UNITED STATES MODEL

INCOME TAX CONVENTION OF

SEPTEMBER 20, 1996

TECHNICAL EXPLANATION
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TITLE AND PREAMBLE

PURPOSE OF MODEL CONVENTION AND TECHNICAL EXPLANATION

Set forth below is an explanation of the purposes for

publishing a Model Convention and Technical Explanation.

The Model is drawn from a number of sources. Instrumental

in its development was the U.S. Treasury Department's draft Model

Income Tax Convention, published on June 16, 1981 ("the 1981

Model") and withdrawn as an official U.S. Model on July 17, 1992,

the Model Double Taxation Convention on Income and Capital, and

its Commentaries, published by the OECD, as updated in 1995 ("the

OECD Model"), existing U.S. income tax treaties, recent U.S.

negotiating experience, current U.S. tax laws and policies and

comments received from tax practitioners and other interested

parties.

For over thirty years the United States has actively

participated in the development of the OECD Model, and the United

States continues its support of that process. Accordingly, the

publication of a U.S. Model does not represent a lack of support

for the work of the OECD in developing and refining its Model

treaty. To the contrary, the strong identity between the

provisions of the OECD and U.S. Models reflects the fact that the

United States drew heavily on the work of the OECD in the

development of the U.S. Model. References are made in the

Technical Explanation to the OECD commentaries, where

appropriate, to note similarities and differences.

Like the OECD Model, the Model is intended to be an

ambulatory document that may be updated from time to time to

reflect further consideration of various provisions in light of

experience, subsequent treaty negotiations, economic, judicial,

legislative or regulatory developments in the United States, and

changes in the nature or significance of transactions between

U.S. and foreign persons. The Technical Explanation is also

intended to be ambulatory, and may be expanded to deal with new

issues that may arise in the future. The Model will be more

useful if it is understood which developments have given rise to

alterations in the Model, rather than leaving such judgements to

be inferred from actual treaties concluded after the release of

the Model. The manner and timing of such updates will be

subsequently determined. 
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The Model does not present alternative provisions that might

be included in a particular treaty under a particular set of

circumstances. For example, a treaty with a country that has a

remittance basis or an integrated system of corporate taxation

might have to depart significantly in several respects from the

Model.

For this reason and others, the Model is not intended to

represent an ideal United States income tax treaty. Rather, a

principal function of the Model is to facilitate negotiations by

helping the negotiators identify differences between income tax

policies in the two countries. In this regard, the Model can be

especially valuable with respect to the many countries that are

conversant with the OECD Model. Such countries can compare the

Model with the OECD Model and very quickly identify issues for

discussion during tax treaty negotiations. By helping to

identify legal and policy differences between the two treaty

partners, the Model will facilitate the negotiations by enabling

the negotiators to move more quickly to the most important issues

that must be resolved. Reconciling these differences will lead

to an agreed text that will differ from the Model in numerous

respects. Another purpose of the Model and the Technical

Explanation is to provide a basic explanation of U.S. treaty

policy for all interested parties, regardless of whether they are

prospective treaty partners.

Since the Model is intended to facilitate negotiations and

not to provide a text that the United States would propose that

the treaty partner accept without variation, it should not be

assumed that a departure from the Model text in an actual treaty

represents an undesirable departure from U.S. treaty policy. The

United States would not negotiate a treaty with a country without

thoroughly analyzing the tax laws and administrative practices of

the other country. For these reasons, it is unlikely that the

United States ever will sign an income tax convention that is

identical to the Model. 

Therefore, variations from the Model text in a particular

case may represent a modification that the United States views as

necessary to address a particular aspect of the treaty partner's

tax law, or even represent a substantive concession by the treaty

partner in favor of the United States. Time is another relevant

consideration, as treaty policies evolve in other countries just

as they do in the United States. Furthermore, language

differences (even with English-speaking countries) sometimes

necessitate changes in Model language. Consequently, it would

not be appropriate to base an evaluation of an actual treaty

simply on the number of differences between the treaty and the
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Model. Rather, such an evaluation must be based on a firm

understanding of the treaty partner's tax laws and policies, how

that law interacts with the treaty and the provisions of U.S. tax

law, precedents in the partner's other treaties, the relative

economic positions of the two treaty partners, the considerations

that gave rise to the negotiations, and the numerous other

considerations that give rise to any agreement between two

sovereign nations.
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TECHNICAL EXPLANATION - ARTICLE 1 (GENERAL SCOPE)

Paragraph 1 of Article 1 provides that the Convention

applies to residents of the United States or the other Contracting State except where the terms of the Convention provide

otherwise. Under Article 4 (Residence) 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 definition governs for all purposes of the Convention. 

