DEPARTMENT OF THE TREASURY TECHNICAL EXPLANATION OF THE 

CONVENTION BETWEEN THE GOVERNMENT OF THE UNITED STATES OF 

AMERICA AND THE GOVERNMENT OF THE DEMOCRATIC SOCIALIST 

REPUBLIC OF SRI LANKA FOR THE AVOIDANCE OF DOUBLE TAXATION 

AND THE PREVENTION OF FISCAL EVASION WITH RESPECT TO TAXES ON 

INCOME SIGNED AT COLOMBO MARCH 14, 1985, AS AMENDED BY 

A PROTOCOL SIGNED AT WASHINGTON ON SEPTEMBER 20, 2002 

This is a Technical Explanation of the Convention between the Government of 

the United States of America and the Government of the Democratic Socialist Republic 

of Sri Lanka for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion 

with Respect to Taxes on Income Signed at Colombo March 14, 1985 (the 

“Convention”). The Convention was amended by a Protocol signed on September 20, 

2002 (the “Protocol”), which was accompanied by an explanatory Exchange of Notes 

(the “Notes”). 

Negotiations with respect to the Protocol took into account the U.S. Treasury 

Department's current tax treaty policy and the U.S. Treasury Department's Model Income 

Tax Convention published September 20, 1996 (the "U.S. Model"). Negotiations also 

took into account the Model Income Tax Convention on Income and on Capital, 

published by the Organization for Economic Cooperation and Development (the "OECD 

Model"), the United Nations Model Double Taxation Convention Between Developed 

and Developing Countries (the “UN Model”), and recent tax treaties concluded by both 

countries. 

The Technical Explanation is an official guide to the Convention. It reflects the 

policies behind particular Convention provisions, as well as understandings reached with 

respect to the application and interpretation of the Convention. 

References in the Technical Explanation to "he" or "his" should be read to mean 

"he or she" and "his or her." 

Article 1 (Personal Scope) 

Paragraph 1 

Paragraph 1 of Article 1 provides that the Convention applies to residents of the 

United States or Sri Lanka, 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 or other similar criteria. If, however, a person is considered a resident of both 

Contracting States, a single state of residence (or no state of residence) is assigned under 

Article 4. This determination generally governs for purposes of the Convention. 
Certain provisions of the Convention are applicable to persons who may not be 

residents of either Contracting State. For example, Article 20 (Government Service) may 

apply to an employee of a Contracting State who is resident in neither State. Paragraph 1 

of Article 25 (Nondiscrimination) applies to nationals of the Contracting States. Under 

Article 27 (Exchange of Information and Administrative Assistance), information may be 

exchanged with respect to residents of third states. 

Paragraph 2 

Paragraph 2 of Article 1 states the generally accepted relationship both between 

the Convention and domestic law and between the Convention and other agreements 

between the Contracting States (i.e., that no provision in the Convention may restrict any 

exclusion, exemption, deduction, credit or other allowance 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 5. 

Under paragraph 2, for example, if a deduction would be allowed under the U.S. 

Internal Revenue Code ("the Code") in computing the taxable income of a resident of Sri 

Lanka, the deduction also is allowed to that person in computing income under the 

Convention. Paragraph 2 also means that the Convention may not increase the tax burden 

on residents of the Contracting States beyond the burden determined under domestic law. 

Thus, a right to 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. For example, 

assume a resident of Sri Lanka has three separate businesses in the United States. One is 

a profitable permanent establishment and the other two are trades or businesses which 

would earn taxable income under the Code but which do not meet the permanent 

establishment threshold tests of the Convention. One of these trades or businesses is 

profitable and the other incurs a loss. Under the Convention, the income of the permanent 

establishment is taxable, 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 profit of the profitable trade or business and invoke the Code to claim the loss 

of the losing 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, the taxpayer would not be precluded from invoking the Convention, 

for example, with respect to any dividend income the taxpayer may receive from the 

United States that is not effectively connected with any of the taxpayer’s business 

activities in the United States. 

2
Nothing in the Convention can be used to deny any benefit granted by any other 

agreement between the United States and the other Contracting State. For example, if 

certain benefits are provided for military personnel or military contractors under a Status 

of Forces Agreement between the United States and Sri Lanka, 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 contains the traditional saving clause found in U.S. tax treaties. The 

Contracting States reserve their rights, except as provided in paragraph 4, 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 Sri Lanka performs 

independent personal services in the United States for less than 183 days within any 12-

month period and the income from the services is not attributable to a fixed base in the 

United States, Article 15 (Independent Personal Services) would by its terms prevent the 

United States from taxing the income. If, however, the resident of Sri Lanka 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 894(a)). 

For purposes of the saving clause, "residence" is determined under Article 4 

(Resident). Thus, an individual who is a U.S. resident under the Internal Revenue Code 

but who is deemed to be a resident of Sri Lanka under the tie-breaker rules of Article 4 

would be subject to U.S. tax only to the extent permitted by the Convention. For 

example, if an individual who is not a U.S. citizen is a resident of the United States under 

the Code, and is also a resident of Sri Lanka under its law, and the individual has a 

permanent home available to him in Sri Lanka and not in the United States, he would be 

treated as a resident of Sri Lanka under Article 4 and for purposes of the saving clause. 

The United States would not be permitted to apply its statutory rules to that person if they 

are inconsistent with the treaty. 

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). 

The application of the saving clause to former citizens and former long-term 

residents of a Contracting State. Each Contracting State reserves its right to tax former 

citizens and long-term residents whose loss of citizenship or long-term resident status had 

as one of its principal purposes the avoidance of tax. In the case of the United States, 

such a former citizen or long-term resident is taxable in accordance with the provisions of 

section 877 of the Code. Under section 877, the United States generally treats an 

3
individual as having a principal purpose to avoid tax if either of the following criteria 

exceed established thresholds: (a) the average annual net income tax of such individual 

for a 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. These thresholds are adjusted 

annually for inflation. Section 877(c) provides certain exceptions to these presumptions 

of a tax avoidance purpose. 

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 15 

taxable years ending with the taxable year in which the individual ceased to be a longterm resident. An individual shall not be treated as a lawful permanent resident for any 

taxable year if such individual is treated as a resident of a foreign country under the 

provisions of a tax treaty between the United States and the foreign country and the 

individual does not waive the benefits of such treaty applicable to residents of the foreign 

country. 

Paragraph 4 

Some provisions of the Convention are intended to provide benefits to citizens 

and residents even if such benefits do not exist under internal law. Paragraph 4 sets forth 

certain exceptions to the saving clause that preserve these benefits for citizens and 

residents of the Contracting States. 

Subparagraph (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 3: 

(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) Article 14 (Grants) covers grants provided by Sri Lanka in respect of an 

enterprise in Sri Lanka owned by a resident of the United States. 

(3) Paragraphs 2 and 3 of Article 19 (Pensions, Social Security, and Child Support 

Payments) deal with social security benefits and child support payments, 

respectively. The inclusion of paragraph 2 in the exceptions to the saving clause 

means that the grant of exclusive taxing rights with respect to social security 

benefits to the paying country applies to deny, for example, to the United States 

the right to tax its citizens and residents on social security benefits paid by Sri 

Lanka. The inclusion of paragraph 3, which exempts child support payments from 

taxation by both States, means that if a resident of Sri Lanka pays child support to 

a citizen or resident of the United States, the United States may not tax the 

recipient on such payments. 

4
(4) Article 24 (Relief from Double Taxation) confirms the benefit of a credit to 

citizens and residents of one Contracting State for income taxes paid to the other, 

even if such a credit may not be available under domestic law. 

(5) Article 25 (Nondiscrimination) requires one Contracting State to grant 

national treatment to nationals of the other Contracting State in certain 

circumstances. The inclusion of this Article in the exceptions to the saving clause 

requires, for example, that the United States give such benefits to a national of Sri 

Lanka even if that person is a citizen of the United States. 

(6) Article 26 (Mutual Agreement Procedure) may confer benefits on citizens and 

residents of the Contracting States. For example, the statute of limitations may be 

waived for refunds and the competent authorities are permitted to use a definition 

of a term that differs from the internal law definition. As with the foreign tax 

credit, these benefits are intended to be granted by a Contracting State to its 

citizens and residents. 

Subparagraph (b) of paragraph 4 provides a different set of exceptions to the 

saving clause. The benefits referred to in subparagraph (b) 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 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 

internal law rules. The benefits preserved by this paragraph are the host country 

exemptions for the following items of income: government service salaries and pensions 

under Article 20 (Government Service); certain income of visiting students and trainees 

under Article 21 (Students and Trainees); and the income of diplomatic agents and 

consular officers under Article 28 (Diplomatic Agents and Consular Officers). 

Paragraph 5 

Paragraph 5 specifically relates to nondiscrimination obligations of the 

Contracting States under other agreements. The provisions of paragraph 5 are an 

exception to the rule provided in subparagraph (b) of paragraph 2 of this Article under 

which the Convention shall not restrict in any manner any exclusive exemption, 

deduction, credit or other allowance now or hereafter accorded by any other agreement 

between the Contracting States. 

Subparagraph (a) of paragraph 5 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 the dispute. Thus, dispute-resolution procedures that may be 

5
incorporated into trade, investment, or other agreements between the Contracting States 

shall not apply for the purpose of determining the scope of the Convention. 

Subparagraph (b) of paragraph 5 provides that, unless the competent authorities 

determine that a taxation measure is not within the scope of this Convention, the 

nondiscrimination 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. 

Subparagraph (c) of paragraph 3 defines a "measure" broadly. It includes, for 

example, a law, regulation, rule, procedure, decision, administrative action or any other 

form of governmental action or guidance. 

Article 2 (Taxes Covered) 

This Article identifies the U.S. and Sri Lankan taxes to which the Convention 

applies. 

Paragraph 1 

Paragraph 1 is based upon the OECD Model and defines the scope of application 

of the Convention. The Convention applies to taxes on income imposed on behalf of a 

Contracting State, irrespective of the manner in which they are levied. Except with 

respect to Article 25 (Nondiscrimination), state and local taxes are not covered by the 

Convention. 

Paragraph 2 

Paragraph 2 lists the taxes in force at the time of signature of the Convention to 

which the Convention applies. 

Subparagraph 2(a) specifies the existing taxes of Sri Lanka that are covered by the 

Convention. In the case of Sri Lanka, the Convention applies to the income tax, including 

the income tax based on the turnover of enterprises licensed by the Greater Colombo 

Economic Commission. 

Subparagraph 2(b) provides that the existing United States covered taxes are the 

Federal income taxes imposed by the Code. Subparagraph 2(b) excludes from coverage 

the accumulated earnings tax and the personal holding company tax. Under the Code, 

however, these taxes will not apply to most foreign corporations because of a statutory 

exclusion or the corporation's failure to meet a statutory requirement. In the few cases 

6
where the taxes may apply to a foreign corporation, the tax due is not likely to be 

significant. 

Social security taxes (Code sections 1401, 3101, 3111 and 3301) also are 

specifically excluded from coverage even though they may be regarded as income taxes. 

Paragraph 3 

Paragraph 3 provides that the Convention will apply to any taxes that are 

substantially similar to those enumerated in paragraph 2, and which are imposed in 

addition to, or in place of, the existing taxes after the date of signature of the Convention. 

Paragraph 3 also provides that the U.S. and Sri Lankan competent authorities will notify 

each other of any significant changes in their taxation laws. The use of the term 

"significant" means that changes must be reported that are of significance to the operation 

of the Convention. 

The competent authorities also are obligated to notify each other of official 

published materials concerning the application of the Convention. This requirement 

encompasses materials such as technical explanations, regulations, rulings and judicial 

decisions relating to the Convention. 

Article 3 (General Definitions) 

Paragraph 1 

Paragraph 1 defines a number of basic terms used in the Convention. Certain 

others 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). The terms "dividends," 

"interest" and "royalties" are defined in Articles 10, 11 and 12, respectively. 

The introduction to paragraph 1 makes clear the definitions in Article 3 apply for 

all purposes of the Convention, unless the context requires otherwise. This latter 

condition allows the Convention to be interpreted in a manner that avoids unintended 

results. Terms that are not defined in the Convention are dealt with in paragraph 2. 

Subparagraph (a) defines the term “Sri Lanka” to mean the Democratic Socialist 

Republic of Sri Lanka. 

Subparagraph (b) defines the term "United States" to mean 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. Unlike the U.S. Model, the Convention does not 

explicitly include certain areas under the sea within the definition of the United States. 

However, the term "United States of America" is interpreted by reference to the U.S. 

internal law definition. Section 638 of the Code treats the continental shelf as part of the 

7
United States. Therefore, the definition of “United States” is understood to extend to 

include the sea bed and subsoil of undersea areas adjacent to the territorial sea of the 

United States. 

Subparagraph (c) states that the term "Contracting State" means the United States 

or Sri Lanka, as the context requires. 

Subparagraph (d) defines the term "person" to include an individual, a 

partnership, a company, an estate, a trust, and any other body of persons. This definition 

is relevant for a variety of provisions. 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 26 (Mutual Agreement Procedure). 

The term "company" is defined in subparagraph (e) as any body corporate or any 

entity treated as a body corporate for tax purposes. Although the Convention does not 

add "in the state where it is organized," as does the U.S. Model, the result should be same 

as under the U.S. Model because the Commentary to Article 3 of the OECD Model 

interprets language identical to that of the Convention in a manner consistent with the 

U.S. Model. 

The terms "enterprise of a Contracting State" and "enterprise of the other 

Contracting State" are defined in subparagraph (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. The term "enterprise" is not defined in the Convention, nor is it 

defined in the OECD Model or its Commentaries. The term is understood to refer to any 

activity or set of activities that constitute a trade or business. 

Like the U.S. Model, subparagraph (f) provides that 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. This phrase has 

been included in order to address more explicitly some of the questions that can arise in 

the context of fiscally transparent entities. In accordance with Article 4 (Resident), 

entities that are fiscally transparent in the country in which their owners are resident are 

not considered to be residents of a Contracting 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). Given the approach taken in Article 4, an enterprise conducted by such 

an entity arguably might not qualify as an enterprise of a Contracting State under the 

OECD Model language which refers to an enterprise conducted by a resident, although 

most countries would attribute the enterprise to the owners of the entity in such 

circumstances. The definition in the Convention is intended to make clear that 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. 

8
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 an enterprise of the United 

States). 

Subparagraph (g) defines the term "international traffic." The term means any 

transport by a ship or aircraft except when the vessel is operated solely between places 

within the other Contracting State. This definition is applicable principally in the context 

of Article 8 (Shipping and Air Transport). 

The exclusion from the definition of international traffic of transport by a ship or 

aircraft 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, therefore, would not apply to income from such carriage. 

Thus, if the carrier engaged in internal U.S. traffic were a resident of Sri Lanka (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 by a carrier resident in Sri Lanka 

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 even 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 international carrier, so long as both parts of the trip were reflected in original 

bills of lading. For this reason, the Convention 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 language of the Convention, based on U.S. Model language, 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. 

The term "national," as it relates to the United States and to Sri Lanka, is defined 

in subparagraph (h). This term is relevant for purposes of Articles 20 (Government 

9
Service) and 25 (Nondiscrimination). In the case of the United States, a national is an 

individual who is a United States citizen, and, in the case of Sri Lanka, a national is an 

individual possessing the nationality of Sri Lanka. In the case of both Contracting States, 

a national is any legal person, partnership or association deriving its status, as such, from 

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

Subparagraph (i) defines the term "competent authority" for Sri Lanka and the 

United States, respectively. The Sri Lankan competent authority is the CommissionerGeneral of Inland Revenue. 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 Director, International (LMSB). With respect to interpretative issues, the 

Director acts with the concurrence of the Associate Chief Counsel (International) of the 

Internal Revenue Service. 

The definition of the term "qualified governmental entity" in subparagraph (j) is 

relevant for purposes of Articles 4 (Resident) and 23 (Limitation on Benefits). The term 

means: 

(i) The Government of a Contracting State or of a political subdivision or 

local authority of the Contracting State; 

(ii) A person that is wholly owned by a governmental entity described in 

subparagraph (i) and that satisfies certain organizational and funding 

standards; and 

(iii) A pension fund of a person that meets the standards of subparagraphs (i) 

and (ii) and that provides pension benefits described in Article 19 

(Pensions, Social Security, And Child Support Payments). 

