applies with 

respect to a share of the partnership income of a partner resident 

in Iceland, and attributable to a U.S. permanent establishment. 

There is no similar obligation with respect to the distributive 

shares of U.S. resident partners. It is understood, however, that 

this distinction is not a form of discrimination within the meaning 

of paragraph 2 of the Article. No distinction is made between U.S. 

and non-U.S. partnerships, since the law requires that partnerships of both U.S. and non-U.S. domicile withhold tax in respect of 

the partnership shares of non-U.S. partners. Furthermore, in distinguishing between U.S. and non-U.S. partners, the requirement 

to withhold on the non-U.S. but not the U.S. partner’s share is not 

discriminatory taxation, but, like other withholding on nonresident 

aliens, is merely a reasonable method for the collection of tax from 

persons who are not continually present in the United States, and 

as to whom it otherwise may be difficult for the United States to 

enforce its tax jurisdiction. If tax has been over-withheld, the partner can, as in other cases of over-withholding, file for a refund. 

Paragraph 2 does not obligate a Contracting State to grant to a 

resident of the other Contracting State any tax allowances, reliefs, 

etc., that it grants to its own residents on account of their civil status or family responsibilities. Thus, if a sole proprietor who is a 

resident of Iceland has a permanent establishment in the United 

States, in assessing income tax on the profits attributable to the 

permanent establishment, the United States is not obligated to 

allow to the resident of Iceland the personal allowances for himself 

and his family that he would be permitted to take if the permanent 

establishment were a sole proprietorship owned and operated by a 

U.S. resident, despite the fact that the individual income tax rates 

would apply. 

Paragraph 3 

Paragraph 3 prohibits discrimination in the allowance of deductions. When a resident or an enterprise of a Contracting State pays 

interest, royalties or other disbursements to a resident of the other 

Contracting State, the first-mentioned Contracting State must 

allow a deduction for those payments in computing the taxable 

profits of the resident or enterprise as if the payment had been 

made under the same conditions to a resident of the first-mentioned Contracting State. Paragraph 3, however, does not require 

a Contracting State to give nonresidents more favorable treatment 

than it gives to its own residents. Consequently, a Contracting 

State does not have to allow nonresidents a deduction for items 

that are not deductible under its domestic law (for example, expenses of a capital nature). 

The term ‘‘other disbursements’’ is understood to include a reasonable allocation of executive and general administrative expenses, research and development expenses and other expenses inVerDate Aug 31 2005 15:57 Sep 15, 2008 Jkt 000000 PO 00000 Frm 00084 Fmt 6659 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-17.TXT sfrela2 PsN: MIKEB
85 

curred for the benefit of a group of related persons that includes 

the person incurring the expense. 

An exception to the rule of paragraph 3 is provided for cases 

where the provisions of paragraph 1 of Article 9 (Associated Enterprises), paragraph 4 of Article 11 (Interest) or para-graph 6 of Article 12 (Royalties) apply. All of these provisions permit the denial 

of deductions in certain circumstances in respect of transactions between related persons. Neither State is forced to apply the non-discrimination principle in such cases. The exception with respect to 

paragraph 4 of Article 11 would include the denial or deferral of 

certain interest deductions under Code section 163(j). 

Paragraph 3 also provides that any debts of an enterprise of a 

Contracting State to a resident of the other Contracting State are 

deductible in the first-mentioned Contracting State for purposes of 

computing the capital tax of the enterprise under the same conditions as if the debt had been contracted to a resident of the firstmentioned Contracting State. Even though, for general purposes, 

the Convention covers only income taxes, under paragraph 6 of this 

Article, the nondiscrimination provisions apply to all taxes levied 

in both Contracting States, at all levels of government. 

Paragraph 4 

Paragraph 4 requires that a Contracting State not impose more 

burdensome taxation or connected requirements on an enterprise of 

that State that is wholly or partly owned or controlled, directly or 

indirectly, by one or more residents of the other Contracting State 

than the taxation or connected requirements that it imposes on 

other similar enterprises of that first-mentioned Contracting State. 

For this purpose it is understood that ‘‘similar’’ refers to similar activities or ownership of the enterprise. 

This rule, like all non-discrimination provisions, does not prohibit 

differing treatment of entities that are in differing circumstances. 