Certain provisions are applicable to persons who may not be

residents of either Contracting State. For example, Article 19

(Government Service) may apply to an employee of a Contracting

State who is resident in neither State. Paragraph 1 of Article

24 (Nondiscrimination) applies to nationals of the Contracting

States. Under Article 26 (Exchange of Information and Administrative Assistance), information may be exchanged with respect to

residents of third states.

Paragraph 2 states the generally accepted relationship both

between the Convention and domestic law and between the Convention and other agreements between the Contracting States (i.e.,

that no provision in the Convention may restrict any exclusion,

exemption, deduction, credit or other benefit accorded by the tax

laws of the Contracting States, or by any other agreement between

the Contracting States). For example, if a deduction would be

allowed under the U.S. Internal Revenue Code (the "Code") in

computing the U.S. taxable income of a resident of the other

Contracting State, the deduction also is allowed to that person

in computing taxable income under the Convention. Paragraph 2

also means that the Convention may not increase the tax burden on

a resident of a Contracting States beyond the burden determined

under domestic law. Thus, a right to tax given by the Convention

cannot be exercised unless that right also exists under internal

law. The relationship between the non-discrimination provisions

of the Convention and other agreements is not addressed in

paragraph 2 but in paragraph 3. 

It follows that under the principle of paragraph 2 a taxpayer's liability to U.S. tax 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 that a resident of the other

Contracting State has three separate businesses in the United
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States. One is a profitable permanent establishment and the

other two are trades or businesses that would earn taxable income

under the Code but that do not meet the permanent establishment

threshold tests of the Convention. One is profitable and the

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

permanent establishment is taxable, 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 be offset

against the profits of the two profitable ventures. The taxpayer

may not invoke the Convention to exclude the profits of the

profitable trade or business and invoke the Code to claim the

loss of the loss trade or business against the profit of the

permanent establishment. (See Rev. Rul. 84-17, 1984-1 C.B. 308.) 

If, however, the taxpayer invokes the Code for the taxation of

all three ventures, he would not be precluded from invoking the

Convention with respect, for example, to any dividend income he

may receive from the United States that is not effectively

connected with any of his business activities in the United

States.

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

benefit granted by any other agreement between the United States

and 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

the other Contracting State, 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 specifically relates to non-discrimination

obligations of the Contracting States under other agreements. 

The provisions of paragraph 3 are an exception to the rule

provided in paragraph 2 of this Article under which the Convention shall not restrict in any manner any benefit now or

hereafter accorded by any other agreement between the Contracting

States.

Subparagraph (a) of paragraph 3 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, procedures for dealing with disputes that may be

incorporated into trade, investment, or other agreements between

the Contracting States shall not apply for the purpose of

determining the scope of the Convention. 
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Subparagraph (b) of paragraph 3 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 would include, for example, a law, regulation, rule,

procedure, decision, administrative action or guidance, or any

other form of measure.

Paragraph 4 contains the traditional saving clause found in

all U.S. treaties. The Contracting States reserve their rights,

except as provided in paragraph 5, to tax their residents and

citizens as provided in their internal laws, notwithstanding any

provisions of the Convention to the contrary. For example, if a

resident of the other Contracting State performs independent

personal services in the United States and the income from the

services is not attributable to a fixed base in the United

States, Article 14 (Independent Personal Services) would normally

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

the resident of the other Contracting State 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 special foreign tax credit

rules applicable to the U.S. taxation of certain U.S. income of

its citizens resident in the other Contracting State, see

paragraph 3 of Article 23 (Relief from Double Taxation). 