A qualified governmental entity described in subparagraphs (ii) and (iii) may not 

engage in any commercial activity. 

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. The 

paragraph makes clear that 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 

10
indicated in paragraph 3(e) of Article 26 (Mutual Agreement Procedure), 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 applied, 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. This allows the Convention to be 

interpreted in a manner that avoids unintended results. 

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 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 must also qualify for benefits under Article 23 (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. 

A person who, under those laws, is a resident of one Contracting State and not of the 

other need look no further. That person is a resident for purposes of the Convention of the 

State in which he is resident under internal law. If, however, a person is a resident of 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. and Sri Lankan law, 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). Subparagraphs (a) 

through (d) each address special cases that may arise in the context of Article 4. 

11
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, RICs, REITs and REMICs are all residents of the United 

States for purposes of the Convention. 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 this special tax treatment. 

Subparagraph (a) provides that a person who is liable to tax in a Contracting State 

only in respect of income from sources within that State will not be treated as a resident 

of that Contracting State for purposes of the Convention. Thus, a Sri Lankan consular 

official 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. income, would not 

be considered a resident of the United States for purposes of the Convention (See Code 

section 7701(b)(5)(B)). Similarly, a Sri Lankan enterprise 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 with 

respect to its income which 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. 

Subparagraph (b) addresses the treatment of fiscally transparent entities such as 

partnerships and certain estates and trusts that are not subject to tax at the entity level. 

This subparagraph 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. Entities falling under this description in the United States would 

include partnerships, common investment trusts under section 584, and grantor trusts. 

This paragraph also applies to U.S. limited liability companies ("LLC's") that are treated 

as partnerships for U.S. tax purposes. 

Under subparagraph (b), an item of income, profit or gain derived through such 

fiscally transparent entities will be considered to be derived by a resident of a Contracting 

State if the resident is treated under the taxation laws of the State where he is resident as 

deriving the item of income. For example, if a Sri Lankan company pays interest to an 

entity that is treated as fiscally transparent for U.S. tax purposes, the interest will be 

considered to be 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. law) as deriving the interest 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 interest income through the partnership. Also, it 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 for the interest paid to the entity under the 

Convention, because they are not residents of the United States for purposes of claiming 

this treaty benefit. (If, however, the country in which they are treated as resident for tax 

purposes, as determined under the laws of that country, has an income tax convention 

12
with Sri Lanka, they may be entitled to claim a benefit under that convention.) In 

contrast, if, for example, an entity is organized under U.S. laws and is classified as a 

corporation for U.S. tax purposes, interest paid by a Sri Lankan company to such 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. 

The same result obtains even if the entity were viewed differently under the tax 

laws of Sri Lanka (e.g., as not fiscally transparent in the first example above where the 

entity is treated as a partnership for U.S. tax purposes). Similarly, the characterization of 

the entity in a third country also is irrelevant, even if the entity is organized in that third 

country. These results 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 Sri Lankan tax 

purposes. These results also obtain regardless of where the entity is organized (i.e., in the 

United States, in Sri Lanka, or, as noted above, in a third country). 

For example, income from U.S. sources received by an entity organized under the 

laws of the United States, which is treated for Sri Lankan tax purposes as a corporation 

and is owned by a Sri Lankan shareholder who is a Sri Lankan resident for Sri Lankan 

tax purposes, is not considered derived by the shareholder of that corporation even if, 

under the tax laws of the United States, the entity is treated as fiscally transparent. Rather, 

for purposes of the Convention, the income is treated as derived by the U.S. entity. 

These principles also apply to trusts to the extent that they are fiscally transparent 

in either Contracting State. For example, if X, a resident of Sri Lanka, creates a revocable 

trust in the United States and names persons resident in a third country as the 

beneficiaries of the trust, X would be treated under U.S. law as the beneficial owner of 

income derived from the United States. In that case, the trust’s income would be regarded 

as being derived by a resident of Sri Lanka only to the extent that the laws of Sri Lanka 

treat X as deriving the income for Sri Lankan tax purposes. 

Subparagraph 1(c) provides that certain tax-exempt entities such as pension funds 

and charitable organizations will be regarded as residents of the United States. An entity 

will be described in this subparagraph if it is generally exempt from tax by reason of the 

fact that it is organized and operated exclusively to perform a charitable or similar 

purpose or to provide pension or similar benefits to employees. The reference to "similar 

benefits" is intended to encompass employee benefits such as health and disability 

benefits. 

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. 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 

13
tax on their unrelated business income. Thus, a U.S. pension trust or a section 501(c) 

organization (such as a U.S. charity) that is generally exempt from tax under U.S. law is 

considered a resident of the United States for all purposes of the Convention. 

Subparagraph 1(d) specifies that a qualified governmental entity (as defined in 

Article 3 (General Definitions)) is to be treated as a resident of the State where it is 

established. 

Paragraph 2 

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 2 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 closer (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 an habitual 

abode. If he has an 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 3 

Dual resident companies are addressed in paragraph 3. If such a person is, under 

the rules of paragraph 1, a resident of both Contracting States, the residence of such 

company will be the Contracting State under the laws of which it is organized or created. 

For example, a company is treated as a resident of the United States if it is created or 

organized under the laws of the United States or a political subdivision. Under Sri 

Lankan law, a company is treated as a resident of Sri Lanka if it is either registered there, 

its principal office is there, or it is managed and controlled there. Dual residence, 

therefore, can arise in the case of a U.S. company is managed and controlled in Sri 

Lanka. Paragraph 3 provides that the residence of such a company will be the Contracting 

State under the laws of which it is created or organized (i.e., the United States in the 

example). 

Paragraph 4 

Dual residents other than individuals or companies (such as trusts or estates) are 

addressed in paragraph 4. If such a person is, under the rules of paragraph 1, a resident of 

both Contracting States, the competent authorities shall seek to determine a single State 

of residence for that person for purposes of the Convention. 

14
Paragraph 5 

Paragraph 5 provides that an individual who is a national of a Contracting State 

will be considered to be a resident of that State if certain requirements are met. First, the 

individual must be an employee of that State or an instrumentality thereof in the other 

Contracting State or a third state. Second, the individual must perform governmental 

functions for the first-mentioned State. Finally, the individual must be subject, in the 

first-mentioned State, to the same income tax obligations as are residents of that State. 

The spouse and minor children of an individual who meets the above requirements also 

will be considered to be residents of the first-mentioned State as long as they are, in their 

own right, subject to the same income tax obligations as are residents of the firstmentioned State. 

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. Since the term 

"fixed base" in Article 15 (Independent Personal Services) is understood by reference to 

the definition of "permanent establishment," this Article is also relevant for purposes of 

Article 15. Articles 10, 11 and 12 (dealing with dividends, interest, and royalties, 

respectively) 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 or fixed base that the recipient has in the source State. The 

permanent establishment concept is also relevant in determining which Contracting State 

may tax certain gains under Article 13 (Capital Gains) and certain "other income" under 

Article 22 (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 4 (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. 

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 

15
of extraction of natural resources. Each of these also is explicitly included in the U.S. 

Model. 

Subparagraph (f) provides that a store or premises used as a sales outlet also 

constitutes a permanent establishment. While this type is not specifically provided for in 

the U.S. Model as a "fixed place of business through which the business of an enterprise 

is carried on," it is fully consistent with the principles of the Model and is, therefore, 

implicitly contained within the permanent establishment definition in the Model. 

Paragraph 3 

Subparagraph (a) provides rules to determine whether a building site or a 

construction or installation project or a drilling rig or ship used for the exploration of 

natural resources constitutes a permanent establishment for the contractor, installer, etc. 

Such an activity does not create a permanent establishment unless the site, project, etc. 

lasts for more than 183 days. 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(g). 

The 183-day test applies separately to each site or project. The 183-day 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 183-day 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 subcontractor itself to be treated as having a permanent establishment, the sub-contractor’s 

activities at the site must last for more then 183 days. If a sub-contractor is on a site 

intermittently, then, for purposes of applying the 183-day 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 subparagraph (a) 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 

subparagraph 3(a) of Article 5 of the Convention. 

If the 183-day threshold is exceeded, the site or project constitutes a permanent 

establishment from the first day of activity. 

16
Subparagraph 3(b) provides the rules for determining whether the furnishing of 

services by an enterprise through employees or other personnel constitutes a permanent 

establishment for the enterprise. Under the subparagraph, the furnishing of services gives 

rise to a permanent establishment if the activity continues for an aggregate of more than 

183 days in a twelve month period. Under the U.S. Model, such activities would 

constitute a permanent establishment only if they are exercised through a fixed place of 

business or by a dependent agent. 

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

display or deliver merchandise belonging to an enterprise, other than goods or 

merchandise held for sale in a store or sales outlet, 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, other than goods or merchandise held for sale in a 

store or sales outlet, does not give rise to a permanent establishment of the firstmentioned 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. Thus, as explained in paragraph 22 of the OECD Commentary to 

Article 5, a news bureau of a newspaper would not constitute a permanent establishment 

of the newspaper. 

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. This 

rule is different than the OECD Model, which requires that the overall combination of 

activities be of a preparatory or auxiliary character. The United States’ position is that a 

combination of activities that are each preparatory or auxiliary always will result in an 

overall activity that is also preparatory or auxiliary. 

Paragraph 5 

Paragraph 5 specifies when activities carried on by agent on behalf of an 

enterprise create a permanent establishment of that enterprise. Under subparagraph 5(a), a 

dependent agent of an enterprise of a Contracting State is deemed to be a permanent 

establishment of the enterprise in the other Contracting State if the agent has and 

habitually exercises an authority to conclude contracts in the name of that enterprise. If, 

however, the agent’s activities are limited to those activities specified in paragraph 4 that 

would not constitute a permanent establishment if carried on by the enterprise through a 

fixed place of business, the agent is not a permanent establishment of the enterprise. 

17
The U.S. Model uses the phrase “binding on the enterprise” rather than “in the 

name of that enterprise” With reference to the conclusion of contracts. There is no 

substantive difference. As indicated in paragraph 32 to the OECD Commentary on 

Article 5, paragraph 5 is intended to encompass a person who has sufficient authority to 

bind the enterprise’s participation in the business activity in the State concerned. It does 

not confine the application of the paragraph to an agent who enters contracts literally in 

the name of the enterprise. 

The contracts referred to in subparagraph (a) are those relating to the essential 

business operations of the enterprise rather than ancillary activities. For example, if the 

agent has no authority to conclude contracts in the name of the enterprise with its 

customers for 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 

used in the agent’s office, this contracting authority would not fall within the scope of the 

paragraph, even if exercised regularly. 

Subparagraph 5(b) provides that an agent will be deemed to be a permanent 

establishment for an enterprise if the agent habitually maintains a stock of goods or 

merchandise in the other State on behalf of the enterprise and regularly makes deliveries 

from that stock, and there have been some additional activities carried on in that other 

State on behalf of the enterprise which have contributed to the sale. It is not necessary 

that the agent have authority to conclude contracts in the name of the enterprise. It is also 

not necessary that the sales activities be carried out by the agent. They may be carried out 

by the enterprise itself or by another agent. 

Paragraph 6 

Paragraph 6 provides that an insurance enterprise of one Contracting States will 

be deemed to have a permanent establishment in the other Contracting State if it collects 

premiums or insures risks in that other State through a person other than an independent 

agent as determined under paragraph 7. 

Paragraph 7 

Under paragraph 7, 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. Thus, there are two conditions that 

must be satisfied: the agent 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 the activities on behalf of the enterprise 

Whether the agent and the enterprise are independent is a factual determination. 

Among the questions to be considered is 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 

18
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 has an exclusive or nearly exclusive relationship with 

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. 

Notwithstanding the above, if the agent’s activities are devoted wholly or almost 

wholly on behalf of the enterprise and transactions between the agent and the enterprise 

are on other than an arm’s-length basis, the agent will not be considered an independent 

agent. 

Paragraph 8 

Paragraph 8 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 of 

whether or not a permanent establishment exists will be made solely on the basis of the 

factors described in paragraphs 1 through 7 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)) 

Paragraph 1 

The first paragraph of Article 6 states the general rule that income of a resident of 

a Contracting State derived from immovable (real) property situated in the other 

Contracting State may be taxed in the Contracting State in which the property is situated. 

19
This Article does not grant an exclusive taxing right to the situs State; the situs 

State is merely given the primary right to tax. The Article does not include paragraph 5 

of Article 6 of the U.S. Model, and therefore does not impose any limitation in terms of 

rate or form of tax on the situs State. However, both the United States and Sri Lanka 

allow non-residents to be taxed on income from real property on a net basis in the same 

manner as a resident. 

Paragraph 2 

The term “immovable property” is defined in paragraph 2 by reference to the 

internal law definition in the situs State. It is to be understood from the parenthetical use 

of the term “real property” in the title to the Article and in paragraph 1, that the term is 

synonymous with the term “immovable property” which is used in the OECD Model. In 

the case of the United States, the term has the meaning given to it by Reg. §1.897-1(b). 

Paragraph 2 clarifies that real property includes, in any case, immovable property 

as described in the OECD Model, which includes references to accessory property, 

livestock and equipment used in agriculture and forestry, and rights to receive payments 

in exchange for the right to extract natural resources. Boats, ships and aircraft are not 

immovable 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. In the 

case of a net lease of real property, the gross rental payment (before deductible expenses 

incurred by the lessee) may be treated as income from the property. Income from the 

disposition of an interest in real property, however, is not considered "derived" from 

immovable property and is not dealt with in this Article. The taxation of that income is 

addressed in Article 13 (Capital Gains). Also, the interest paid on a mortgage on real 

property and distributions by a U.S. REIT are not dealt with in Article 6. Such payments 

would fall under Article 10 (Dividends), 11 (Interest) or 13 (Capital Gains). Finally, 

dividends paid by 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 (Dividends) or 13 (Capital Gains). 

Paragraph 4 

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

paragraph 3) applies to income from real property of an enterprise and to income from 

real property used for the performance of independent personal services. 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 or fixed base in the situs State. This provision represents an exception to 

the general rule under Articles 7 (Business Profits) and 15 (Independent Personal 

20
Services) that income must be attributable to a permanent establishment or fixed base, 

respectively, in order to be taxable in the host 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 in 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 this condition is 

met, the State in which the permanent establishment is situated may tax the enterprise on 

the income that is attributable to: (a) the permanent establishment; (b) sales in that State 

of goods or merchandise of the same or similar kind as those sold through the permanent 

establishment; or (c) other business activities carried on in that State of the same or 

similar kind as those effected through the permanent establishment. This limited force of 

attraction rule in paragraph 1 is similar to the rule in Article 7 of the U.N. Model. The 

rule in Article 7 of the U.S. Model is narrower, limiting the taxation of business profits to 

income attributable to a permanent establishment. 

Although the Convention does not include a definition of the term “business 

profits,” the term is intended to have the same meaning as under paragraph 7 of Article 7 

of the U.S. Model. Thus, the term “business profits” generally means income from any 

trade or business. It would include 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 22 

(Other Income). 

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 an independent enterprise engaged in the 

same or similar activities under the same or similar circumstances. This language 

incorporates the arm’s-length standard for purposes of determining the profits attributable 

to a permanent establishment. The computation of business profits attributable to a 

permanent establishment under this paragraph is subject to the rules of paragraph 3 for 

the allowance of expenses incurred for the purposes of earning the profits. 

21
The “attributable to” concept of paragraph 2 is analogous but not entirely 

equivalent to the “effectively connected” concept in Code section 864(c). The profits 

attributable to a permanent establishment may be from sources within or without a 

Contracting State. Thus, certain items of foreign source income described in section 

864(c)(4)(B) of the Code may be attributable to a U.S. permanent establishment of a Sri 

Lankan enterprise and subject to tax in the United States. However, the concept of 

“attributable to” in the Convention is narrower than the concept of “effectively 

connected” in section 864(c) of the Code. The limited “force of attraction” rule in Code 

section 864(c)(3), therefore, is not applicable under the Convention. 

Paragraph 3 

Paragraph 3 provides that in determining the business profits of a permanent 

establishment, deductions shall be allowed for the expenses 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 also includes a reasonable allocation of 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 State if properly allocable thereto. 