Rather, a protected enterprise is only required to be treated in the 

same manner as other enterprises that, from the point of view of 

the application of the tax law, are in substantially similar circumstances both in law and in fact. The taxation of a distributing 

corporation under section 367(e) on an applicable distribution to 

foreign shareholders does not violate paragraph 4 of the Article because a foreign-owned corporation is not similar to a domesticallyowned corporation that is accorded non-recognition treatment 

under sections 337 and 355. 

For the reasons given above in connection with the discussion of 

paragraph 2 of the Article, it is also understood that the provision 

in section 1446 of the Code for withholding of tax on non-U.S. partners does not violate paragraph 5 of the Article. 

It is further understood that the ineligibility of a U.S. corporation with nonresident alien shareholders to make an election to be 

an ‘‘S’’ corporation does not violate paragraph 4 of the Article. If 

a corporation elects to be an S corporation, it is generally not subject to income tax and the shareholders take into account their pro 

rata shares of the corporation’s items of income, loss, deduction or 

credit. (The purpose of the provision is to allow an individual or 

small group of individuals the protections of conducting business in 

corporate form while paying taxes at individual rates as if the business were conducted directly.) A nonresident alien does not pay 

86 

U.S. tax on a net basis, and, thus, does not generally take into account items of loss, deduction or credit. Thus, the S corporation 

provisions do not exclude corporations with nonresident alien 

shareholders because such shareholders are foreign, but only because they are not net-basis taxpayers. Similarly, the provisions exclude corporations with other types of shareholders where the purpose of the provisions cannot be fulfilled or their mechanics implemented. For example, corporations with corporate shareholders are 

excluded because the purpose of the provision to permit individuals 

to conduct a business in corporate form at individual tax rates 

would not be furthered by their inclusion. 

Finally, it is understood that paragraph 4 does not require a 

Contracting State to allow foreign corporations to join in filing a 

consolidated return with a domestic corporation or to allow similar 

benefits between domestic and foreign enterprises. 

Paragraph 5 

Paragraph 5 of the Article confirms that no provision of the Article will prevent either Contracting State from imposing the branch 

profits tax described in paragraph 8 of Article 10 (Dividends). 

Paragraph 6 

As noted above, notwithstanding the specification of taxes covered by the Convention in Article 2 (Taxes Covered) for general 

purposes, for purposes of providing nondiscrimination protection 

this Article applies to taxes of every kind and description imposed 

by a Contracting State or a political subdivision or local authority 

thereof. Customs duties are not considered to be taxes for this purpose. 

Relationship to Other Articles 

The saving clause of paragraph 4 of Article 1 (General Scope) 

does not apply to this Article by virtue of the exceptions in subparagraph 5(a) of Article 1. Thus, for example, a U.S. citizen who 

is a resident of Iceland may claim benefits in the United States 

under this Article. 

Nationals of a Contracting State may claim the benefits of paragraph 1 regardless of whether they are entitled to benefits under 

Article 21 (Limitation on Benefits), because that paragraph applies 

to nationals and not residents. They may not claim the benefits of 

the other paragraphs of this Article with respect to an item of income unless they are generally entitled to treaty benefits with respect to that income under a provision of Article 21. 

ARTICLE 24 (MUTUAL AGREEMENT PROCEDURE)

This Article provides the mechanism for taxpayers to bring to the 

attention of competent authorities issues and problems that may 

arise under the Convention. It also provides the authority for cooperation between the competent authorities of the Contracting 

States to resolve disputes and clarify issues that may arise under 

the Convention and to resolve cases of double taxation not provided 

for in the Convention. The competent authorities of the two Contracting States are identified in subparagraph 1(i) of Article 3 

(General Definitions). 

87 

Paragraph 1 

This paragraph provides that where a resident of a Contracting 

State considers that the actions of one or both Contracting States 

will result in taxation that is not in accordance with the Convention, he may present his case to the competent authority of either 

Contracting State. This rule is more generous than in most treaties, which generally allow taxpayers to bring competent authority 

cases only to the competent authority of their country of residence, 

or citizen-ship/nationality. Under this more generous rule, a U.S. 

permanent establishment of a corporation resident in Iceland that 

faces inconsistent treatment in the two countries would be able to 

bring its request for assistance to the U.S. competent authority. If 

the U.S. competent authority can resolve the issue on its own, then 

the taxpayer need never involve the Icelandic competent authority. 