For purposes of the saving clause, "residence" is determined

under Article 4 (Residence). Thus, 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 the other Contracting State under its

law, and that individual has a permanent home available to him in

the other Contracting State and not in the United States, he

would be treated as a resident of the other Contracting State

under Article 4 and for purposes of the saving clause. The

United States would not be permitted to apply its statutory rules
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to that person if they are inconsistent with the treaty. Thus,

an individual who is a U.S. resident under the Internal Revenue

Code but who is deemed to be a resident of the other Contracting

State under the tie-breaker rules of Article 4 (Residence) would

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

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

resident for U.S. tax purposes other than determining the

individual’s U.S. tax liability. For example, in determining

under Code section 957 whether a foreign corporation is a

controlled foreign corporation, shares in that corporation held

by the individual would be considered to be held by a U.S.

resident. As a result, other U.S. citizens or residents might be

deemed to be United States shareholders of a controlled foreign

corporation subject to current inclusion of Subpart F income

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

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

Under paragraph 4 each Contracting State also reserves its

right to tax former citizens and long-term residents whose loss

of citizenship or long-term residence had as one of its principal

purposes the avoidance of tax. The United States treats an

individual as having a principal purpose to avoid tax if (a) the

average annual net income tax of such individual for the period

of 5 taxable years ending before the date of the loss of status

is greater than $100,000, or (b) the net worth of such individual

as of such date is $500,000 or more. The United States defines

“long-term resident” as an individual (other than a U.S. citizen)

who is a lawful permanent resident of the United States in at

least 8 of the prior 15 taxable years. An individual 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. In the United States, such a former citizen or longterm resident is taxable in accordance with the provisions of

section 877 of the Code.

Some provisions are intended to provide benefits to citizens

and residents that do not exist under internal law. Paragraph 5

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. 
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(2) Paragraphs 2 and 5 of Article 18 (Pensions, Social Security,

Annuities, Alimony and Child Support) 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 right of 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 the other Contracting State. The

inclusion of paragraph 5, which exempts child support payments

from taxation by the State of residence of the recipient, means

that if a resident of the other Contracting State pays child

support to a citizen or resident of the United States, the United

States may not tax the recipient. (3) Article 23 (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. (3) Article 24 (Nondiscrimination) requires one

Contracting State to grant national treatment to residents and

citizens of the other Contracting State in certain circumstances. 

Excepting this Article from the saving clause requires, for

example, that the United States give such benefits to a resident

or citizen of the other Contracting State even if that person is

a citizen of the United States. (4) Article 25 (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 5 provides a different set of

exceptions to the saving clause. The benefits referred to are

all intended to be granted to temporary residents of a Contracting State (for example, in the case of the United States, holders

of non-immigrant visas), but not to citizens or to persons who

have acquired permanent residence in that State. If

beneficiaries of these provisions travel from one of the

Contracting States to the other, and remain in the other long

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

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

they do not become "green card" holders) and are not citizens of

that State, the host State will continue to grant these benefits

even if they conflict with the statutory rules. The benefits

preserved by this paragraph are the host country exemptions for

the following items of income: tax treatment of pension fund

contributions under paragraph 6 of Article 18 (Pensions, Social

Security , Annuities, Alimony, and Child Support), government

service salaries and pensions under Article 19 (Government
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Service); certain income of visiting students and trainees under

Article 20 (Students and Trainees); and the income of diplomatic

agents and consular officers under Article 27 (Diplomatic Agents

and Consular Officers).
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ARTICLE 2 (TAXES COVERED)

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

other Contracting State to which the Convention applies. Unlike

Article 2 in the OECD Model, this Article does not contain a

general description of the types of taxes that are covered (i.e.,

income taxes), but only a listing of the specific taxes covered

for both of the Contracting States. With two exceptions, the

taxes specified in Article 2 are the covered taxes for all

purposes of the Convention. A broader coverage applies, however,

for purposes of Articles 24 (Nondiscrimination) and 26 (Exchange

of Information and Administrative Assistance). Article 24

(Nondiscrimination applies with respect to all taxes, including

those imposed by state and local governments. Article 26

(Exchange of Information and Administrative Assistance) applies

with respect to all taxes imposed at the national level. 

Subparagraph 1(a) provides that the United States covered

taxes are the Federal income taxes imposed by the Code, together

with the excise taxes imposed with respect to private foundations

(Code sections 4940 through 4948). Although they may be regarded

as income taxes, social security taxes (Code sections 1401, 3101,

3111 and 3301) are specifically excluded from coverage. It is

expected that social security taxes will be dealt with in

bilateral Social Security Totalization Agreements, which are

negotiated and administered by the Social Security Administration. Except with respect to Article 24 (Nondiscrimination),

state and local taxes in the United States are not covered by the

Convention. 