The paragraph specifies that the expenses that may be considered to be incurred 

for the purposes of the permanent establishment are expenses for research and 

development, interest and other similar expenses, as well as a reasonable amount of 

executive and general administrative expenses. This rule permits (but does not require) 

each Contracting State to apply the type of expense allocation rules provided by U.S. law 

(such as Treas. Reg. §§1.861-8 and 1.882-5). 

Paragraph 3 also states that a permanent establishment will not be permitted to 

deduct amounts it pays to the head office, or any other office, of the enterprise as 

royalties, fees or other similar payments in return for the use of patents, know-how or 

other rights, as commissions or other charges for specific services performed or for 

management, or as interest on moneys lent to the permanent establishment. Such 

payments made by the head office or any other office of the enterprise to a permanent 

establishment are similarly treated in determining the permanent establishment's profits. 

This provision is similar to the rule in Article 7(3) of the U.N. Model. 

Paragraph 4 

Paragraph 4 corresponds to paragraph 4 of Article 7 of the OECD Model and 

provides that a Contracting State in certain circumstances may determine the profits 

attributable to a permanent establishment on the basis of an apportionment of the total 

profits of the enterprise. A total profits method may be employed by a Contracting State 

22
if it has been customary in that State to use the method even though the figure may differ 

to some extent from a separate enterprise method so long as the result is in accordance 

with the principles of Article 7 (i.e., the application of the arm's length standard). 

Although this paragraph is not included in the U.S. Model, this is not a substantive 

difference because the result provided by paragraph 4 is consistent with the rest of Article 

7. 

The U.S. view is that paragraphs 2 and 3 of Article 7 authorize the use of total 

profits methods independently of paragraph 4 of Article 7 of the OECD Model because 

total profits methods are acceptable methods for determining the arm’s length profits of 

affiliated enterprises under Article 9. Accordingly, it is understood that, under paragraph 

2 of the Convention, it is permissible to use methods other than separate accounting to 

estimate the arm’s length profits of a permanent establishment where it is necessary to do 

so for practical reasons, such as when the affairs of the permanent establishment are so 

closely bound up with those of the head office that it would be impossible to disentangle 

them on any strict basis of accounts. Any such approach, like any approach used under 

paragraph 4, is acceptable only if it approximates the result that would be achieved under 

an approach based on separate accounting. This view is confirmed by the OECD 

Commentary on paragraphs 2 and 3 of Article 7. 

Paragraph 5 

Paragraph 5 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 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 permanent establishment is the purchase of goods or merchandise 

because such activity does not give rise to a permanent establishment under Article 5 

(Permanent Establishment). A common situation in which paragraph 5 is relevant is one 

in which a permanent establishment purchases raw materials for the enterprise's 

manufacturing operation conducted outside the Contracting State in which the permanent 

establishment is located and then the permanent establishment 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 6 

Paragraph 6 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. 

23
Paragraph 7 

Paragraph 7 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 

(Dividends). 

Paragraph 8 

Paragraph 8 incorporates into the Convention the rule of Code section 864(c)(6). 

Like the Code section on which it is based, paragraph 8 provides that any income or gain 

attributable to a permanent establishment or a fixed base during its existence is taxable in 

the Contracting State where the permanent establishment or fixed base is situated, even if 

the payment of that income or gain is deferred until after the permanent establishment or 

fixed base ceases to exist. This rule applies with respect to paragraphs 1 and 2 of Article 

7 (Business Profits), paragraph 4 of Article 10 (Dividends), paragraph 5 of Articles 11 

(Interest) and 12 (Royalties), paragraph 3 of Article 13 (Capital Gains), and Article 15 

(Independent Personal Services). 

The effect of this rule can be illustrated by the following example. Assume a 

company that is a resident of Sri Lanka 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. 

Relation to Other Articles 

This Article is subject to the saving clause of paragraph 3 of Article 1 (Personal 

Scope). Thus, if a citizen of the United States who is a resident of Sri Lanka under the 

Convention derives business profits from the United States that are not attributable to a 

permanent establishment in the United States, the United States may tax those profits as 

24
part of the worldwide income of the citizen, 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 23 (Limitation on Benefits). 

Thus, an enterprise of Sri Lanka 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 23. 

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(g) of Article 3 (General Definitions). The taxation of gains from the alienation of ships, 

aircraft or containers is dealt with not in this Article, but in paragraph 4 of Article 13 

(Gains). 

Paragraph 1 

Paragraph 1 provides that profits derived by an enterprise of a Contracting State 

from the operation of aircraft in international traffic are taxable only in that Contracting 

State. Because paragraph 7 of Article 7 (Business Profits) defers to Article 8 with respect 

to income from the operation of aircraft, 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 

Sri Lanka, Sri Lanka may not tax the airline's profits attributable to that office under 

Article 7. 

Paragraph 2 

Paragraph 2 provides for limited source-country taxation of income from the 

operation of ships in international traffic. Under this paragraph, the amount of tax that 

may be imposed by a Contracting State on profits derived by an enterprise of the other 

Contracting State from the operation of ships in international traffic shall be reduced to 

fifty percent of the amount which would have been imposed in the absence of the 

Convention. Thus, for example, under paragraph 2, the U.S. tax on the income of a Sri 

Lankan shipping company from the operation of ships in international traffic would be 

limited to a maximum of two percent of the company’s U.S. source gross transportation 

income from such operation (under section 887 of the Code, the tax rate is four percent). 

In the case of Sri Lanka, paragraph 2 limits the Sri Lankan tax on shipping profits to the 

lesser of fifty percent of the amount otherwise due or six percent of the gross receipts 

from passengers or freight embarked in Sri Lanka. 

Paragraph 2 is subject to paragraph 6 of Article 8, which further limits the amount 

of tax a Contracting State may impose under paragraph 2. The tax imposed by either 

Contracting State under paragraph 2 may not exceed the lowest rate that Sri Lanka 

imposes on profits of the same kind derived by a resident of a third state under any 

25
agreement with that third state. Sri Lanka has extended to other jurisdictions a full 

exemption for shipping income. Accordingly, the Notes clarify that the current effect of 

paragraph 6 is to grant a full exemption for income from the operation of ships in 

international traffic. 

Paragraph 3 

Paragraph 3 provides that income from the operation of aircraft in international 

traffic includes income from the rental of aircraft if the aircraft is operated in 

international traffic by the lessee or if such rental income is incidental to other profits 

described in paragraph 1. Thus, if a resident of the United States leases an aircraft to a 

resident of Sri Lanka, the lease payments will be exempt from tax in Sri Lanka either if 

the aircraft is used in international traffic by the resident of Sri Lanka, or if the U.S. 

lessor is engaged in the operation of aircraft in international traffic and the rental profits 

are incidental to such operation, regardless of whether the aircraft is used internationally 

or domestically by the lessee. Income from the rental of aircraft is incidental to income 

from the operation of aircraft in international traffic if the lessor is an airline and the 

aircraft is part of the body of equipment used by the lessor in its business as an 

international carrier. Such rental income is treated the same as income from the operation 

of aircraft under paragraph 1. 

Paragraph 4 

Paragraph 4 provides that incidental income of a resident of a Contracting State 

from the rental on a full (i.e., with crew) or bareboat (i.e., without crew) basis of ships 

operated by the lessee in international traffic may be taxable in both Contracting States, 

but the rate of tax imposed by the State of source may not exceed half of the rate of tax 

applied to royalties under paragraph 3 of Article 12 (Royalties) (i.e., 2.5 percent). 

Paragraph 4, like paragraph 2, is subject to paragraph 6 of this Article, which 

limits the amount of tax either Contracting State may impose under paragraph 4 to the 

lowest amount that Sri Lanka imposes under any agreement with a third state. Sri Lanka 

has extended to other jurisdictions a full exemption for shipping income, including the 

incidental income specified in paragraph 4. Accordingly, the Notes clarify that the current 

effect of paragraph 6 is to grant a full exemption for incidental income from the full or 

bareboat rental of ships operated by the lessee in international traffic. In addition, 

paragraph 5 of the Commentary to Article 8 of the OECD Model provides that "[p]rofits 

obtained by leasing a ship or aircraft on charter fully equipped, manned and supplied 

must be treated like the profits from the carriage or passengers or cargo." Accordingly, 

the combined effect of paragraph 6 and the exemption given by Sri Lanka to other 

countries is to exempt income from rentals on a full basis, whether or not the ship is used 

in international traffic by the lessee. 

26
Paragraph 5 

Under this paragraph, profits of an enterprise of a Contracting State from the use, 

maintenance or rental of containers (including equipment for their transport) that are used 

for the transport of goods or merchandise in international traffic are exempt from tax in 

the other Contracting State. This result obtains under paragraph 5 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. 

Paragraph 6 

Paragraph 6 states that Sri Lanka will provide to the United States most-favorednation treatment with respect to shipping income. Sri Lanka has provided to third states a 

full exemption for such income in Sri Lanka’s existing income tax conventions. 

Therefore, the Notes clarify that the same exemption extends to the United States on a 

most-favored-nation basis under paragraph 6. 

Subparagraph 6(a) provides that tax imposed by either State under paragraph 2, 

regarding income from the operation of ships in international traffic, shall not exceed the 

amount of Sri Lankan tax that may be imposed on this type of income derived by a 

resident of a third State. Sri Lanka agreed to provide a full exemption for such income in 

Article 8(1) of the Convention between the Government of the Democratic Socialist 

Republic of Sri Lanka and the Government of the United Kingdom of Great Britain and 

Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal 

Evasion with Respect to Taxes on Income and Capital Gains, signed at London on June 

21, 1979, and in Article 8(1) of the Convention Between the Government of the Polish 

People's Republic and the Government of the Democratic Socialist Republic of Sri Lanka 

for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect 

to Taxes on Income and Capital, signed at Colombo on April 25, 1980. Accordingly, Sri 

Lanka acknowledged in the Notes that the same exemption for income from the operation 

of ships in international traffic extends to such income derived by an enterprise of the 

United States. 

Subparagraph 6(b) states that the tax imposed by either Contracting State under 

paragraph 4, regarding rental income which is incidental to income described in 

paragraph 2, shall not exceed the amount of Sri Lankan tax that may be imposed on this 

type of income derived by a resident of a third State. The exemptions provided for 

shipping income in the Sri Lanka-United Kingdom and Sri Lanka-Poland conventions 

extend to this type of income. Accordingly, the Notes clarify that the current effect of 

paragraph 6 is to grant a full exemption for rental income which is incidental to income 

described in paragraph 2. 

Paragraph 6 also states that the limitations imposed on Sri Lanka’s ability to tax 

by subparagraphs 6(a) and 6(b) shall not apply on the basis of special domestic statutes 

applicable only to income derived by the government or governmental agency of a third 

27
State. Because those limitations have been otherwise reduced to zero, as reflected in the 

Notes, this statement has no current effect. 

Paragraph 7 

Paragraph 7 clarifies that the provisions of paragraphs 1 through 6 also apply to 

profits derived by an enterprise of a Contracting State from participation in a pool, joint 

business or international operating agency of any kind by enterprises engaged in the 

operation of ships or aircraft in international traffic. 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 7 makes clear that, with respect to each carrier, the Article 

applies to all income earned by the carrier with respect to the pool, and not just the 

income derived directly by that carrier. This paragraph corresponds to paragraph 4 of 

Article 8 of the U.S. Model. 

Relation to Other Articles 

This Article is subject to the saving clause of paragraph 3 of Article 1 (Personal 

Scope) of the Convention. Thus, if a citizen of the United States who is a resident of Sri 

Lanka derives profits from the operation of aircraft in international traffic, 

notwithstanding the exclusive residence country taxation in paragraph 1 of Article 8 

(Shipping and Air Transport), the United States may 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.) 

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 23 (Limitation on Benefits). 

Article 9 (Associated Enterprises) 

This Article incorporates in the Convention the arms-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. 

28
Paragraph 1 

Paragraph 1 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 Article 9 of 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.) 

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 transaction 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 

29
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 payer. Paragraph 2 of the Commentary to Article 9 of the OECD Model, together 

with the U.S. observation set forth in paragraph 15 thereof, 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 

Convention, like 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 to Article 9 of the OECD Model makes clear that the paragraph is to be 

read that way. 

As explained in the OECD Commentary to Article 9, Article 9 leaves the 

treatment of "secondary adjustments" to the laws of the Contracting States. When an 

adjustment under Article 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 had the funds at arm's length, 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 Sri Lanka, the provisions of Article 10 (Dividends) will 

apply, and the United States may impose a 15 percent withholding tax on the dividend. 

Also, if under Article 24 (Relief from Double Taxation) Sri Lanka 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 26 (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 26 (Mutual Agreement Procedure), notwithstanding 

any time limits or other procedural limitations in the law of the Contracting State making 

30
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 the other 

Contracting State. See Rev. Proc. 2002-52, 2002-31 I.R.B. 242, Section 7.04. 

Paragraph 3 

Paragraph 3 provides that the Contracting States preserve their rights to apply 

internal law provisions relating to adjustments between related parties. They also reserve 

the right to make adjustments in cases involving tax evasion or fraud. Such adjustments --

the distribution, apportionment, or allocation of income, deductions, credits or allowances 

-- are permitted even if they are different from, or go beyond, those authorized by 

paragraph 1, as long as they accord with the general principles of paragraph 1 (i.e., that 

the adjustment reflects what would have transpired had the related parties been acting at 

arm's length). For example, while paragraph 1 explicitly allows adjustments of 

deductions in computing taxable income, it does not deal with adjustments to tax credits. 

It does not, however, preclude such adjustments if they can be made under internal law. 

The OECD Model reaches the same result. See paragraph 4 of the Commentary to Article 

9. 

Relationship to Other Articles 

The saving clause of paragraph 3 of Article 1 (Personal Scope) does not apply to 

paragraph 2 of Article 9 by virtue of the exceptions to the saving clause in paragraph 4(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-country taxation of such 

dividends and a limited source-State right to tax. Finally, the article prohibits a State 

from imposing taxes on dividends paid by companies resident in the other Contracting 

State and from imposing taxes, other than a branch profits tax, on undistributed earnings. 

Article 12A provides rules for the imposition of a tax on branch profits by the 

State of source. 

Paragraph 1 

The right of a shareholder's country of residence to tax dividends arising in the 

other 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 

31
Contracting State. For dividends from any other source paid to a resident, Article 22 

(Other Income) grants the residence country exclusive taxing jurisdiction (other than for 

dividends attributable to a permanent establishment or fixed base 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 in paragraph 2. Generally, the source State's tax is 

limited to 15 percent of the gross amount of the dividend paid. 

Paragraph 2 also provides that this 15 percent maximum rate of withholding tax is 

applicable to dividends paid by a U.S. real estate investment trust only if one of three 

conditions is satisfied. First, the dividend may qualify for the 15 percent maximum rate 

of withholding tax if the beneficial owner of the dividend is an individual holding an 

interest in the REIT of not more than 10 percent. Second, the dividend may qualify for 

the 15 percent maximum rate of withholding tax if it is paid on a class of stock that is 

publicly traded and the beneficial owner of the dividends is a person holding an interest 

of not more than 5 percent of any class of the REIT’s stock. Third, the dividend may 

qualify for the 15 percent maximum rate of withholding tax if the beneficial owner of the 

dividend is a person holding an interest in the REIT of not more than 10 percent and the 

value of no single interest in real property owned by the REIT exceeds 10 percent of the 

value of the REIT’s total interest (i.e., the REIT is diversified). If none of these 

conditions is met, dividends paid by the REIT will be subject to the U.S. domestic 

withholding rate of 30 percent. 

The restrictions set forth above are intended to prevent the use of REITs to gain 

inappropriate source-country tax benefits for certain shareholder resident in the other 

Contracting State. For example, a resident of Sri Lanka directly holding U.S. real 

property would pay U.S. tax either at a 30-percent rate of withholding tax on the gross 

income or at graduated rates on the net income. By placing the real property in a REIT, 

the investor could transform real estate income into dividend income, taxable at the 15 

percent withholding tax rate provided in Article 10, reducing the U.S. tax that otherwise 

would be imposed. Paragraph 2 prevents this result and thereby avoids disparity between 

the taxation of direct real estate investments and real estate investments made through 

REITs. In the cases covered by the exceptions, the holding in the REIT is not considered 

the equivalent of a direct holding in the underlying real property. 