Thus, the rule provides flexibility that might result in greater efficiency. 

Although the typical cases brought under this paragraph will involve economic double taxation arising from transfer pricing adjustments, the scope of this paragraph is not limited to such cases. For 

example, a taxpayer could request assistance from the competent 

authority if one Contracting State determines that the taxpayer 

has received deferred compensation taxable at source under Article 

14 (Income from Employment), while the taxpayer believes that 

such income should be treated as a pension that is taxable only in 

his country of residence pursuant to Article 17 (Pensions, Social Security, and Annuities). 

It is not necessary for a person requesting assistance first to 

have exhausted the remedies provided under the national laws of 

the Contracting States before presenting a case to the competent 

authorities, nor does the fact that the statute of limitations may 

have passed for seeking a refund preclude bringing a case to the 

competent authority. Unlike the OECD Model, no time limit is provided within which a case must be brought. 

Paragraph 2 

Paragraph 2 sets out the framework within which the competent 

authorities will deal with cases brought by taxpayers under paragraph 1. It provides that, if the competent authority of the Contracting State to which the case is presented judges the case to 

have merit, and cannot reach a unilateral solution, it shall seek an 

agreement with the competent authority of the otherContracting 

State pursuant to which taxation not in accordance with the Convention will be avoided. 

Any agreement is to be implemented even if such implementation otherwise would be barred by the statute of limitations or by 

some other procedural limitation, such as a closing agreement. 

Paragraph 2, however, does not prevent the application of domestic-law procedural limitations that give effect to the agreement 

(e.g., a domestic-law requirement that the taxpayer file a return reflecting the agreement within one year of the date of the agreement). 

Where the taxpayer has entered a closing agreement (or other 

written settlement) with the United States before bringing a case 

to the competent authorities, the U.S. competent authority will endeavor only to obtain a correlative adjustment from Iceland. See 

88 

Rev. Proc. 2006–54, 2006–49 I.R.B. 1035, § 7.05. Because, as specified in paragraph 2 of Article 1 (General Scope), the Convention 

cannot operate to increase a taxpayer’s liability, temporal or other 

procedural limitations can be overridden only for the purpose of 

making refunds and not to impose additional tax. 

Paragraph 3 

Paragraph 3 authorizes the competent authorities to resolve difficulties or doubts that may arise as to the application or interpretation of the Convention. The paragraph includes a non- exhaustive 

list of examples of the kinds of matters about which the competent 

authorities may reach agreement. This list is purely illustrative; it 

does not grant any authority that is not implicitly present as a result of the introductory sentence of paragraph 3. 

The competent authorities may, for example, agree to the same 

allocation of income, deductions, credits or allowances between an 

enterprise in one Contracting State and its permanent establishment in the other or between related persons. These allocations are 

to be made in accordance with the arm’s length principle underlying Article 7 (Business Profits) and Article 9 (Associated Enterprises). Agreements reached under these subparagraphs may include agreement on a methodology for determining an appropriate 

transfer price, on an acceptable range of results under that methodology, or on a common treatment of a taxpayer’s cost sharing arrangement. 

As indicated in subparagraphs 3(a) through 3(f), the competent 

authorities also may agree to settle a variety of conflicting applications of the Convention. They may agree to settle conflicts regarding the characterization of particular items of income, including the 

same characterization of income that is assimilated to income from 

shares by the taxation law of one of the Contracting States and 

that is treated as a different class of income in the other State. 

They may also agree to the characterization of persons, the application of source rules to particular items of income, the meaning of 

a term, or the timing of an item of income. 

The competent authorities also may agree as to the application 

of the provisions of domestic law regarding penalties, fines, and interest in a manner consistent with the purposes of the Convention. 

Since the list under paragraph 3 is not exhaustive, the competent 

authorities may reach agreement on issues not enumerated in 

paragraph 3 if necessary to avoid double taxation. For example, the 

competent authorities may seek agreement on a uniform set of 

standards for the use of exchange rates. Agreements reached by 

the competent authorities under paragraph 3 need not conform to 

the internal law provisions of either Contracting State. 

Finally, paragraph 3 authorizes the competent authorities to consult for the purpose of eliminating double taxation in cases not provided for in the Convention and to resolve any difficulties or doubts 

arising as to the interpretation or application of the Convention. 