In this Model, unlike some U.S. treaties, the Accumulated

Earnings Tax and the Personal Holding Companies Tax are covered

taxes because they are income taxes and they are not otherwise

excluded from coverage. Under the Code, 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 where the taxes may apply to a

foreign corporation, the tax due is likely to be insignificant. 

Treaty coverage therefore confers little if any benefit on such

corporations.

Subparagraph 1(b) specifies the existing taxes of the other

Contracting State that are covered by the Convention.

Under paragraph 2, the Convention will apply to any taxes

that are identical, or substantially similar, to those enumerated

in paragraph 1, and which are imposed in addition to, or in place
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of, the existing taxes after the date of signature of the Convention. The paragraph also provides that the competent authorities

of the Contracting States will notify each other of significant

changes in their taxation laws or of other laws that affect their

obligations under the Convention. The use of the term "significant" means that changes must be reported that are of significance to the operation of the Convention. Other laws that may

affect a Contracting State's obligations under the Convention may

include, for example, laws affecting bank secrecy.

The competent authorities are also 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.
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ARTICLE 3 (GENERAL DEFINITIONS)

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 (Residence). 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 that these definitions apply for all

purposes of the Convention, unless the context requires

otherwise. This latter condition allows flexibility in the

interpretation of the treaty in order to avoid results not

intended by the treaty's negotiators. Terms that are not defined

in the Convention are dealt with in paragraph 2. 

Subparagraph 1(a) defines the term "person" to include an

individual, a trust, a partnership, a company and any other body

of persons. The definition is significant for a variety of

reasons. For example, under Article 4, only a "person" can be a

"resident" and therefore eligible for most benefits under the

treaty. Also, all "persons" are eligible to claim relief under

Article 25 (Mutual Agreement Procedure). 

This definition is more specific but not substantively

different from the corresponding provision in the OECD Model. 

Unlike the OECD Model, it specifically includes a trust, an

estate, and a partnership. Since, however, the OECD Model's

definition also uses the phrase "and any other body of persons,"

partnerships would be included, consistent with paragraph 2 of

the Article, to the extent that they are treated as "bodies of

persons." Furthermore, because the OECD Model uses the term

"includes," trusts and estates would be persons. Under Article

3(2) the meaning of the terms "partnership," "trust" and "estate"

would be determined by reference to the law of the Contracting

State whose tax is being applied.

The term "company" is defined in subparagraph 1(b) as a body

corporate or an entity treated as a body corporate for tax

purposes in the state where it is organized. 

The terms "enterprise of a Contracting State" and "enterprise of the other Contracting State" are defined in subparagraph

1(c) 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. Despite the absence of a clear, generally accepted meaning
-14- Article 3

for the term "enterprise," the term is understood to refer to any

activity or set of activities that constitute a trade or

business.

Unlike the OECD Model, subparagraph 1(c) also 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 the Model in order to

address more explicitly some of the problems presented by

fiscally transparent entities. In accordance with Article 4

(Residence), 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 could not qualify as an enterprise of a

Contracting State under the OECD Model because the OECD

definition of enterprise requires that the enterprise be

conducted by a resident, although most countries would attribute

the enterprise to the owners of the entity in such circumstances. 

The definition in the Model 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. 

An enterprise of a Contracting State need not be carried on

in that State. It may be carried on in the other Contracting

State or a third state (e.g., a U.S. corporation doing all of its

business in the other Contracting State would still be a U.S.

enterprise). 

Subparagraph 1(d) 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 a Contracting

State. This definition is applicable principally in the context

of Article 8 (Shipping and Air Transport). The definition in the

OECD Model refers to the operator of the ship or aircraft having

its place of effective management in a Contracting State (i.e.,

being a resident of that State). The U.S. Model does not include

this limitation. The broader definition combines with paragraphs

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

income from the rental of ships, aircraft or containers that is
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earned both by lessors that are operators of ships and aircraft

and by those lessors that are not (e.g., a bank or a container

leasing company). 