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. 

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 

32
governed by the internal law of the Contracting State, subject to the provisions of 

paragraph 4 of Article 25 (Nondiscrimination). 

The term "beneficial owner" is not defined in the Convention, and is, therefore, 

defined as under the internal law of the country imposing the 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 the 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 results are confirmed by paragraph 12 of the Commentary to Article 10 of the 

OECD Model. See also paragraph 24 of the Commentary to Article 1 of the OECD 

Model. 

Companies holding shares through fiscally transparent entities such as 

partnerships are considered for purposes of this paragraph to hold their proportionate 

interest in the shares held by the intermediate entity. 

Paragraph 3 

Paragraph 3 defines the term “dividends” broadly. 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 “dividends” includes income from shares, mining shares, founders’ 

shares or other corporate rights that are not treated as debt under the law of the source 

State, that 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. 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. 

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 subsidiary's 

and sister'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 

characterized by the United States as a dividend and, therefore, is not a dividend for 

purposes of Article 10, provided the limited liability company is not characterized as an 

association taxable as a corporation under U.S. law. 

33
Paragraph 4 

Paragraph 4 excludes from the general limitations on source-country tax under 

paragraph 2 dividends paid with respect to holdings that form part of the business 

property of a permanent establishment or a fixed base situated in the source country. 

Such 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 or fixed base is 

located, as 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. 

Relation to other Articles 

The saving clause of paragraph 3 of Article 1 (Personal Scope) permits the United 

States to tax dividends received by its residents and citizens, notwithstanding the 

foregoing limitation on source country taxation of dividends. 

The benefits of this Article are also subject to the provisions of Article 23 

(Limitation on Benefits). Thus, if a resident of Sri Lanka is the beneficial owner of 

dividends paid by a U.S. company, the shareholder must qualify for treaty benefits under 

at least one of the tests of Article 23 in order to receive the benefits of this Article. 

Article 11 (Interest) 

Article 11 provides rules for the taxation of interest arising in one Contracting 

State and paid to a beneficial owner that is a resident of the other Contracting State. 

Paragraph 1 

Paragraph 1 generally grants to the State of residence the exclusive right to tax 

interest paid to its residents and arising in the other Contracting State. 

Paragraph 2 

The State of source also may tax interest beneficially owned by a resident of the 

other State, subject to the limitations in paragraph 2. Generally, the source State's tax is 

limited to 10 percent of the gross amount of the interest paid if the beneficial owner is a 

resident of 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 interest income is attributable for tax 

purposes under the laws of the State of source. 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 

34
State would be entitled to benefits. These results are confirmed by paragraph 8 of the 

OECD Commentary to Article 11. See also paragraph 24 of the OECD Commentary to 

Article 1. 

Paragraph 3 

Paragraph 3 provides exceptions from the rule of paragraph 2 allowing sourcecountry tax. The exceptions apply to interest that is included in any of three categories. 

The first category of interest that is exempt from tax in the source State is interest the 

payer of which is the Government of the source State, or a political subdivision or a local 

authority thereof. The second category of interest that is exempt from tax in the source 

State is interest that is derived and beneficially owned by the Government of the other 

Contracting State (including, in the case of the United States, the Export-Import Bank 

and the Overseas Private Investment Corporation). The third category of interest that is 

exempt from tax in the source State is interest paid to the Federal Reserve Banks of the 

United States or the Central Bank of Ceylon. 

Paragraph 4 

The term "interest" as used in Article 11 is defined in paragraph 4 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 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), and (viii) interest with respect to notional principal 

contracts that are recharacterized as loans because of a “substantial non-periodic 

payment.” 

35
Paragraph 5 

Paragraph 5 provides exceptions to the limitations on source-country tax in 

paragraphs 2 and 3 for three classes of interest payments. 

Subparagraph (a) of paragraph 5 allows source-country taxation of interest in 

cases where the beneficial owner of the interest carries on business through a permanent 

establishment in the State of source or performs independent personal services from a 

fixed base situated in that State and the interest is attributable to that permanent 

establishment or fixed base. In such cases the provisions of Article 7 (Business Profits) or 

Article 14 (Independent Personal Services) 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 or fixed base that once existed in the 

State but that no longer exists, the provisions of subparagraph (a) also apply, by virtue of 

paragraph 8 of Article 7 (Business Profits), 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 8 of Article 7. 

The second exception, in subparagraph (b) of paragraph 5, 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. 

Subparagraph (c) deals with contingent interest of a type that does not qualify as 

portfolio interest under United States law, whether arising in the United States or Sri 

Lanka. Under this provision, contingent interest arising in one of the Contracting States 

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 that is paid to a resident of the other State, also may be 

taxed in the Contracting State in which it arises, and according to the laws of that State. 

If the beneficial owner of such interest is a resident of the other Contracting State, the 

gross amount of the interest may be taxed at a rate not exceeding 15 percent. 

Paragraph 6 

Paragraph 6 provides a source rule for interest. It provides that interest shall be 

deemed to arise in a Contracting State when the payer is that State itself or a political 

subdivision, local authority, or resident of that State. The exception to the general rule 

that interest is sourced in the State of the payer's residence is the case in which the payer 

of the interest, whether a resident of a Contracting State or not, is subject to tax on a net 

36
basis in the other State (either because it carries on business through a permanent 

establishment in the other State, performs independent personal services from a fixed 

base situated in the other State, or is subject to tax under Article 6 (Income from 

Immovable Property (Real Property)) or Article 13 (Capital Gains)) and the interest is 

borne by the activity subject to net basis taxation. In such cases, the interest will be 

deemed to arise in that other State. 

Paragraph 7 

Paragraph 7 provides that, in cases involving special relationships between 

persons, Article 11 applies only to that portion of the total interest payments between 

those persons that would have been made absent such special relationships (i.e., an arm'slength interest payment). Any excess amount of interest paid remains taxable according 

to the laws of the United States and Sri Lanka, 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 would be 

taxed as a dividend rather than as interest, but the tax would be subject, if appropriate, to 

the rate limitations of Article 10 (Dividends). 

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 (Associated Enterprises), which in turn correspond to the definition of "control" 

for purposes of section 482 of the Code. 

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 2. Consistent with Article 9 

(Associated Enterprises), the United States would apply section 482 or 7872 of the Code 

to determine the amount of imputed interest in those cases. 

Relation to Other Articles 

The saving clause of paragraph 3 of Article 1 (Personal Scope) permits the United 

States to tax its residents and citizens, notwithstanding the foregoing limitations on 

source country taxation of interest. 

The benefits of this Article are also subject to the provisions of Article 23 

(Limitation on Benefits). Thus, if a resident of Sri Lanka is the beneficial owner of 

interest paid by a U.S. corporation, the shareholder must qualify for treaty benefits under 

at least one of the tests of Article 23 in order to receive the benefits of this Article. 

37
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. 

Paragraph 1 

Paragraph 1 generally grants to the State of residence the exclusive right to tax 

royalties paid to its residents and arising in the other Contracting State. 

Paragraph 2 

Paragraph 2 provides an exception to exclusive residence-State taxation in the 

case of certain royalties. However, if the beneficial owner of such royalties is a resident 

of the other Contracting State, the source State shall not impose a tax that exceeds 10 

percent of the gross amount of the royalties. 

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 royalty income is attributable for tax 

purposes under the laws of the State of source. 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 results are confirmed by paragraph 4 of the 

OECD Commentary to Article 12. See also paragraph 24 of the OECD Commentary to 

Article 1. 

Paragraph 3 

Paragraph 3 provides an exception to exclusive residence-State taxation in the 

case of rentals for the use of tangible personal property. However, if the beneficial owner 

of such rentals is a resident of the other Contracting State, the source State may not 

impose a tax that exceeds 5 percent of the gross amount of the rentals. 

Paragraph 4 

Paragraph 4 defines the term "royalties" as used in Article 12. 

Subparagraph (a) provides that the term includes payments of any kind received 

as a consideration for the use of, or the right to use, any copyright of a literary, artistic, 

scientific or other work; for the use of, or the right to use, any patent, trademark, design 

or model, plan, secret formula or process, or other like right or property; or for 

information concerning industrial, commercial, or scientific experience. 

38
Subparagraph (b) provides that the term “royalties” includes rentals for the use of 

tangible 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 of 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. 

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 18 (Entertainers and Athletes), such as, 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 of, 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 of, 

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. 

39
The term "industrial, commercial, or scientific experience" (sometimes referred to 

as "know-how") has the meaning ascribed to it in paragraph 11 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 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 guarantee, or for pure technical assistance. 

The term "royalties" also does not include payments for professional services 

(such as architectural, engineering, legal, managerial, medical, or 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 transfer 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 5 

Paragraph 5 provides an exception to rules of paragraphs 2 and 3 that limit the 

rate of source country taxation of royalties. This paragraph applies in cases where the 

beneficial owner of the royalties carries on business through a permanent establishment 

in the State of source or performs independent personal services from a fixed base 

situated in that State and the royalties are attributable to that permanent establishment or 

fixed base. In such cases the provisions of Article 7 (Business Profits) or Article 15 

(Independent Personal Services) will apply. 

The provisions of paragraph 8 of Article 7 (Business Profits) apply for purposes 

of this paragraph. For example, royalty income that is attributable to a permanent 

establishment or a fixed base and that accrues during the existence of the permanent 

establishment or fixed base, but is received after the permanent establishment or fixed 

base no longer exists, remains taxable under the provisions of Articles 7 (Business 

Profits) or 15 (Independent Personal Services), respectively, and not under this Article. 

Paragraph 6 

Paragraph 6 provides a source rule for royalties. 

40
With respect to royalties defined in subparagraph 4(a), subparagraph (a) of 

paragraph 6 provides generally that such royalties are deemed to arise in a Contracting 

State if paid by a resident of that State, including the State itself or a political subdivision 

or local authority thereof. However, where the right or property for which the royalties 

are paid is used within the United States, the royalties are deemed to arise in the United 

States to the extent of such use. 

Subparagraph (b) of paragraph 6 provides that royalties defined in subparagraph 

4(b) are deemed to arise in a Contracting State to the extent the property for which the 

royalties are paid is used within the Contracting State. 

Paragraph 7 

Paragraph 4 provides that in cases involving special relationships between the 

payer 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). 

Relation to Other Articles 

The saving clause of paragraph 3 of Article 1 (Personal Scope) permits the United 

States to tax its residents and citizens, notwithstanding the foregoing limitations on 

source country taxation of royalties. 

The benefits of this Article are also subject to the provisions of Article 23 

(Limitation on Benefits). Thus, if a resident of Sri Lanka is the beneficial owner of 

royalties paid by a U.S. corporation, the shareholder must qualify for treaty benefits 

under at least one of the tests of Article 23 in order to receive the benefits of this Article. 

Article 12A (Branch Tax) 

Paragraph 1 

Paragraph 1 permits a State to impose a branch profits tax on a company resident 

in the other State. The tax is in addition to other taxes permitted by the Convention. Since 

the term "company" is not defined in the Convention, it will be defined for this purpose 

under the law of the host State. 

41
Paragraph 2 

Clause (i) of subparagraphs (a) and (b) permits the United States and Sri Lanka, 

respectively, to impose a branch profits tax on a company resident in the other State if the 

company has income attributable to a permanent establishment in the first-mentioned 

State, derives income from real property in the first-mentioned State that is taxed on a net 

basis under Article 6, or realizes gains taxable in the first-mentioned State under 

paragraph 1 of Article 13. The tax is limited, however, to the aforementioned items of 

income that are included in the "dividend equivalent amount." 

Clause (ii) of subparagraphs (a) and (b) permits the United States and Sri Lanka, 

respectively, to impose branch taxes on the excess interest of a company resident in the 

other State which derives business profits attributable to a permanent establishment in the 

first-mentioned State or which derives income subject to tax on a net basis in the firstmentioned State under Articles 6 or 13. 

The term "dividend equivalent amount" used in paragraph 2 has the same 

meaning that it has under section 884 of the Code, as amended from time to time, 

provided the amendments are consistent with the purpose of the branch profits tax. 

Generally, the dividend equivalent amount for a particular year is the income described 

above that is included in the corporation's effectively connected earnings and profits for 

that year, after payment of the corporate tax under Articles 6, 7 or 13, reduced for any 

increase in the branch's U.S. net equity during the year and increased for any reduction in 

its U.S. net equity during the year. U.S. net equity is U.S. assets less U.S. liabilities. See 

Treas. Reg. section 1.884-1. 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. In the case that the other 

Contracting State 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. 

Excess interest is generally the portion of the entire enterprise’s interest expense 

that is allocated to the branch over the amount of interest paid by the branch to third 

parties. The excess amount is deemed paid to the head office, and a tax is applied to the 

amount of that deemed payment. Such excess interest is treated under Article 11 as 

arising from the Contracting State in which the branch is located because it is borne by 

the permanent establishment. 

Neither Contracting State may impose a branch profits tax on the business profits 

of a company resident in the other State that are effectively connected with a trade or 

business in that Contracting State but that are not attributable to a permanent 

establishment and are not otherwise subject to in that State under Article 6 or paragraph 1 

of Article 13. 

42
Paragraph 3 

Subparagraph (a) provides that the branch profits tax imposed by the United 

States or Sri Lanka under subparagraphs (a)(i) and (b)(i) of paragraph 2 on the dividend 

equivalent amount shall be imposed at a rate not to exceed 15 percent. 

Subparagraph (b) provides that the branch tax imposed by the United States or Sri 

Lanka under subparagraphs (a)(ii) and (b)(ii) of paragraph 2 on excess interest shall be 

imposed at a rate not to exceed 10 percent. 

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 and defines the 

terms necessary to apply the Article. 

Paragraph 1 

Paragraph 1 of Article 13 preserves the non-exclusive right of the State of source 

to tax gains attributable to the alienation of real property situated in that State. The 

paragraph therefore permits the United States to apply section 897 of the Code to tax 

gains derived by a resident of Sri Lanka that are attributable to the alienation of real 

property situated in the United States (as defined in paragraph 2). Gains attributable to 

the alienation of real property include gain from any other property that is treated as a 

real property interest within the meaning of paragraph 2. 

Paragraph 2 

This paragraph defines the term "real property situated in the other Contracting 

State." 

Under subparagraph (a), the term “real property situated in the other Contracting State” 

includes both real property referred to in Article 6 (i.e., an interest in the real property 

itself) and a "United States real property interest," when the United States is the other 

Contracting State under paragraph 1. The "United States real property interest" includes 

shares in a U.S. company that owns sufficient U.S. real property interests to satisfy an 

asset-ratio test on certain testing dates. See I.R.C. §897(c). The term “United States real 

property interest” also encompasses an interest in a foreign company that has elected to 

be treated as a U.S. company for this purpose. See I.R.C. §897(i). The term also 

includes an interest in a partnership, trust or estate to the extent the assets of the 

partnership, trust or estate consist of property situated in the United States or of an 

interest referred to in the preceding sentence. In applying paragraph 1 the United States 

will look through capital gain distributions made by a REIT. Accordingly, distributions 

made by a REIT are taxable under paragraph 1 of Article 13 (not under Article 10 

(Dividends)) when they are attributable to gains derived from the alienation of real 

property. 

43
Under subparagraph (b), the term “real property situated in the other Contracting 

State” includes, when Sri Lanka is the other Contracting State, real property referred to in 

Article 6 (i.e., an interest in the real property itself) and an interest in a company the 

assets of which consist, directly or indirectly, principally of real property referred to in 

Article 6. The term also includes an interest in a partnership, trust or estate to the extent 

the assets of the partnership, trust or estate consist of property situated in Sri Lanka, or of 

an interest referred to in the preceding sentence. 

Paragraph 3 

Paragraph 3 of Article 13 deals with the taxation of certain gains from the 

alienation of property, other than real property, forming part of the business property of a 

permanent establishment that an enterprise of a Contracting State has in the other 

Contracting State or of property, other than real property, pertaining to a fixed base 

available to a resident of a Contracting State in the other Contracting State for the 

purpose of performing independent personal services. This also includes gains from the 

alienation of such a permanent establishment (alone or with the whole enterprise) or of 

such fixed base. Such gains may be taxed in the State in which the permanent 

establishment or fixed base is located. 