This provision is intended to permit the competent authorities to 

implement the treaty in particular cases in a manner that is consistent with its expressed general purposes. It permits the competent authorities to deal with cases that are within the spirit of 

the provisions but that are not specifically covered. An example of 

such a case might be double taxation arising from a transfer pricVerDate Aug 31 2005 15:57 Sep 15, 2008 Jkt 000000 PO 00000 Frm 00088 Fmt 6659 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-17.TXT sfrela2 PsN: MIKEB
89 

ing adjustment between two permanent establishments of a thirdcountry resident, one in the United States and one in Iceland. 

Since no resident of a Contracting State is involved in the case, the 

Convention does not apply, but the competent authorities nevertheless may use the authority of this Article to prevent the double taxation of income. 

Paragraph 4 

Paragraph 4 provides that the competent authorities may communicate with each other for the purpose of reaching an agreement. This makes clear that the competent authorities of the two 

Contracting States may communicate without going through diplomatic channels. Such communication may be in various forms, including, where appropriate, through face-to-face meetings of representatives of the competent authorities. 

Treaty termination in relation to competent authority dispute resolution 

A case may be raised by a taxpayer after the Convention has 

been terminated with respect to a year for which a treaty was in 

force. In such a case the ability of the competent authorities to act 

is limited. They may not exchange confidential information, nor 

may they reach a solution that varies from that specified in its law. 

Triangular competent authority solutions 

International tax cases may involve more than two taxing jurisdictions (e.g., transactions among a parent corporation resident in 

country A and its subsidiaries resident in countries B and C). As 

long as there is a complete network of treaties among the three 

countries, it should be possible, under the full combination of bilateral authorities, for the competent authorities of the three States 

to work together on a three-sided solution. Although country A may 

not be able to give information received under Article 26 (Exchange 

of Information and Administrative Assistance) from country B to 

the authorities of country C, if the competent authorities of the 

three countries are working together, it should not be a problem for 

them to arrange for the authorities of country B to give the necessary information directly to the tax authorities of country C, as 

well as to those of country A. Each bilateral part of the trilateral 

solution must, of course, not exceed the scope of the authority of 

the competent authorities under the relevant bilateral treaty. 

Relationship to Other Articles 

This Article is not subject to the saving clause of paragraph 4 of 

Article 1 (General Scope) by virtue of the exceptions in subparagraph 5(a) of that Article. Thus, rules, definitions, procedures, etc. 

that are agreed upon by the competent authorities under this Article may be applied by the United States with respect to its citizens 

and residents even if they differ from the comparable Code provisions. Similarly, as indicated above, U.S. law may be overridden to 

provide refunds of tax to a U.S. citizen or resident under this Article. A person may seek relief under Article 24 regardless of whether he is generally entitled to benefits under Article 21 (Limitation 

on Benefits). As in all other cases, the competent authority is vestVerDate Aug 31 2005 15:57 Sep 15, 2008 Jkt 000000 PO 00000 Frm 00089 Fmt 6659 Sfmt 6602 H:\DOCS\EXEC~1.REP\EX110-17.TXT sfrela2 PsN: MIKEB
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ed with the discretion to decide whether the claim for relief is justified. 

ARTICLE 25 (EXCHANGE OF INFORMATION AND ADMINISTRATIVE

ASSISTANCE)

This Article provides for the exchange of information and administrative assistance between the competent authorities of the Contracting States. 

Paragraph 1 

The obligation to obtain and provide information to the other 

Contracting State is set out in paragraph 1. The information to be 

exchanged is that which is relevant for carrying out the provisions 

of the Convention or the domestic laws of the United States or of 

the Iceland concerning taxes of every kind applied at the national 

level. Exchange of information with respect to each State’s domestic law is authorized to the extent that taxation under domestic law 

is not contrary to the Convention. Thus, for example, information 

may be exchanged with respect to a covered tax, even if the transaction to which the information relates is a purely domestic transaction in the requesting State and, therefore, the exchange is not 

made to carry out the Convention. An example of such a case is 

provided in the OECD Commentary: a company resident in the 

United States and a company resident in Iceland transact business 

between themselves through a third-country resident company. 