The exclusion from international traffic of transport solely

between places within a Contracting State means, for example,

that carriage of goods or passengers solely between New York and

Chicago would not be treated as international traffic, whether

carried by a U.S. or a foreign carrier. The substantive taxing

rules of the Convention relating to the taxation of income from

transport, principally Article 8 (Shipping and Air Transport),

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

if the carrier engaged in internal U.S. traffic were a resident

of the other Contracting State (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 the other Contracting State from

a non-U.S. port to, for example, New York, and some of the goods

or passengers continue on to Chicago, the entire transport would

be international traffic. This would be true if the

international carrier transferred the goods at the U.S. port of

entry from a ship to a land vehicle, from a ship to a lighter, or

even if the overland portion of the trip in the United States was

handled by an independent carrier under contract with the

original international carrier, so long as both parts of the trip

were reflected in original bills of lading. For this reason, the

U.S. Model refers, in the definition of "international traffic,"

to "such transport" being solely between places in the other

Contracting State, while the OECD Model refers to the ship or

aircraft being operated solely between such places. The 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.

Subparagraphs 1(e)(i) and (ii) define the term "competent

authority" for the United States and the other Contracting State,
-16- Article 3

respectively. 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

Assistant Commissioner (International). With respect to

interpretative issues, the Assistant Commissioner acts with the

concurrence of the Associate Chief Counsel (International) of the

Internal Revenue Service. 

The term "United States" is defined in subparagraph 1(f) 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 1981 Model, this Model explicitly includes certain areas

under the sea within the definition of the United States. For

certain purposes, the definition is extended to include the sea

bed and subsoil of undersea areas adjacent to the territorial sea

of the United States. This extension applies to the extent that

the United States exercises sovereignty in accordance with

international law for the purpose of natural resource exploration

and exploitation of such areas. This extension of the definition

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

which the Convention is being applied is connected with such

natural resource exploration or exploitation. Thus, it would not

include any activity involving the sea floor of an area over

which the United States exercised sovereignty for natural

resource purposes if that activity was unrelated to the

exploration and exploitation of natural resources. The other

Contracting State is defined in subparagraph 1(g).

This result is consistent with the result that would be

obtained under the sometimes less precise definitions in some

U.S. treaties. In the absence of a precise definition

incorporating the continental shelf, the term "United States of

America" would be interpreted by reference to the U.S. internal

law definition. Section 638 treats the continental shelf as part

of the United States. 

The term "national," as it relates to the United States and

to the other Contracting State, is defined in subparagraphs

1(h)(i) and (ii). This term is relevant for purposes of Articles

19 (Government Service) and 24 (Non-discrimination). A national

of one of the Contracting States is (1) an individual who is a

citizen or national of that State, and (2) any legal person,

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

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

definition is closely analogous to that found in the OECD Model. 
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The definition differs in two substantive respects from that

in the 1981 Model. First, in the 1981 Model a U.S. national was

defined as a citizen of the United States, and did not include

juridical persons. The addition of juridical persons to the

definition may have significance in relation to paragraph 1 of

Article 24 (Nondiscrimination), which provides that nationals of

one Contracting State may not be subject in the other to any

taxes or connected requirements that are other or more burdensome

than those applicable to nationals of that other State who are in

the same circumstances. Second, the 1981 Model (and the 1977

OECD Model) included the definition of the term "national" in

Article 24 (Nondiscrimination) rather than in Article 3. Since

the term has application in other articles as well (e.g., Article

19 (Government Service)), the definition has been moved to

Article 3 (as it has been in the current OECD Model).

This Model adds a definition that was not included in

previous U.S. Models, or in the OECD Model. This is the

definition of "qualified governmental entity" in subparagraph

1(i). This definition is relevant for purposes of Articles 4

(Residence) and 22 (Limitation on Benefits). A portion of this

definition (i.e., sub-subparagraph (iii) dealing with

governmental pension funds) also is relevant for purposes of

Article 10 (Dividends). 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 wholly owned by

a governmental entity described in subparagraph (i), that

satisfies certain organizational and funding standards; and (iii)

a pension fund that meets the standards of subparagraphs (i) and

(ii) and that provides government service pension benefits,

described in Article 19 (Government Service). A qualified

governmental entity described in subparagraphs (ii) and (iii) may

not engage in any commercial activity. 

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 text of the paragraph has been amended from

previous Models to clarify 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.
-18- Article 3

If the meaning of a term cannot be readily determined under

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

meaning under the laws of the two States that creates difficulties in the application of the Convention, the competent authorities, as indicated in paragraph 3(f) of Article 25 (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. 