A resident of Sri Lanka 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 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 personal (movable) property 

forming part of the business property of the partnership in the United States. 

Paragraph 4 

This paragraph limits the taxing jurisdiction of the State of source with respect to 

gains from the alienation of ships or aircraft operated in international traffic by the 

enterprise alienating the ship or aircraft, from containers used in international traffic, 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 

Under paragraph 5, gains derived by a resident of a Contracting State from the 

sale of shares of a company, which is a resident of the other Contracting State, 

44
representing a participation of 50 percent or more may be taxed in the State in which the 

company is a resident. 

Paragraph 6 

This paragraph provides that gains described in Article 12 (Royalties) are taxable 

only under Article 12. Accordingly, gains derived from the alienation of any property, 

such as a patent or copyright, that produces income taxable under Article 12 is taxable 

under Article 12 and not under this Article, provided that such gain is of the type 

described in paragraph 4(a) of Article 12 (i.e., it is contingent on the productivity, use, or 

disposition of the property). 

Paragraph 7 

Paragraph 7 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 6. For example, gain derived from shares (other than shares described in 

paragraph 2 or 5, 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. Sales by a resident of a Contracting State of 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. 

Relation to other Articles 

The saving clause of paragraph 3 of Article 1 (Personal Scope) permits the United 

States to tax its citizens and residents, notwithstanding the foregoing limitations on 

taxation of certain gains by the State of source. 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. citizens or 

resident. 

The benefits of this Article are also subject to the provisions of Article 23 

(Limitation on Benefits). Thus, only a resident of a Contracting State that satisfies one of 

the conditions in Article 23 is entitled to the benefits of this Article. 

Article 14 (Grants) 

This Article details the manner in which Sri Lankan governmental grants to U.S. 

residents will be treated for U.S. tax purposes. This Article confirms, with some 

clarifying detail, the result which would obtain under U.S. law in the absence of the 

Convention. This provision is not found in the U.S. Model or the OECD Model, but a 

similar provision is contained in Article 10 (Grants) of the U.S.-Israel Income Tax 

Convention. 

45
Paragraph 1 

Paragraph 1 provides that for the purpose of computing United States tax, if Sri 

Lanka or any agency thereof makes a cash grant or any similar payment to a United 

States resident in respect of a wholly owned enterprise or company in Sri Lanka, then the 

amount of such grant will be excluded from the gross income of such resident or 

company and will not increase the earnings and profits of such resident or company. 

Paragraph 2 

Paragraph 2 specifies additional U.S. income tax consequences to certain 

recipients of a grant or payment described in paragraph 1. If the recipient is a U.S. 

resident that is a company, then the amount of the grant will be treated as a contribution 

to its capital. The U.S. resident will be considered to have contributed the amount of such 

grant to the Sri Lankan corporation designated by the terms of the grant, and the 

resident's basis for the stock of the Sri Lankan corporation will not be increased by the 

amount of the contributed grant. The basis of the assets of the Sri Lankan corporation will 

be reduced by the amount of the deemed contribution, in accordance with rules 

prescribed by the Secretary of the Treasury. 

The Convention has no special provision with respect to a U.S. resident who 

acquires assets directly from the proceeds of a grant. Thus, for example, if the U.S. 

resident is a corporation, the rules of section 362(c) of the Code will apply and the U.S. 

resident will be required to reduce its basis in certain assets acquired after the 

contribution. 

Paragraph 3 

Paragraph 3 specifies additional U.S. income tax consequences to certain grant 

recipients not described in paragraph 2. If Sri Lanka or its agency makes the grant or 

payment directly to a Sri Lankan company wholly owned by a U.S. resident, as described 

in paragraph 1, then the amount of the grant or payment will be treated as a contribution 

to the capital of the Sri Lankan company, and the basis of the assets of the Sri Lankan 

corporation will be reduced by the amount of the deemed contribution. [New] 

Paragraph 4 

Paragraph 4 limits the types of grants or payments that may qualify for treatment 

under paragraph 1. A qualifying grant will not include any amount which in whole or 

part, directly or indirectly, is in consideration for services rendered or to be rendered or 

for the sale of goods; is measured in any manner by the amount of profits or tax liability 

of the investor or the Sri Lankan corporation in which the investment is made; or which is 

taxed by Sri Lanka. These requirements generally are consistent with section 118 of the 

Code, regarding non-shareholder contributions to capital, and the regulations thereunder. 

46
Paragraph 5 

Paragraph 5 provides for an election by a U.S. resident who receives a grant or 

payment described in paragraph 1 to include such grant or payment in income. If he so 

elects, and the grant is included in income, Article 14 (Grants) would not apply, and the 

U.S. resident would increase his basis in the stock of the Sri Lankan corporation by the 

amount of the grant. [Israel/New] 

Article 15 (Independent Personal Services) 

The Convention deals in separate articles with different classes of income from 

personal services. Article 15 deals with the general class of income from independent 

personal services and Article 16 deals with the general class of income from dependent 

personal services. Articles 17 through 21 provide exceptions and additions to these 

general rules for directors' fees (Article 17); performance income of artistes and athletes 

(Article 18); pensions in respect of personal service income, social security benefits, and 

child support payments (Article 19); government service income (Article 20); and certain 

income of students and trainees (Article 21). 

Paragraph 1 

Paragraph l of Article 15 provides the general rule that an individual who is a 

resident of a Contracting State and who derives income from performing personal 

services in an independent capacity will be exempt from tax in respect of that income by 

the other Contracting State. The income may be taxed in the other Contracting State only 

if the services are performed there and (a) the individual is present in that other State for 

a period of more than 183 days in any 12-month period; or (b) the income is attributable 

to a fixed base that is regularly available to the individual in that other State for the 

purpose of performing his services. 

Income derived by persons other than individuals or groups of individuals from 

the performance of independent personal services is not covered by Article 15. Such 

income generally would be business profits taxable in accordance with Article 7 

(Business Profits). Income derived by employees of such persons generally would be 

taxable in accordance with Article 16 (Dependent Personal Services). 

The term "fixed base" is not defined in the Convention, but its meaning is 

understood to be similar, but not identical, to that of the term "permanent establishment," 

as defined in Article 5 (Permanent Establishment). The term "regularly available" also is 

not defined in the Convention. Whether a fixed base is regularly available to a person will 

be determined based on all the facts and circumstances. In general, the term encompasses 

situations where a fixed base is at the disposal of the individual whenever he performs 

services in that State. It is not necessary that the individual regularly use the fixed base, 

only that the fixed base be regularly available to him. For example, a U.S. resident 

partner in a law firm that has offices Sri Lanka would be considered to have a fixed base 

regularly available to him in Sri Lanka if the law firm had an office in Sri Lanka that was 

available to him whenever he wished to conduct business in the other State, regardless of 

47
how frequently he conducted business in the other State. On the other hand, an individual 

who had no office in the other State and occasionally rented a hotel room to serve as a 

temporary office would not be considered to have a fixed base regularly available to him. 

It is not necessary that the individual actually use the fixed base. It is only 

necessary that the fixed base be regularly available to him. For example, if an individual 

has an office in the other State that he can use if he chooses when he is present in the 

other State, that fixed base will be considered to be regularly available to him regardless 

of whether he conducts his activities there. 

The taxing right conferred by this Article with respect to income from 

independent personal services can be more limited than that provided in Article 7 for the 

taxation of business profits. In both articles the income of a resident of one Contracting 

State must be attributable to a permanent establishment or fixed base in the other State in 

order for that other State to have a taxing right. In Article 15 the income also must be 

attributable to services performed in that other State, while Article 7 does not require that 

all of the income generating activities be performed in the State where the permanent 

establishment is located. 

The term "personal services of an independent character" is not defined. It clearly 

includes those activities listed in paragraph 2 of Article 14 of the OECD Model, such as 

independent scientific, literary, artistic, educational or teaching activities, as well as the 

independent activities of physicians, lawyers, engineers, architects, dentists, and 

accountants. That list, however, is not exhaustive. The term includes all personal services 

performed by an individual for his own account, whether as a sole proprietor or a partner, 

where he receives the income and bears the risk of loss arising from the services. The 

taxation of income of an individual from those types of independent services which are 

covered by Articles 16 through 20 is governed by the provisions of those articles. For 

example, taxation of the income of a professional musician would be governed by Article 

18 (Artistes and Athletes) rather than Article 15. 

This Article 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 fixed base in that other State. 

The application of Article 15 to a service partnership may be illustrated by the 

following example: a partnership formed in Sri Lanka has five partners (who agree to 

split profits equally), four of whom are resident and perform services only in Sri Lanka at 

Office A, and one of whom performs personal services at Office B, a fixed base in the 

United States. In this case, the four partners of the partnership resident in Sri Lanka may 

be taxed in the United States in respect of their share of income attributable to the fixed 

base in the United State, Office B. The services giving rise to income which may be 

attributable to the fixed base 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 

48
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 8 of Article 7 (Business Profits) refers to Article 15. That rule clarifies 

that income that is attributable to a permanent establishment or a fixed base, but that is 

deferred and received after the permanent establishment or fixed base no longer exists, 

may nevertheless be taxed by the State in which the permanent establishment or fixed 

base was located. Thus, under Article l5, income derived by an individual resident of a 

Contracting State from services performed in the other Contracting State and attributable 

to a fixed base there may be taxed by that other State even if the income is deferred and 

received after there is no longer a fixed base available to the resident in that other State. 

If an individual resident of the other Contracting State who is also a U.S. citizen 

performs independent personal services in the United States, the United States may, by 

virtue of the saving clause of paragraph 3 of Article 1 (Personal Scope), tax his income 

without regard to the restrictions of this Article, subject to the special foreign tax credit 

rules of Article 23 (Relief from Double Taxation). 

Article 16 (Dependent Personal Services) 

Article 16 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 16 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 18 

(Artistes and Athletes), 19 (Pensions, Social Security, and Child Support Payments), and 

20 (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 16, it may not have the right to tax that income under the 

Convention if the income is described, for example, in Article 19 (Pensions, Social 

Security, and Child Support Payments) and is not taxable in the State of source under the 

provisions of that article. 

The Convention refers to “other remuneration." This language was intended to 

make clear that Article 16 applies to any form of compensation for employment, 

including payments in kind, regardless of whether the remuneration is "similar" to 

salaries and wages. The interpretation of Article 16 to include in kind payments is 

reflected in the addition of paragraph 2.1 to the Commentaries to Article 15 of the OECD 

Model. 

49
Consistent with section 864(c)(6), 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 services performed in the other Contracting State with respect to a 

particular taxable year would be subject to Article 16 for that year even if it was paid 

after the close of the year. Similarly, an annuity received for services performed in a 

taxable year would be subject to Article 16 despite the fact that it was paid in subsequent 

years. In either case, whether such payments were taxable in the State where the 

employment was exercised would depend on whether the tests of paragraph 2 were 

satisfied. 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. 

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: (1) the individual is present in the other Contracting State for a 

period or periods not exceeding 183 days in any 12-month period; (2) the remuneration is 

paid by, or on behalf of, an employer who is not a resident of that other Contracting 

State; and (3) the remuneration is not borne as a deductible expense by a permanent 

establishment or fixed base 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 similar to that set forth in the U.S. and OECD Models. 

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. See 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. These rules are consistent 

with the description of the 183-day period in paragraph 5 of the Commentary to Article 

15 in the OECD Model. 

Conditions (b) and (c) are intended to ensure that a Contracting State will not be 

required to allow a deduction to the payer 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 payer with a payment that can be identified as a 

50
reimbursement, 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 or fixed 

base 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 or fixed base notwithstanding 

the fact that the expenses will be neither deductible nor capitalizable since the payer is 

exempt from tax. 

Article 16 contains a special rule applicable to remuneration for services 

performed as an employee aboard a ship or aircraft operated in international traffic by an 

enterprise of a Contracting State. Under this paragraph, the employment income of a 

member of the regular complement of a ship or aircraft may be taxed only in the State of 

residence of the enterprise operating 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. This paragraph 

does not apply to persons dealt with in Article 15 (Independent Personal Services). 

U.S. internal law does not impose tax on non-U.S. source income of a person who 

is neither a U.S. citizen nor a U.S. resident, even if that person is an employee of a U.S. 

resident enterprise. Thus, under U.S. internal law, the United States will not tax the 

salary of a resident of Sri Lanka who is employed by a U.S. carrier and who is not a U.S. 

citizen or resident, except as provided in paragraph 2. 

Relation with other Articles 

Notwithstanding the foregoing limitations on taxation of certain income by the 

State of source the saving clause of paragraph 3 of Article l (Personal Scope) permits the 

Untied 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 income 

from employment does not apply to income of a U.S. citizen or resident. 

Article 17 (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 in 

that State by a resident of the other Contracting State as a director of the company. This 

rule is an exception to the more general rules of Article 15 (Independent Personal 

Services) and Article 16 (Dependent Personal Services). Thus, for example, in 

determining whether a director's fee paid to a non-employee director is subject to tax in 

51
the country of residence of the company, it is not relevant to establish whether the fee is 

attributable to a fixed base in that State. 

The analogous OECD provision reaches a different result in certain cases. Under 

the OECD Model provision, a resident of one Contracting State who is a director of a 

company 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. The 

United States has entered a reservation with respect to the OECD Model provision. Under 

this Convention, the State of residence of the company may tax nonresident directors 

with no time or dollar threshold, but only with respect to remuneration for services 

performed in that State. 

The Convention refers to “other compensation.” This language was intended to 

make clear that Article 17 applies to any form of compensation, including payments in 

kind, regardless of whether the remuneration is “similar” to director’s fees. This 

language was used even though it is no longer necessary because of a recent addition to 

the Commentary to Article 16 of the OECD Model; paragraph 1.1 now confirms that 

payments in kind are covered by the Article. 

Relation to other Articles 

Article 17 is subject to the saving clause of paragraph 3 of Article 1 (Personal 

Scope). Thus, if a U.S. citizen who is a resident of Sri Lanka is a director of a U.S. 

corporation, the United States may tax his full remuneration regardless of where he 

performs his services. 

Article 18 (Artistes and Athletes) 

This Article deals with the taxation in a Contracting State of entertainers (i.e., 

performing artists) and athletes 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 athlete 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 15 (Independent Personal Services) and 16 (Dependent Personal 

Services) 

This Article applies only with respect to the income of entertainers and athletes. 

Others involved in a performance or athletic event, such as producers, directors, 

technicians, managers, coaches, etc., remain subject to the provisions of Articles 15 and 

16. In addition, except as provided in paragraph 2, income earned by juridical persons is 

not covered by Article 18. 

52
Paragraph 1 

Paragraph 1 describes the circumstances in which a Contracting State may tax the 

performance income of an entertainer or athlete 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 athlete 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 $6,000 (or its equivalent in Sri Lanka rupees) for the taxable year. The 

$6,000 includes expenses reimbursed to the individual or borne on his behalf. If the gross 

receipts exceed $6,000, the full amount, not just the excess, may be taxed in the State of 

performance. 

The OECD Model provides for taxation by the country of performance of the 

remuneration of entertainers or athletes with no dollar or time threshold. The United 

States includes the dollar threshold test in its treaties to distinguish between two groups 

of entertainers and athletes -- those who are paid very 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. The United States has entered a reservation to the OECD Model 

on this point. 

Tax may be imposed under paragraph 1 even if the performer would have been 

exempt from tax under Articles 15 (Independent Personal Services) or 16 (Dependent 

Personal Services). On the other hand, if the performer would be exempt from hostcountry tax under Article 18, but would be taxable under either Article 15 or 16, 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 remuneration is not 

attributable to a fixed base in the host State, he may be taxed by the host State in 

accordance with Article 18 if his remuneration exceeds $6,000 annually, despite the fact 

that he generally would be exempt from host State taxation under Article 15. Moreover, a 

performer who receives less than the $6,000 threshold amount and therefore is not 

taxable under Article 18, nevertheless may be subject to tax in the host country under 

Articles 15 or 16 if the tests for host-country taxability under the relevant Article are met. 

For example, if an entertainer who is an independent contractor earns $5,000 of income 

in a State for the calendar year, but the income is attributable to a fixed base regularly 

available to him in the State of performance, that State may tax his income under Article 

15. 