Neither Contracting State has a treaty with the third State. To enforce their internal laws with respect to transactions of their residents with the third-country company (since there is no relevant 

treaty in force), the Contracting States may exchange information 

regarding the prices that their residents paid in their transactions 

with the third-country resident. 

Paragraph 1 clarifies that information may be exchanged that relates to the assessment or collection of, the enforcement or prosecution in respect of, or the determination of appeals in relation to, the 

taxes covered by the Convention. Thus, the competent authorities 

may request and provide information for cases under examination 

or criminal investigation, in collection, on appeals, or under prosecution. 

The taxes covered by the Convention for purposes of this Article 

constitute a broader category of taxes than those referred to in Article 2 (Taxes Covered). Exchange of information is authorized with 

respect to taxes of every kind imposed by a Contracting State at 

the national level. Accordingly, information may be exchanged with 

respect to U.S. estate and gift taxes, excise taxes or, with respect 

to Iceland, value added taxes. 

Information exchange is not restricted by paragraph 1 of Article 

1 (General Scope). Accordingly, information may be requested and 

provided under this article with respect to persons who are not 

residents of either Contracting State. For example, if a third-country resident has a permanent establishment in Iceland, and that 

permanent establishment engages in transactions with a U.S. enterprise, the United States could request information with respect 

to that permanent establishment, even though the third-country 

resident is not a resident of either Contracting State. Similarly, if 

a third-country resident maintains a bank account in Iceland, and 

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the Internal Revenue Service has reason to believe that funds in 

that account should have been reported for U.S. tax purposes but 

have not been so reported, information can be requested from Iceland with respect to that person’s account, even though that person 

is not the taxpayer under examination. 

Although the term ‘‘United States’’ does not encompass U.S. possessions for most purposes of the Convention, Section 7651 of the 

Code authorizes the Internal Revenue Service to utilize the provisions of the Internal Revenue Code to obtain information from the 

U.S. possessions pursuant to a proper request made under Article 

25. If necessary to obtain requested information, the Internal Revenue Service could issue and enforce an administrative summons 

to the taxpayer, a tax authority (or a government agency in a U.S. 

possession), or a third party located in a U.S. possession. 

Paragraph 1 also provides assurances that any information exchanged will be treated as secret, subject to the same disclosure 

constraints as information obtained under the laws of the requesting State. Information received may be disclosed only to persons, 

including courts and administrative bodies, involved in the assessment, collection, or administration of, the enforcement or prosecution in respect of, or the determination of the of appeals in relation 

to, the taxes covered by the Convention. The information must be 

used by these persons in connection with the specified functions. 

Information may also be disclosed to legislative bodies, such as the 

tax-writing committees of Congress and the Government Accountability Office, engaged in the oversight of the preceding activities. 

Information received by these bodies must be for use in the performance of their role in overseeing the administration of U.S. tax 

laws. Information received may be disclosed in public court proceedings or in judicial decisions. 

Paragraph 2 

Paragraph 2 provides that when information is requested by a 

Contracting State in accordance with this Article, the other Contracting State is obligated to obtain the requested information as 

if the tax in question were the tax of the requested State, even if 

that State has no direct tax interest in the case to which the request relates. In the absence of such a paragraph, some taxpayers 

have argued that subparagraph 3(a) prevents a Contracting State 

from requesting information from a bank or fiduciary that the Contracting State does not need for its own tax purposes. This paragraph clarifies that paragraph 3 does not impose such a restriction 

and that a Contracting State is not limited to providing only the 

information that it already has in its own files. 

Paragraph 3 

Paragraph 3 provides that the obligations undertaken in paragraphs 1 and 2 to exchange information do not require a Contracting State to carry out administrative measures that are at 

variance with the laws or administrative practice of either State. 

Nor is a Contracting State required to supply information not obtainable under the laws or administrative practice of either State, 

or to disclose trade secrets or other information, the disclosure of 

which would be contrary to public policy. 

92 

Thus, a requesting State may be denied information from the 

other State if the information would be obtained pursuant to procedures or measures that are broader than those available in the requesting State. However, the statute of limitations of the Contracting State making the request for information should govern a 

request for information. Thus, the Contracting State of which the 

request is made should attempt to obtain the information even if 

its own statute of limitations has passed. In many cases, relevant 

information will still exist in the business records of the taxpayer 

or a third party, even though it is no longer required to be kept 

for domestic tax purposes. 