It has been understood implicitly in previous U.S. Models

and in the OECD Model that 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. This use of "ambulatory definitions" has been clarified in the text of this Model. 

The use of an ambulatory definition, 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 requiring" a definition different from the

treaty definition, in paragraph 1, or from the internal law

definition of the Contracting State whose tax is being imposed,

under paragraph 2, refers to a circumstance where the result

intended by the Contracting States is different from the result

that would obtain under either the paragraph 1 definition or the

statutory definition.
-19- Article 4

ARTICLE 4 (RESIDENCE)

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 also must

qualify for benefits under Article 22 (Limitation on Benefits) in

order to receive benefits conferred on residents of a Contracting

State.

The determination of residence for treaty purposes looks

first to a person's liability to tax as a resident under the

respective taxation laws of the Contracting States. As a general

matter, a person who, under those laws, is a resident of one

Contracting State and not of the other need look no further. 

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 resident in both Contracting States under their respective taxation laws, the Article proceeds, where possible, to

assign a single State of residence to such a person for purposes

of the Convention through the use of tie-breaker rules.

Paragraph 1

The term "resident of a Contracting State" is defined in

paragraph 1. In general, this definition incorporates the

definitions of residence in U.S. law and that of the other

Contracting State 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.

Certain entities that are nominally subject to tax but that

in practice rarely 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 treaty. Although the income earned by these

entities normally is not subject to U.S. tax in the hands of the
-20- Article 4

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

distribute their profits, and therefore may be regarded as

"liable to tax." They also must satisfy a number of requirements

under the Code in order to be entitled to special tax treatment.

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

consular official of the other Contracting State who is posted in

the United States, who may be subject to U.S. tax on U.S. source

investment income, but is not taxable in the United States on

non-U.S. source income, would not be considered a resident of the

United States for purposes of the Convention. (See Code section

7701(b)(5)(B)). Similarly, an enterprise of the other

Contracting State 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 that is

attributable to the U.S. permanent establishment, not with

respect to its worldwide income, as is a U.S. resident.

Subparagraph (b) provides that certain tax-exempt entities

such as pension funds and charitable organizations will be

regarded as residents regardless of whether they are generally

liable for income tax in the State where they are established. 

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 tax on their unrelated business

income. Thus, a U.S. pension trust, or an exempt 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 treaty.
-21- Article 4

Subparagraph (c) specifies that a qualified governmental

entity (as defined in Article 3) is to be treated as a resident

of that State. Although this provision is not contained in

previous U.S. Models, it is generally understood that such

entities are to be treated as residents under all of those Model

treaties. The purpose of including the rule in the Model is to

make this understanding explicit. Article 4 of the OECD Model

was amended in 1995 to adopt a similar approach.

Subparagraph (d) addresses special problems presented by

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.

Subparagraph (d) provides that an item of income 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 U.S.

corporation distributes a dividend to an entity that is treated

as fiscally transparent in the other State, the dividend will be

considered to be derived by a resident of that State to the

extent that the taxation law of that State treats residents of

that State as deriving the income for tax purposes. In the case

of a partnership, this normally would include the partners of the

entity that are residents of that other Contracting State. 

 The taxation laws of a Contracting State may treat an item

of income, profit or gain as income, profit or gain of a resident

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

particular item of income, profit or gain. For example, if a

Contracting State has a participation exemption for certain

foreign-source dividends and capital gains, such income or gains

would be regarded as income or gain of a resident of that State

who otherwise derived the income or gain, despite the fact that

the resident could be exempt from tax in that State on the income

or gain.

Income is “derived through” a fiscally transparent entity if

the entity’s participation in the transaction giving rise to the

income, profit or gain in question is respected after application
-22- Article 4

of any source State anti-abuse principles based on substance over

form and similar analyses. For example, if a partnership with

U.S. partners receives income arising in the other Contracting

State, that income will be considered to be derived through the

partnership by its partners as long as the partnership’s

participation in the transaction is not disregarded for lack of

economic substance. In such a case, the partners would be

considered to be the beneficial owners of the income.

Where income is derived through an entity organized in a

third state that has owners resident in one of the Contracting

States, the characterization of the entity in that third state is

irrelevant for purposes of determining whether the resident is

entitled to treaty benefits with respect to income derived by the

entity. 