Since it frequently is not possible to know until year-end whether the income an 

entertainer or athlete derived from a performance in a Contracting State will exceed 

$6,000, nothing in the Convention precludes that Contracting State from withholding tax 

during the year and refunding it after the close of the year if the taxability threshold has 

not been met. 

53
As explained in paragraph 9 of the Commentary to Article 17 of the OECD 

Model, Article 18 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 15 (Independent 

Personal Services). For example, if an entertainer receives royalty income from the sale 

of live recordings, the royalty income could be taxed by the source country under Article 

12 and he could also be taxed in the source country with respect to income from the 

performance itself under Article 18 if the dollar threshold is exceeded. 

In determining whether income falls under Article 18 or another article, the 

controlling factor will be whether the income in question is predominantly attributable to 

the performance itself or 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 18. 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 18 as well. As indicated in 

paragraph 9 of the Commentary to Article 17 of the OECD Model, a cancellation fee 

would not be considered to fall within Article 18 but would be dealt with under Article 7 

(Business Profits), 15 (Independent Personal Services) or 16 (Dependent Personal 

Services). 

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 16 (Dependent Personal Services), Article 18 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 with 

respect to a particular taxable year would be subject to Article 18 for that year even if it 

was paid after the close of the year. 

Paragraph 2 

Paragraph 2 of the Article provides an exception to the rules in paragraph 1 in the 

case of a visit to a Contracting State by an entertainer or athlete who is a resident of the 

other Contracting State, if the visit is wholly or mainly supported by the public funds of 

his State of residence or of a political subdivision or local authority of that State. In that 

case, only the Contracting State of which the entertainer or athlete is a resident may tax 

his income from those services. 

54
Paragraph 3 

Paragraph 3 is intended to deal with the potential for abuse 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 abuse of 

the tax system 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 in another form or 

at a later time. In such case, absent the provisions of paragraph 3, 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 in the year the services are performed, 

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 deferred salary payments, dividends or liquidating 

distributions. 

Paragraph 3 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 3, 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 (Article 7) or independent personal services 

(Article 15). Thus, even if the "employer" has no permanent establishment or fixed base 

in the host country, its income may be subject to tax there under the provisions of 

paragraph 3. Taxation under paragraph 3 is on the person providing the services of the 

performer. This paragraph does not affect the rules of paragraph 1, which apply to the 

performer himself. The income taxable by virtue of paragraph 3 is reduced to the extent 

of salary payments to the performer, which fall under paragraph 1. 

For purposes of paragraph 3, 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 not limited to, the 

accrual or receipt of deferred remuneration, bonuses, fees, dividends, partnership income 

or other income or distributions. 

Paragraph 3 does not apply if the person receiving the income establishes that 

neither the performer nor any persons related to the performer participate directly or 

55
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 Sri Lanka, 

and promoters of the performance in Sri Lanka pay the circus, which, in turn, pays 

salaries to the circus performers. The circus is determined to have no permanent 

establishment in Sri Lanka. 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 $6,000 threshold in paragraph 1. 

This exception from paragraph 3 for non-abusive cases is not found in the OECD 

Model. The United States has entered a reservation to the OECD Model on this point. 

Since pursuant to Article 1 (Personal Scope) the Convention only applies to 

persons who are residents of one of the Contracting States, if the star company is not a 

resident of one of the Contracting States then taxation of the income is not affected by 

Article 18 or any other provision of the Convention. 

Relationship to other articles 

This Article is subject to the provisions of the saving clause of paragraph 3 of 

Article 1 (Personal Scope). Thus, if an entertainer or a athlete who is resident in Sri 

Lanka 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 Article 24 (Relief from Double 

Taxation). In addition, benefits of this Article are subject to the provisions of Article 23 

(Limitation on Benefits) 

Article 19 (Pensions, Social Security and Child Support) 

This Article deals with the taxation of private (i.e., non-government service) 

pensions, social security benefits, and child support payments . 

Paragraph 1 

Paragraph 1 provides that distributions from pensions and other similar 

remuneration beneficially owned by a resident of a Contracting State in consideration of 

past employment are taxable only in the State of residence of the beneficiary. The term 

"pension distributions and other similar remuneration" includes both periodic and single 

sum payments. 

The phrase "pension distributions and other similar remuneration" is intended to 

encompass payments made by private retirement plans and arrangements in consideration 

of past employment. 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 

56
408(k), individual retirement accounts and section 408(p) accounts), section 457(g) 

governmental plans, section 403(a) qualified annuity plans, and section 403(b) plans. The 

competent authorities may agree that distributions from other plans that generally meet 

similar criteria to those applicable to other plans established under their respective laws 

also qualify for the benefits of Paragraph 1. 

Pensions in respect of government service 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 Article 20 (Government Service). Thus, Article 20 covers section 

457, 401(a) and 403(b) plans established for government employees. If a pension in 

respect of government service is not covered by Article 20 solely because the service is 

not "in the discharge of functions of a governmental nature," the pension is covered by 

this article. 

Paragraph 2 

Paragraph 2 provides for exclusive source-country taxation of social security 

benefits. 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 system to a resident of the other Contracting State will be taxable 

only in the Contracting State making the payment. This paragraph applies to social 

security beneficiaries whether they have contributed to the system as private sector or 

government employees. 

Paragraph 3 

Paragraph 3 generally covers periodic payments for the support of a minor child 

made pursuant to a written separation agreement or a decree of divorce, separate 

maintenance, or compulsory support. Paragraph 3 exempts from tax in both Contracting 

States such payments made by a resident of a Contracting State to a resident of the other 

Contracting State. Thus, child support payments from a resident of a Contracting State to 

a resident of the other Contracting State are taxable in neither Contracting State. 

Relationship to other Articles 

Paragraph 1 of Article 19 is subject to the saving clause of paragraph 3 of Article 

1 (Personal Scope). Thus, a U.S. citizen who is resident in Sri Lanka and receives a U.S. 

pension will be subject to U.S. net income tax on the payment, notwithstanding the rule 

in paragraph 1 that gives the State of residence of the recipient the exclusive taxing right. 

Paragraphs 2 and 3 of Article 19 are exceptions to the saving clause by virtue of 

Paragraph 4(a) of Article 1. Accordingly, a U.S. citizen who is a resident of Sri Lanka 

will not be subject to U.S. tax on any Sri Lanka social security benefits or child support 

payments. 

57
Article 20 (Government Service) 

Article 20 deals with the taxation of government compensation. This Article 

provides that remuneration paid from the public funds of one of the States or its political 

subdivisions 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. The 

paragraph applies both to government employees and to independent contractors engaged 

by governments to perform services for them. 

The remuneration described in this Article is subject to the provisions of this 

paragraph and not to those of Articles 15 (Independent Personal Services), 16 (Dependent 

Personal Services), 18 (Artistes and Athletes) or Article 19 (Pensions, Social Security, 

and Child Support Payments). If, however, the remuneration or pension is paid for 

services performed in connection with a business carried on the by a Contracting State or 

a political subdivision or local authority thereof, those other Articles will apply. This 

provision conforms with the OECD Model. 

Relation to other Articles 

Under paragraph 4(b) of Article 1 (Personal Scope), the saving clause (paragraph 

3 of Article 1) does not apply to the benefits conferred by one of the States under Article 

20 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 Sri Lanka who, in the course of rendering services to the 

government of Sri Lanka becomes a resident of the United States (but not a permanent 

resident), would be entitled to the exemption from source State taxation provided by this 

Article. 

Article 21 (Students and Trainees) 

This Article provides regarding the taxation of students, apprentices or business 

trainees. 

Paragraph 1 

Paragraph 1 provides that persons who meet the tests of the Article will be exempt 

from tax with respect to designated classes on income in the State they are visiting (the 

“host State”). Several conditions must be satisfied in order for an individual to be entitled 

to the benefits of this Article. 

First, the visitor must have been, either at the time of his arrival in the host State 

or immediately before, a resident of the other Contracting State. 

Second, the purpose of the visit must be the full-time education or training of the 

visitor. Thus, if the visitor comes principally to work in the host State but also is a parttime student, he would not be entitled to the benefits of this Article, even with respect to 

58
any payments he may receive from abroad for his maintenance or education, and 

regardless of whether or not he is in a degree program. Whether a student is to be 

considered full-time will be determined by the rules of the educational institution where 

he is studying. A person who visits the host State to obtain business training and who 

also receives a salary from his employer for providing services would not be considered a 

trainee and would not be entitled to the benefits of this Article with respect to the 

payments for services. 

The host-country exemption in Article 21 applies only to payments arising outside 

the host State that are received by the student, apprentice or business trainee for the 

purpose of his maintenance, education or training. A payment will be considered to arise 

outside the host State if the payer is located outside the host State. Thus, if an employer 

from one of the Contracting States sends an employee to the other Contracting State for 

training, the payments the trainee receives from abroad from his employer for his 

maintenance or training while he is present in the host State will be exempt from hostcountry tax. Where appropriate, substance prevails over form in determining the identity 

of the payer. Thus, for example, payments made directly or indirectly by the U.S. person 

with whom the visitor is training, but which have been routed through a source outside 

the United States (e.g., a foreign bank account) are not treated as arising outside the 

United States for this purpose. 

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 firstmentioned 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 $6,000 or its 

equivalent in Sri Lankan rupees. 

The saving clause of paragraph 3 of Article 1 (Personal Scope) does not apply to 

this Article with respect to an individual who is neither a citizen of the host State nor has 

been admitted for permanent residence there. The saving clause, however, does apply 

with respect to citizens and permanent residents of the host State. Accordingly, a U.S. 

citizen who is a resident of Sri Lanka and who visits the United States as a full-time 

student will not be exempt from U.S. tax on remittances from abroad that otherwise 

constitute U.S. taxable income. Under subparagraph (b) of paragraph 4 of Article 1, 

however, a Sri Lankan resident 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. 

59
Article 22 (Other Income) 

Article 22 generally assigns taxing jurisdiction over income not dealt with in the 

other articles (Articles 6 through 21) of the Convention. An item of income is "dealt 

with" in another article if it is the type of income described in the article and it has 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). 

Examples of items of income covered by Article 22 include income from 

gambling, punitive (but not compensatory) damages, covenants not to compete, and 

income from certain financial instruments to the extent derived by persons not engaged in 

the trade or business of dealing in such instruments (unless the transaction giving rise to 

the income is related to a trade or business, in which case it is dealt with under Article 7 

(Business Profits)). The article 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 22. 

Distributions from partnerships and trust distributions are not generally dealt with 

under Article 22 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. 

Under the Code, the trust income and distributions have the character of the associated 

distributable net income and therefore would generally be covered by another article of 

the Convention. See Code section 641 et seq. 

Paragraph 1 

The general rule of Article 22 is contained in paragraph 1. Subject to paragraph 2, 

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. 

Paragraph 2 

Paragraph 2 modifies the exclusive residence State taxation right to tax "other 

income" granted by paragraph 1. Under this paragraph, "other income" which arises in a 

Contracting State may be taxed by that State even if it is received by a resident of the 

other Contracting State. This is not an exclusive taxing right; the residence State may 

continue to tax. Any resulting double taxation is taken care of by the provisions of Article 

24 (Relief from Double Taxation). This rule is taken from the U.N. Model, and is 

consistent with the rules of several other U.S. treaties. 

60
Article 23 (Limitation on Benefits) 

Purpose of Limitation on Benefits Provisions 

The United States views an income tax treaty as a vehicle for providing treaty 

benefits to residents of the two Contracting States. The proper operation of a treaty 

requires that it apply to those that are bona fide residents of one of the Contracting States 

for the purpose of being granted treaty benefits. This principal has long been recognized. 

For example, the Commentaries to the OECD Model authorize a tax authority to deny 

treaty benefits, under substance-over-form principles, to a nominee in one State deriving 

income from the other on behalf of a third-country resident. In addition, although the text 

of the OECD Model does not contain express anti-abuse provisions, the Commentary to 

Article 1 contains an extensive discussion regarding the appropriateness of such 

provisions in tax treaties in order to limit the ability of third state residents to obtain 

treaty benefits. The United States holds strongly to the view that tax treaties should 

include provisions that specifically prevent misuse of treaties by residents of third 

countries. Consequently, all recent U.S. income tax treaties contain comprehensive 

Limitation on Benefits provisions. 

A treaty that provides treaty benefits to any resident of a Contracting State 

permits "treaty shopping": the use, by residents of third states, of legal entities 

established in a Contracting State with a principal purpose to obtain the benefits of a tax 

treaty between the United States and the other Contracting State. Treaty shopping does 

not encompass every case in which a third state resident establishes an entity in a U.S. 

treaty partner, and that entity enjoys treaty benefits to which the third state resident would 

not itself be entitled. If the third country resident had substantial reasons for establishing 

the structure that were unrelated to obtaining treaty benefits, the use of the entity in the 

U.S. treaty partner structure would not fall within this concept of treaty shopping. 

An anti-treaty shopping approach that required the tax authority to investigate the 

taxpayer's motives in establishing an entity in a particular country would be difficult to 

administer. In order to avoid the necessity of making such a subjective determination, 

Article 23 sets forth a series of objective tests. The assumption underlying each of these 

tests is that a taxpayer that satisfies the requirements of the test likely has a real business 

purpose for the structure it has adopted, or has a sufficiently strong nexus to the other 

Contracting State (e.g., a resident individual) to warrant benefits even in the absence of a 

business connection, and that this business purpose or connection is sufficient to justify 

the conclusion that obtaining the benefits of the treaty is not a principal purpose of 

establishing or maintaining residence in that other State. 

For instance, the assumption underlying the active trade or business test under 

paragraph 3 is that a third country resident that establishes a "substantial" operation in Sri 

Lanka and that derives income from a similar activity in the United States would not do 

so primarily to avail itself of the benefits of the Convention; it is presumed in such a case 

that the investor had a valid business purpose for investing in Sri Lanka, and that the link 

between that trade or business and the U.S. activity that generates the treaty-benefited 

61
income manifests a business purpose for placing the U.S. investments in the entity in Sri 

Lanka. It is considered unlikely that the investor would incur the expense of establishing 

a substantial trade or business in Sri Lanka simply to obtain the benefits of the 

Convention. A similar rationale underlies the other tests in Article 23. 

While these tests provide useful surrogates for identifying actual intent, these 

mechanical tests cannot account for every case in which the taxpayer was not treaty 

shopping. Accordingly, Article 23 also includes a provision (paragraph 4) authorizing the 

competent authority of a Contracting State to grant benefits in situations where none of 

the other tests of Article 23 is met. While an analysis under paragraph 4 may well differ 

from that under one of the other tests of Article 23, its objective is the same: to identify 

investors whose residence in the other State can be justified by factors other than a 

purpose to derive treaty benefits. 

Article 23 and the anti-abuse provisions of domestic law complement each other, 

as Article 23 effectively determines whether an entity has a sufficient nexus to the 

Contracting State to be treated as a resident for treaty purposes, while domestic antiabuse 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 State may be applied to identify 

the beneficial owner of an item of income, and Article 23 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. 

Structure of the Article 

Article 23 follows the form used in other recent U.S. income tax treaties. 

Paragraph 1 states the general rule that a resident of a Contracting State is 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 that, with respect to a person not entitled to benefits under paragraph 2, 

benefits nonetheless may be granted to that person with regard to certain types of income. 

Paragraph 4 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 5 defines the term "recognized stock exchange" as used in 

paragraph 2(c). 

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 through 

22, the treaty-based relief from double taxation provided by Article 24 (Relief from 

Double Taxation), and the protection afforded to residents of a Contracting State under 

62
Article 25 (Nondiscrimination). Some provisions do not require that a person be a 

resident in order to enjoy the benefits of those provisions. These include paragraph 1 of 

Article 25 (Non- Discrimination), Article 26 (Mutual Agreement Procedure), and Article 

28 (Diplomatic Agents and Consular Officers). Article 23 accordingly does not limit the 

availability of the benefits of these provisions. 

Paragraph 2 

Paragraph 2 has six subparagraphs, each of which describes a category of 

residents that are entitled to all benefits of the Convention. 

Individuals -- Subparagraph 2(a) 

Subparagraph (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. 