While paragraph 3 states conditions under which a Contracting 

State is not obligated to comply with a request from the other Contracting State for information, the requested State is not precluded 

from providing such information, and may, at its discretion, do so 

subject to the limitations of its internal law. 

Paragraph 7 of the Protocol provides that the powers of each 

Contracting State’s competent authority to obtain information include powers to obtain information held by financial institutions, 

nominees, or persons acting in an agency or fiduciary capacity (not 

including information that would reveal confidential communications between a client and an attorney, solicitor, or other legal representative, where the client seeks legal advice), and information 

relating to the ownership of legal persons. Paragraph 7 of the Protocol acknowledges that each Contracting State’s competent authority is able to exchange such information in accordance with Article 

25. The provisions of paragraph 7 of the Protocol prevent a Contracting State from relying on paragraph 3 of the Convention to 

argue that its domestic bank secrecy laws (or similar legislation relating to disclosure of financial information by financial institutions 

or intermediaries) override its obligation to provide information 

under paragraph 1. 

Paragraph 4 

Paragraph 4 provides that the requesting State may specify the 

form in which information is to be provided (e.g., depositions of witnesses and authenticated copies of original documents). 

The intention is to ensure that the information may be introduced as evidence in the judicial proceedings of the requesting 

State. The requested State should, if possible, provide the information in the form requested to the same extent that it can obtain information in that form under its own laws and administrative practices with respect to its own taxes. 

Paragraph 5 

Paragraph 5 provides for assistance in collection of taxes to the 

extent necessary to ensure that treaty benefits are enjoyed only by 

persons entitled to those benefits under the terms of the Convention. Under paragraph 5, a Contracting State will endeavor to collect on behalf of the other State only those amounts necessary to 

ensure that any exemption or reduced rate of tax at source granted 

under the Convention by that other State is not enjoyed by persons 

not entitled to those benefits. For example, if the payer of a U.S.- 

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mitted to withhold at the portfolio dividend rate of 15 percent. If, 

however, the addressee is merely acting as a nominee on behalf of 

a third-country resident, paragraph 5 would obligate the other Iceland to withhold and remit to the United States the additional tax 

that should have been collected by the U.S. withholding agent. 

This paragraph also makes clear that the Contracting State 

asked to collect the tax is not obligated, in the process of providing 

collection assistance, to carry out administrative measures that are 

different from those used in the collection of its own taxes, or that 

would be contrary to its sovereignty, security or public policy. 

Paragraph 6 

Paragraph 6 provides that a Contracting State must notify the 

competent authority of the other Contracting State before sending 

representatives to enter the requested State to interview individuals and examine books and records with the consent of the persons subject to examination. 

ARTICLE 26 (MEMBERS OF DIPLOMATIC MISSIONS AND CONSULAR

POSTS)

This Article confirms that any fiscal privileges to which diplomatic or consular officials are entitled under general provisions of 

international law or under special agreements will apply notwithstanding any provisions to the contrary in the Convention. The 

agreements referred to include any bilateral agreements, such as 

consular conventions, that affect the taxation of diplomats and consular officials and any multilateral agreements dealing with these 

issues, such as the Vienna Convention on Diplomatic Relations and 

the Vienna Convention on Consular Relations. The U.S. generally 

adheres to the latter because its terms are consistent with customary international law. 

The Article does not independently provide any benefits to diplomatic agents and consular officers. Article 18 (Government Service) 

does so, as do Code section 893 and a number of bilateral and multilateral agreements. In the event that there is a conflict between 

the Convention and international law or such other treaties, under 

which the diplomatic agent or consular official is entitled to greater 

benefits under the latter, the latter laws or agreements shall have 

precedence. Conversely, if the Convention confers a greater benefit 

than another agreement, the affected person could claim the benefit of the tax treaty. 

Pursuant to subparagraph 5(b) of Article 1 (General Scope), the 

saving clause of paragraph 4 of Article 1 does not apply to override 

any benefits of this Article available to an individual who is neither 

a citizen of the United States nor has immigrant status in the 

United States. 

ARTICLE 27 (ENTRY INTO FORCE)

This Article contains the rules for bringing the Convention into 

force and giving effect to its provisions. 