Qualified Governmental Entities -- Subparagraph 2(b) 

Subparagraph (b) provides that qualified governmental entities, as defined in 

subparagraph 3(j) of Article 3 (Definitions), also will be entitled to all benefits of the 

Convention. As described in Article 3, in addition to federal, state and local governments, 

the term "qualified governmental entity" encompasses certain government-owned 

corporations and other entities, and certain pension trusts or funds that administer pension 

benefits described in Article 19 (Government Service). 

Publicly-Traded Corporations -- Subparagraph 2(c)(i) 

Subparagraph (c) applies to two categories of corporations: publicly-traded 

corporations and subsidiaries of publicly-traded corporations. Clause (i) of subparagraph 

2(c) provides that a company will be entitled to all the benefits of the Convention if all 

the shares in the class or classes of shares that represent more than 50 percent of the 

voting power and value of the company are regularly traded on a "recognized stock 

exchange" located in either State. The term "recognized stock exchange" is defined in 

paragraph 5. 

If a company has only one class of shares, it is only necessary to consider whether 

the shares of that class are regularly traded on a recognized stock exchange. If the 

company has more than one class of shares, it is necessary as an initial matter to 

determine whether one of the classes accounts for more than half of the voting power and 

value of the company. If so, then only those shares are considered for purposes of the 

regular trading requirement. If no single class of shares accounts for more than half of the 

company's voting power and value, it is necessary to identify a group of two or more 

classes of the company's shares that account for more than half of the company's voting 

63
power and value, and then to determine whether each class of shares in this group 

satisfies the regular trading requirement. 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. 

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 (i.e., 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 the other Contracting State. Authorized but 

unissued shares are not considered for purposes of this test. 

Subsidiaries of Publicly-Traded Corporations -- Subparagraph 2(c)(ii) 

Clause (ii) of subparagraph 2(c) provides a test under which certain companies 

that are directly or indirectly controlled by companies satisfying the publicly-traded test 

of subparagraph 2(c)(i) may be entitled to the benefits of the Convention. Under this test, 

a company will be entitled to the benefits of the Convention if 50 percent or more of each 

class of shares in the company is directly or indirectly owned by companies that are 

described in subparagraph 2(c)(i). 

This test differs from that under subparagraph 2(c)(i) in that 50 percent of each 

class of the company's shares, not merely the class or classes accounting for more than 50 

percent of the company's votes and value, must be held by publicly-traded companies 

described in subparagraph 2(c)(i). Thus, the test under subparagraph 2(c)(i) considers the 

ownership of every class of shares outstanding, while the test under subparagraph 2(c)(ii) 

only considers those classes that account for a majority of the company's voting power 

and value. 

64
Clause (ii) permits indirect ownership. Consequently, the ownership by publiclytraded companies described in clause (i) need not be direct. However, any intermediate 

owners in the chain of ownership must themselves be entitled to benefits under paragraph 

2. 

Tax Exempt Organizations -- Subparagraph 2(d) 

Subparagraph 2(d) provides that the tax exempt organizations described in 

subparagraph 1(c)(i) of Article 4 (Resident) will be entitled to all the benefits of the 

Convention. These entities are entities that generally are exempt from tax in their State of 

residence and that are organized and operated exclusively to fulfill religious, educational, 

scientific and other charitable purposes. Unlike some recent U.S. treaties, there is no 

requirement that specified percentages of the beneficiaries of these organizations be 

residents of one of the Contracting States. 

Pension Funds -- Subparagraph 2(e) 

Subparagraph 2(e) provides that organizations described in subparagraph 1(c)(ii) 

of Article 4 (Resident) will be entitled to all the benefits of the Convention, as long as 

more than half of the beneficiaries, members or participants of the organization are 

individual residents of either Contracting State. The organizations referred to in this 

provision are tax-exempt entities that provide pension and other benefits to employees 

pursuant to a plan. For purposes of this provision, the term "beneficiaries" should be 

understood to refer to the persons receiving benefits from the organization. 

Ownership/Base Erosion -- Subparagraph 2(f) 

Subparagraph 2(f) provides an additional test that applies to any form of legal 

entity that is a resident of a Contracting State. The test provided in paragraph (f), the socalled ownership, base erosion test, is a two-part test. Both prongs of the test must be 

satisfied for the resident to be entitled to benefits under subparagraph 2(f). 

The ownership prong of the test, under clause (i), requires that 50 percent or more 

of each class of beneficial interests in the person (in the case of a corporation, 50 percent 

or more of each class of its shares) be owned on at least half the days of the person's 

taxable year by persons who are themselves entitled to benefits under the other tests of 

paragraph 2 (i.e., subparagraphs (a), (b), (c), (d), or (e)). The ownership may be indirect 

through other persons themselves entitled to benefits under paragraph 2. 

Trusts may be entitled to benefits under this provision if they are treated as 

residents under Article 4 (Resident) 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 the other 

65
provisions of paragraph 2 if it is not possible to determine the beneficiary's actuarial 

interest. Consequently, if it is not possible to determine the actuarial interest of any 

beneficiaries in a trust, the ownership test under clause (i) cannot be satisfied, unless all 

possible beneficiaries are persons entitled to benefits under the other subparagraphs of 

paragraph 2. 

The base erosion prong of clause (ii) of subparagraph (f) disqualifies a person if 

fifty percent or more of the person's gross income for the taxable year be paid or accrued, 

directly or indirectly, to a person or persons who are not residents of either Contracting 

State (unless income is attributable to a permanent establishment located in either 

Contracting State), in the form of payments deductible for tax purposes in the payer's 

State of residence. 

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. 

Deductible payments also do not include arm’s length payments in the ordinary course of 

business for services or tangible property or with respect to financial obligations to banks 

that are residents of either Contracting State, or that have a permanent establishment in 

either Contracting State to which the payment is attributable. 

The term "gross income" is not defined in the Convention. Thus, in accordance 

with paragraph 2 of Article 3 (General Definitions), in determining whether a person 

deriving income from United States sources is entitled to the benefits of the Convention, 

the United States will ascribe the meaning to the term that it has in the United States. In 

such cases, "gross income" will be defined as gross receipts less cost of goods sold. 

It is intended that the provisions of paragraph 2 will be self executing. Unlike the 

provisions of paragraph 4, 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. 

Paragraph 3 

Paragraph 3 sets forth a test under which a resident of a Contracting State that is 

not generally entitled to benefits of the Convention under paragraph 2 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. 

Subparagraph (a) sets forth a three-pronged test that must be satisfied in order for 

a resident of a Contracting State to be entitled to the benefits of the Convention with 

respect to a particular item of income. First, the resident must be engaged in the active 

conduct of a trade of business in its State of residence. Second, the income derived from 

the other State must be derived in connection with, or be incidental to, that trade or 

66
business. Third, the trade or business must be substantial in relation to the activity in the 

other State that generated the item of income. 

Trade or Business -- Subparagraphs 3(a)(i) and (b) 

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 

Sri Lanka 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 367(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. 

Notwithstanding this general definition of trade or business, subparagraph 3(b) 

provides that 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, insurance company, or 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 headquarter company will not be considered to be 

engaged in an active trade or business for purposes of paragraph 3(a). 

Derived in Connection With Requirement -- Subparagraphs 3(a)(ii) and (d) 

Subparagraph 3(d) provides that 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. A business activity generally will be considered to 

"form a 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. 

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 SLCo, a corporation resident in Sri Lanka. SLCo distributes 

USCo products in Sri Lanka. Because the business activities conducted by the two 

67
corporations involve the same products, SLCo's distribution business is considered to 

form a part of USCo's manufacturing. 

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 SLCo. 

SLCo and other USCo affiliates then manufacture and market the USCo-designed 

products in their respective markets. Since the activities conducted by SLCo 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. SLSub is a wholly-owned subsidiary of Americair 

resident in Sri Lanka. SLSub operates a chain of hotels in Sri Lanka that are located near 

airports served by Americair flights. Americair frequently sells tour packages that include 

air travel to Sri Lanka and lodging at SLSub 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 SLSub's 

business does not form a part of Americair's business. However, SLSub'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 SLSub owns an 

office building in Sri Lanka instead of a hotel chain. No part of Americair's business is 

conducted through the office building. SLSub'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 

68
the shares of SLHolding, a corporation resident in Sri Lanka. SLHolding is a holding 

company that is not engaged in a trade or business. SLHolding owns all the shares of 

three corporations that are resident in Sri Lanka: SLFlower, SLLawn, and SLFish. 

SLFlower distributes USFlower flowers under the USFlower trademark in Sri Lanka. 

SLLawn markets a line of lawn care products in Sri Lanka under the USFlower 

trademark. In addition to being sold under the same trademark, SLLawn and SLFlower 

products are sold in the same stores and sales of each company's products tend to 

generate increased sales of the other's products. SLFish imports fish from the United 

States and distributes it to fish wholesalers in Sri Lanka. For purposes of paragraph 3, the 

business of SLFlower forms a part of the business of USFlower, the business of SLLawn 

is complementary to the business of USFlower, and the business of SLFish is neither part 

of nor complementary to that of USFlower. 

Finally, a resident in one of the States also will be entitled to the benefits of the 

Convention with respect to income derived from the other State if the income is 

"incidental" to the trade or business conducted in the recipient's State of residence. 

Subparagraph 3(d) provides that income derived from a State will be incidental to a trade 

or business conducted in the other State if the production of such income facilitates the 

conduct of the trade or business in the other State. An example of incidental income is the 

temporary investment of working capital derived from a trade or business. 

Substantiality -- Subparagraphs 3(a)(iii) and (c) 

As indicated above, subparagraph 3(a)(iii) provides that income that a resident of 

a State derives from the other State will be entitled to the benefits of the Convention 

under paragraph 3 only if the income is derived in connection with a trade or business 

conducted in the recipient's State of residence and that trade or business is "substantial" in 

relation to the income-producing activity in the State of source. Subparagraph 3(c) 

provides that whether the trade or business of the income recipient is substantial will be 

determined based on all the facts and circumstances. These circumstances generally 

would include comparative sizes of the trades or businesses in each Contracting State 

(measured by reference to asset values, income and payroll expenses), the nature of the 

activities performed in each Contracting State, and the relative contributions made to that 

trade or business in each Contracting State. In making each determination or 

comparison, due regard will be given to the relative sizes of the U.S. and Sri Lankan 

economies. 

The determination in subparagraph 3(a)(iii) 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. 

The substantiality requirement is intended to prevent a narrow case of treatyshopping abuse in which a company attempts to qualify for benefits by engaging in de 

69
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). 

In addition to the subjective rule, subparagraph 3(c) provides a safe harbor under 

which the trade or business of the income recipient may be deemed to be substantial 

based on three ratios that compare the size of the recipient's activities to those conducted 

in the other State. The three ratios compare: (i) the value of the assets in the recipient's 

State to the assets used in the other State; (ii) the gross income derived in the recipient's 

State to the gross income derived in the other State; and (iii) the payroll expense in the 

recipient's State to the payroll expense in the other State. The average of the three ratios 

with respect to the preceding taxable year must exceed 10 percent, and each individual 

ratio must exceed 7.5 percent. If any individual ratio does not exceed 7.5 percent for the 

preceding taxable year, the average for the three preceding taxable years may be used 

instead. Thus, if the taxable year is 2005, the preceding year is 2004. If one of the ratios 

for 2004 is not greater than 7.5 percent, the average ratio for 2002, 2003, and 2004 with 

respect to that item may be used. 

The term "value" also is not defined in the Convention. Therefore, this term also 

will be defined under U.S. law for purposes of determining whether a person deriving 

income from United States sources is entitled to the benefits of the Convention. In such 

cases, "value” generally will be defined using the method used by the taxpayer in keeping 

its books for purposes of financial reporting in its country of residence. See Treas. Reg. 

section 1.884-5(e)(3)(ii)(A). 

Only items actually located or incurred in the two Contracting States are included 

in the computation of the ratios. If the person from whom the income in the other State is 

derived is not wholly-owned by the recipient (and parties related thereto) then the items 

included in the computation with respect to such person must be reduced by a percentage 

equal to the percentage control held by persons not related to the recipient. For instance, 

if a United States corporation derives income from a corporation in the other State in 

which it holds 80 percent of the shares, and unrelated parties hold the remaining shares, 

for purposes of subparagraph 3(c) only 80 percent of the assets, payroll and gross income 

of the company in the other State would be taken into account. 

Consequently, if neither the recipient nor a person related to the recipient has an 

ownership interest in the person from whom the income is derived, the substantiality test 

always will be satisfied (the denominator in the computation of each ratio will be zero 

and the numerator will be a positive number). Of course, the other two prongs of the test 

under paragraph 3 would have to be satisfied in order for the recipient of the item of 

income to receive treaty benefits with respect to that income. For example, assume that a 

resident of a Contracting State is in the business of banking in that State. The bank loans 

money to unrelated residents of the United States. The bank would satisfy the 

substantiality requirement of this subparagraph with respect to interest paid on the loans 

because it has no ownership interest in the payers. 

70
Paragraph 4 

Paragraph 4 provides that a resident of one of the States that is not otherwise 

entitled to the benefits of the Convention may be granted benefits under the Convention if 

the competent authority of the State from which benefits are claimed so determines. This 

discretionary provision is included in recognition of the fact that, with the increasing 

scope and diversity of international economic relations, there may be cases where 

significant participation by third country residents in an enterprise of a Contracting State 

is warranted by sound business practice or long-standing business structures and does not 

necessarily indicate a motive of attempting to derive unintended Convention benefits. 

The competent authority of a State will base a determination under this paragraph 

on whether 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. Thus, persons that 

establish operations in one of the States with the principal purpose of obtaining the 

benefits of the Convention ordinarily will not be granted relief under paragraph 4. 

The competent authority may determine to grant all benefits of the Convention, or 

it may determine to grant only certain benefits. For instance, it may determine to grant 

benefits only with respect to a particular item of income in a manner similar to paragraph 

3. Further, the competent authority may set time limits on the duration of any relief 

granted. 

It is assumed that, for purposes of implementing paragraph 4, a taxpayer will not 

be required to wait until the tax authorities of one of the States have determined that 

benefits are denied before he will be permitted to seek a determination under this 

paragraph. 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. For instance, a 

resident of a State could apply to the competent authority of his State of residence in a 

case in which he had been denied a treaty-based credit under Article 24 (Relief from 

Double Taxation) on the grounds that he was not entitled to benefits of the article under 

Article 23. 

Paragraph 5 

Paragraph 5 provides that the term "recognized stock exchange" means (i) the 

NASDAQ System owned by the National Association of Securities Dealers, 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 

Colombo Stock Exchange; and (3) any other stock exchange agreed upon by the 

competent authorities of the Contracting States. 

71
Article 24 (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 the appropriate amount of income taxes paid or accrued to Sri 

Lanka. Paragraph 1 also 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 Sri Lanka 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 of Sri Lanka on the profits out of 

which the dividends are considered paid. For purposes of paragraph 1, the taxes covered 

by subparagraph (a) of paragraph 2 and by paragraph 3 of Article 2 (Covered Taxes) are 

Sri Lankan taxes. 

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 this Article, i.e., 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 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. When the 

alternative minimum tax is due, the alternative minimum tax foreign tax credit generally 

is limited in accordance with U.S. law to 90 percent of alternative minimum tax liability. 

Paragraph 2 

Paragraph 2 provides that taxes paid to Sri Lanka by a company which is a 

resident of Sri Lanka on a distribution or remittance of dividends will be regarded as a tax 

on the shareholder for purposes of the credit allowed by the United States. 

Paragraph 3 

Sri Lanka agrees, in paragraph 3, to allow to its residents a credit against the Sri 

Lanka tax for the appropriate amount of income taxes paid or accrued to the United 

States. Paragraph 3 also provides for a deemed-paid credit to a Sri Lankan corporation in 

72
respect of dividends received from a corporation resident in United States of which the 

Sri Lankan corporation owns at least 10 percent of the voting stock. This credit is for the 

tax paid by the corporation of the United States on the profits out of which the dividends 

are considered paid. For purposes of paragraph 3, the taxes covered by subparagraph (b) 

of paragraph 2 and by paragraph 3 of Article 2 (Covered Taxes) are U.S. taxes. 

Paragraph 4 

Paragraph 4 provides that, for purposes of this Article, income which may be 

taxed in a Contracting State under the terms of this Convention will be considered to 

have its source in that State. However, domestic law source rules that apply for purposes 

of limiting the foreign tax credit will govern if they differ from the rules resulting from 

the treaty source rules. This permits the United States to apply the anti-abuse rules of 

Code section 904(g), for example. 

Article 25 (Nondiscrimination) 

This Article assures 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. 

For this purpose, non-discrimination means providing national treatment. Not all 

differences in tax treatment, either as between nationals of the two States, or between 

residents of the two States, are violations of this national treatment standard. Rather, the 

national treatment obligation of this Article applies 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 are 

comparably 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 (e.g., 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 will be 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 other or more burdensome," while paragraph 2 specifies that a tax "shall 

not be less favorably levied." Regardless of these differences 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. 

73
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 other than or 

more burdensome than the taxes and connected requirements imposed upon a national of 

that other State in the same circumstances. As noted above, whether or not the two 

persons are both taxable on worldwide income is a significant circumstance for this 

purpose. The use of the term “other” in paragraph 1 does not simply refer to different 

requirements; the only relevant question under this provision should be whether the 

requirement imposed on a national of the other State is more burdensome. A requirement 

may be different from the requirements imposed on U.S. nationals without being more 

burdensome. 

A national of a Contracting State is afforded protection under paragraph 1 even if 

the national is not a resident of either Contracting State. Accordingly, a U.S. citizen who 

is resident in a third country is entitled, under this paragraph, to the same treatment in Sri 

Lanka as a national of Sri Lanka who is in similar circumstances (i.e., presumably one 

who is resident in a third State). The term "national" in relation to a Contracting State is 

defined in subparagraph 1(h) of Article 3 (General Definitions). 

Because the relevant circumstances referred to in the paragraph relate, among 

other things, to taxation on worldwide income, the Convention specifically provides that 

a U.S. national who is not a resident in the United States is not in the same circumstances 

as a Sri Lanka national who is not a resident of 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 the other Contracting State who are not United States 

residents. Thus, for example, Article 25 would not entitle a national of the other 

Contracting State resident in a third country to taxation at graduated rates of 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, like the comparable paragraphs in the OECD and U.S. 

Models, 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 firstmentioned State that is carrying on the same activities. This provision, however, 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 Sri Lanka 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 Sri Lanka the personal allowances for himself and his family that he 

would be permitted to take if the permanent establishment were a sole proprietorship 

74
owned and operated by a U.S. resident, despite the fact that the individual income tax 

rates would apply. 

The fact that a U.S. permanent establishment of an enterprise of Sri Lanka 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 deny national treatment to 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)). Further, 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 Sri 

Lanka, 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 also provides that, notwithstanding the provisions of that paragraph, 

Sri Lanka retains the right to impose a tax on a permanent establishment of a U.S. 

enterprise under subsection 1(b) of Section 34 of Inland Revenue Act, No. 28 of 1979, as 

amended. However, the tax so imposed is limited to 15 percent of remittances, as defined 

in such section. 

75
Paragraph 3 

Paragraph 3 prohibits discrimination in the allowance of deductions. When a 

resident or 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 non-residents more favorable treatment than 

it gives 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 incurred for the benefit of a group of related persons that includes the 

person incurring the expense. 

The opening part of the paragraph lists provisions of the Convention where the 

protection it gives for deductions does not apply. These are concerned with transactions 

involving potential abuse, where it is appropriate for the Contracting State to continue to 

apply their anti-avoidance safeguards. The paragraph carves out from its coverage the 

special relationship paragraphs at paragraph 1 of Article 9 (Associated Enterprises), 

paragraph 7 of Article 11 (Interest) or paragraph 7 of Article 12 (Royalties) because 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 nondiscrimination principle in such cases. This exception with respect to paragraph 7 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 a resident or enterprise of a 

Contracting State to a resident of the other Contracting State are deductible in the firstmentioned Contracting State for computing the capital tax of the enterprise under the 

same conditions as if the debt had been contracted to a resident of the first-mentioned 

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. 

76
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 domestically-owned corporation 

that is accorded nonrecognition 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 4 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 (requiring 75 or 

fewer shareholders), 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 to conduct business in corporate form while paying taxes at individual rates 

as if the business were conducted directly.) A nonresident alien does not pay 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. 

Paragraph 5 

Paragraph 5 of the Article confirms that no provision of the Article will prevent 

either Contracting State from imposing the branch tax described in Article 12A (Branch 

Tax). 

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 

non-discrimination protection this Article applies, in relation to the United States, to taxes 

of every kind imposed at a national level. In relation to Sri Lanka, the Article applies to 

all taxes administered by the Commissioner-General of Inland Revenue. Customs duties 

are not considered to be taxes for this purpose. 

77
Relation to Other Articles 

The saving clause of paragraph 3 of Article 1 (Personal Scope) does not apply to 

this Article, by virtue of the exceptions in paragraph 4(a) of Article 1. Thus, for example, 

a U.S. citizen who is a resident of the other Contracting State 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 23 (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 23. 

Article 26 (Mutual Agreement Procedure) 

This Article provides the mechanism for taxpayers to bring to the attention of the 

competent authorities of the Contracting States issues and problems that may arise under 

the Convention. This Article also provides a mechanism 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 (i) of paragraph 1 of Article 3 (General Definitions). 

Paragraph 1 

This paragraph provides that where a person 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 the Contracting State of 

which he is a resident or national. 

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, if the United States treats income derived by a 

company resident in Sri Lanka as attributable to a permanent establishment in the United 

States, and the Sri Lankan resident believes that the income is not attributable to a 

permanent establishment, or that no permanent establishment exists, the Sri Lankan 

company may bring a complaint under paragraph 1 to the competent authority of Sri 

Lanka. 

It is not necessary for a person bringing a complaint 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. 

Like the U.S. Model, no time limit is provided within which a case must be brought. 

78
Paragraph 2 

This paragraph instructs the competent authorities in dealing with cases brought 

by taxpayers under paragraph 1. Paragraph 2 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 other Contracting 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 agreement). 

Where 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 Sri 

Lanka. See Rev. Proc. 2002-52, 2002-31 I.R.B. 242, § 7.04. Because, as specified in 

paragraph 2 of Article 1 (Personal 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 attribution of 

income, deductions, credits or allowances between an enterprise in one Contracting State 

and its permanent establishment in the other (subparagraph (a)) or between related 

persons (subparagraph (b)). 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, common treatment of a 

taxpayer's cost sharing arrangement, or upon an acceptable range of results under that 

methodology. 

As indicated in subparagraphs (c), (d), (e) and (g), the competent authorities also 

may agree to settle a variety of conflicting applications of the Convention. They may 

agree to characterize particular items of income in the same way (subparagraph (c)), to 

79
apply the same source rules to particular items of income (subparagraph (d)), and to 

adopt a common meaning of a term (subparagraph (e)). They 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 (subparagraph (g)). 

Subparagraph (f) authorizes the competent authorities to increase any dollar 

amounts (but not percentages) referred to in the Convention to reflect economic and 

monetary developments. The rule under subparagraph (f) is intended to operate as 

follows: if, for example, after the Convention has been in force for some time, inflation 

rates have been such as to make the $6,000 exemption threshold for entertainers 

unrealistically low in terms of the original objectives intended in setting the threshold, the 

competent authorities may agree to a higher threshold without the need for formal 

amendment to the treaty and ratification by the Contracting States. This authority can be 

exercised, however, only to the extent necessary to restore those original objectives. 

Because of paragraph 2 of Article 1 (Personal Scope), it is clear that this provision can be 

applied only to the benefit of taxpayers, i.e., only to increase thresholds, not to reduce 

them. 

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, or agree on consistent timing of gain recognition 

with respect to a transaction to the extent necessary to avoid double taxation. 

Agreements reached 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 pricing adjustment between two permanent 

establishments of a third-country resident, one in the United States and one in Sri Lanka. 

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 the Convention 

to prevent the double taxation. 

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 

80
appropriate, through face-to-face meetings of representatives of the competent 

authorities. 

Treaty effective dates and termination in relation to competent authority dispute 

resolution 

A case may be raised by a taxpayer under a treaty with respect to a year for which 

a treaty was in force after the treaty has been terminated. 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 their respective domestic 

laws. 

A case also may be brought to a competent authority under a treaty that is in 

force, but with respect to a year prior to the entry into force of the treaty. The scope of the 

competent authorities to address such a case is not constrained by the fact that the treaty 

was not in force when the transactions at issue occurred, and the competent authorities 

have available to them the full range of remedies afforded under this Article. 

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 threesided solution. Although country A may not be able to give information received under 

Article 27 (Exchange of Information) 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. 

Relation to Other Articles 

This Article is not subject to the saving clause of paragraph 3 of Article 1 

(Personal Scope) by virtue of the exceptions in paragraph 4(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 26 regardless of whether he is generally 

entitled to benefits under Article 23 (Limitation on Benefits). As in all other cases, the 

81
competent authority is vested with the discretion to decide whether the claim for relief is 

justified. 

Article 27 (Exchange of Information and Administrative Assistance) 

Paragraph 1 

This Article provides for the exchange of information between the competent 

authorities of the Contracting States. 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 Sri Lanka concerning the taxes covered by the Convention. Like the 

OECD Model and earlier U.S. Models, but unlike the most recent U.S. Model, paragraph 

1 refers to information that is “necessary” for carrying out the provisions of the 

Convention. This term consistently has been interpreted as being equivalent to 

"relevant," as used in the most recent U.S. Model, and does not require a requesting State 

to demonstrate that it would be prevented from enforcing its tax laws unless it obtained a 

particular item of information. 

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). As 

provided in paragraph 6, for purposes of exchange of information, covered taxes include 

taxes of every kind imposed at the national level by the United States, and to all taxes 

administered by the Commissioner-General of Inland Revenue of Sri Lanka. 

Exchange of information with respect to each State’s domestic law is authorized 

insofar as the taxation under those domestic laws 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 for the purpose of carrying 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 Sri Lanka transact 

business between themselves through a third-country resident company. Neither 

Contracting State has a treaty with the third State. In order 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 State may exchange information regarding 

the prices that their residents paid in their transactions with the third-country resident. 

Paragraph 1 clarifies that information exchange is not restricted by Article 1 

(Personal 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 Sri Lanka which 

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 Sri Lanka, and the Internal Revenue Service has reason to 

believe that funds in that account should have been reported for U.S. tax purposes but 

82
have not been so reported, information can be requested from Sri Lanka with respect to 

that person's account, even though that person is not the taxpayer under examination. 

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 appeals in relation to, the taxes covered by the Convention. The information must be 

used by these persons in connection with these designated functions. Information 

received may be disclosed in public court proceedings or in judicial decisions. 

The Article authorizes the competent authorities to exchange information on a 

routine basis, on request in relation to a specific case, or spontaneously. It is 

contemplated that the Contracting States will utilize this authority to engage in all of 

these forms of information exchange, as appropriate. 

Paragraph 2 

Paragraph 2 provides that the obligations undertaken in paragraph 1 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. 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, each Contracting State has confirmed in the Notes its ability to obtain and 

exchange certain information under Article 27. The information that may be exchanged 

includes 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, where the client seeks legal advice). In 

the case of the United States, the scope of the privilege for such confidential 

communications is co-extensive with the attorney-client privilege under U.S. law. The 

Contracting States may also obtain and exchange information relating to the ownership of 

legal persons. 

While paragraph 2 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 3 

Paragraph 3 provides that when information is requested by a Contracting State in 

accordance with this Article, the other Contracting State is obligated to obtain the 

83
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 information requested. 

Paragraph 3 further provides that the requesting State may specify the form in 

which such information is to be provided (e.g., depositions of witnesses and authenticated 

copies of original documents) so that the information can be usable 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 4 

Paragraph 4 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 4, 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.-source portfolio dividend receives a Form W-8BEN or other appropriate 

documentation from the payee, the withholding agent is permitted 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 4 would obligate Sri Lanka to 

take collection action against the person for the difference in applicable withholding rates 

in response to a specific request from the U.S. competent authority. 

Paragraph 5 

Paragraph 5 makes clear that the Contracting State asked to collect the tax 

pursuant to paragraph 4 is not obligated, in the process of providing such 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 

As noted above in the discussion of paragraph 1, the exchange of information 

provisions of the Convention apply to taxes of every kind imposed by the at the national 

level by the United States, and to all taxes administered by the Commissioner-General of 

Inland Revenue of Sri Lanka. The U.S. competent authority may, therefore, request 

information for purposes of, for example, estate and gift taxes or federal excise taxes. 

Treaty effective dates and termination in relation to exchange of information 

Once the Convention is in force, the competent authority may seek information 

under the Convention with respect to a year prior to the entry into force of the 

Convention. Even though the Convention was not in effect during the years in which the 

transaction at issue occurred, the exchange of information provisions of the Convention 

84
apply. In that case, the competent authorities have available to them the full range of 

information exchange provisions afforded under this Article. 

A tax administration may also seek information with respect to a year for which a 

treaty was in force after the treaty has been terminated. In such a case the ability of the 

other tax administration to act is limited. The treaty no longer provides authority for the 

tax administrations to exchange confidential information. They may only exchange 

information pursuant to domestic law. 

Article 28 (Diplomatic Agents and Consular Officers) 

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 20 (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 tax treaty confers a 

greater benefit than another agreement, the affected person could claim the benefit of the 

tax treaty. 

Pursuant to subparagraph 4(b) of Article 1, the saving clause of paragraph 3 of 

Article 1 (Personal Scope) 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 there. 

Article 29 (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 for the ratification of the Convention by both Contracting 

States according to their constitutional and statutory requirements. Instruments of 

ratification shall be exchanged as soon as possible. 

85
The Protocol amending the Convention, signed September 20, 2002, provides that 

the Protocol shall also be subject to ratification in accordance with the applicable 

procedures of each Contracting State and that instruments of ratification shall be 

exchanged as soon as possible. 

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 receiving the advice and consent of the Senate to ratification, the treaty is returned 

to the President for his signature on the ratification document. The President's signature 

on the document completes the process in the United States. 

Paragraph 2 

Paragraph 2 provides that the Convention will enter into force upon exchange of 

instruments of ratification. 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 paragraph 2(a), the Convention will have effect with respect to taxes 

withheld at source (principally dividends, interest and royalties) for amounts paid or 

credited on or after the first day of the second month following the date on which the 

Convention enters into force. For example, if instruments of ratification are exchanged 

on April 25 of a given year, the withholding rates specified in paragraph 2 of Article 10 

(Dividends) would be applicable to any dividends paid or credited on or after June 1 of 

that year. This rule allows the benefits of the withholding reductions to be put into effect 

quickly, while allowing sufficient time for withholding agents to be informed about the 

change in withholding rates. If for some reason a withholding agent withholds at a higher 

rate than that provided by the Convention (perhaps because it was not able to re-program 

its computers before the payment is made), a beneficial owner of the income that is a 

resident of Sri Lanka may make a claim for refund pursuant to section 1464 of the Code. 

With respect to all other taxes (including the branch profits tax), paragraph 2(b) 

specifies that the Convention will have effect for any taxable year or assessment period 

beginning on or after January 1 of the year in which the Convention enters into force. 

As discussed under Articles 26 (Mutual Agreement Procedure) and 27 (Exchange 

of Information), the powers afforded the competent authority under these articles apply 

retroactively to taxable periods preceding entry into force. 

86
Article 30 (Termination) 

The Convention is to remain in effect indefinitely, unless terminated by one of the 

Contracting States in accordance with the provisions of Article 30. The Convention may 

be terminated at any time after 5 years from the date on which the Convention enters into 

force. A Contracting State seeking to terminate the Convention must give at least six 

months' notice through diplomatic channels. 

If notice of termination is given, the provisions of the Convention with respect to 

withholding at source will cease to have effect for payments made or credited on or after 

January 1 next following the expiration of the six month notification period. With 

respect to other taxes, the Convention will cease to have effect with respect to income of 

taxable years beginning on or after January 1 next following the expiration of the six 

month notification period. 

Article 30 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 six-month 

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. 

Protocol 

A Protocol accompanies and forms part of the Convention. The provisions of 

Articles I through XIX of the Protocol are discussed in connection with the relevant 

Articles of the Convention. 

87