Paragraph 1 

Paragraph 1 provides that the Convention is subject to ratification in accordance with the applicable procedures of the United 

States and Iceland. Further, the Contracting States shall notify 

94 

each other by written notification, through diplomatic channels, 

when their respective applicable procedures have been satisfied. 

In the United States, the process leading to ratification and entry 

into force is as follows: Once a treaty has been signed by authorized representatives of the two Contracting States, the Department 

of State sends the treaty to the President who formally transmits 

it to the Senate for its advice and consent to ratification, which requires approval by two-thirds of the Senators present and voting. 

Prior to this vote, however, it generally has been the practice for 

the Senate Committee on Foreign Relations to hold hearings on the 

treaty and make a recommendation regarding its approval to the 

full Senate. Both Government and private sector witnesses may 

testify at these hearings. After the Senate gives its advice and consent to ratification of the treaty, an instrument of ratification is 

drafted for the President’s signature. ThePresident’s signature completes the process in the United States. 

Paragraph 2 

Paragraph 2 provides that the Convention will enter into force on 

the date of the later of the notifications referred to in paragraph 

1. The relevant date is the date on the second of these notification 

documents, and not the date on which the second notification is 

provided to the other Contracting State. The date on which a treaty 

enters into force is not necessarily the date on which its provisions 

take effect. Paragraph 2, therefore, also contains rules that determine when the provisions of the treaty will have effect. 

Under subparagraph 2(a), the Convention will have effect with 

respect to taxes withheld at source (principally dividends, interest 

and royalties) for income derived on or after the first day of January in the first calendar year following the date on which the Convention enters into force. For all other taxes, subparagraph 2(b) 

specifies that the Convention will have effect for taxes chargeable 

for any tax year beginning on or after January 1 of the year following entry into force. 

Paragraph 3 

Paragraph 3 provides an exception to the general rule of paragraph 2. Under paragraph 3, if the prior income tax convention between the United States and Iceland would have afforded greater 

relief from tax than this Convention, that prior convention shall, at 

the election of any person that was entitled to benefits under the 

prior convention, continue to have effect in its entirety for a twelvemonth period from the date on which this Convention otherwise 

would have had effect with respect to such person. 

Thus, a taxpayer may elect to extend the benefits of the prior 

convention for one year from the date on which the relevant provision of the new Convention would first take effect. During the period in which the election is in effect, the provisions of the prior 

convention will continue to apply only insofar as they applied before the entry into force of the Convention. If the grace period is 

elected, all of the provisions of the prior convention must be applied for that additional year. The taxpayer may not apply certain, 

more favorable provisions of the prior convention and, at the same 

time, apply other, more favorable provisions of this Convention. 

95 

The taxpayer must choose one convention in its entirety or the 

other. 

The prior convention shall terminate on the last date on which 

it has effect with respect to any tax in accordance with the provisions of Article 28. 

Paragraph 4 

Paragraph 4 provides that an individual who was entitled to benefits under Article 21 (Teachers) of the prior convention at the time 

of the entry into force of this Convention is ‘‘grandfathered,’’ and 

will continue to be entitled to the benefits available under the prior 

convention until such time as that individual would cease to be entitled to benefits if the prior convention remained in force. 

ARTICLE 28 (TERMINATION)

The Convention is to remain in effect indefinitely, unless terminated by one of the Contracting States in accordance with the provisions of Article 28. The Convention may be terminated by giving 

notice of termination in writing at least six months before the end 

of any calendar year. If notice of termination is given, the provisions of the Convention with respect to withholding at source will 

cease to have effect on income derived on or after the first day of 

January in the first calendar year following the year in which notice is given. For other taxes, the Convention will cease to have effect for taxes chargeable for any tax year beginning on or after the 

first day of January in the first calendar year following the year 

in which notice is given. 

Article 28 relates only to unilateral termination of the Convention by a Contracting State. Nothing in that Article should be construed as preventing the Contracting States from concluding a new 

bilateral agreement, subject to ratification, that supersedes, 

amends or terminates provisions of the Convention without the notification period. 

Customary international law observed by the United States and 

other countries, as reflected in the Vienna Convention on Treaties, 

allows termination by one Contracting State at any time in the 

event of a ‘‘material breach’’ of the agreement by the other Contracting State. 

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