This rule also applies to trusts to the extent that they are

fiscally transparent in their beneficial owner’s State of

residence. For example, if X, a resident of the other

Contracting State, creates a revocable trust and names persons

resident in a third country as the beneficiaries of the trust, X

would be treated as the beneficial owner of income derived from

the United States under the Code's rules. If the other State had

no rules comparable to those in sections 671 through 679 then it

is possible that under the laws of the other State neither X nor

the trust would be taxed on the income derived from the United

States. In these cases subparagraph (d) provides that the

trust’s income would be regarded as being derived by a resident

of the other State only to the extent that the laws of that State

treat residents of that State as deriving the income for tax

purposes. 

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 3 to determine a single State of residence

for that individual. These tests are to be applied in the order

in which they are stated. The first test is based on where the

individual has a permanent home. If that test is inconclusive

because the individual has a permanent home available to him in

both States, he will be considered to be a resident of the

Contracting State where his personal and economic relations are

closest (i.e., the location of his "center of vital interests"). 

If that test is also inconclusive, or if he does not have a

permanent home available to him in either State, he will be

treated as a resident of the Contracting State where he maintains
-23- Article 4

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 his

Contracting State of citizenship. If he is a citizen of both

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

competent authorities, who will attempt to agree to assign a

single State of residence. 

Paragraph 3

Paragraph 3 seeks to settle dual-residence issues for 

companies. A company is treated as resident in the United States

if it is created or organized under the laws of the United States

or a political subdivision. If the same test is used to

determine corporate residence under the laws of the other Contracting State, dual corporate residence will not occur. If,

however, as is frequently the case, a company is treated as a

resident of the other Contracting State if it is either incorporated or managed and controlled there, dual residence can arise

in the case of a U.S. company that is managed and controlled in

the other Contracting State. Under paragraph 3, the residence of

such a company will be in 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 by paragraph 4. If such a

person is, under the rules of paragraph 1, resident in both

Contracting States, the competent authorities shall seek to

determine a single State of residence for that person for

purposes of the Convention. 
-24- Article 5

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 14

(Independent Personal Services) is understood by reference to the

definition of "permanent establishment," this Article is also

relevant for purposes of Article 14. 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 concept is

also relevant in determining which Contracting State may tax

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

under Article 21 (Other Income).

The Article follows closely both the OECD Model and the 1981

U.S. Model provisions.

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. 

Paragraph 2

Paragraph 2 lists a number of types of fixed places of

business that constitute a permanent establishment. This list is

illustrative and non-exclusive. According to paragraph 2, the

term permanent establishment includes a place of management, a

branch, an office, a factory, a workshop, and a mine, oil or gas

well, quarry or other place of extraction of natural resources. 

As indicated in the OECD Commentaries (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. 
-25- Article 5

Paragraph 3

This paragraph provides rules to determine whether a

building site or a construction, assembly or installation

project, or a drilling rig or ship used for the exploration of

natural resources constitutes a permanent establishment for the

contractor, driller, etc. An activity is merely preparatory and

does not create a permanent establishment under paragraph 4(e)

unless the site, project, etc. lasts or continues for more than

twelve months. It is only necessary to refer to "exploration"

and not "exploitation" in this context because exploitation

activities are defined to constitute a permanent establishment

under subparagraph (f) of paragraph 2. Thus, a drilling rig does

not constitute a permanent establishment if a well is drilled in

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

the well becomes a permanent establishment as of that date. 

The twelve-month test applies separately to each site or

project. The twelve-month period begins when work (including

preparatory work carried on by the enterprise) physically begins

in a Contracting State. A series of contracts or projects by a

contractor that are interdependent both commercially and geographically are to be treated as a single project for purposes of

applying the twelve-month 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. Several drilling rigs operated by a

drilling contractor in the same sector of the continental shelf

also normally would be treated as a single project. 

If the twelve-month threshold is exceeded, the site or

project constitutes a permanent establishment from the first day

of activity. In applying this paragraph, time spent by a subcontractor on a building site is counted as time spent by the

general contractor at the site for purposes of determining

whether the general contractor has a permanent establishment. 

However, for the sub-contractor itself to be treated as having a

permanent establishment, the sub-contractor's activities at the

site must last for more than 12 months. If a sub-contractor is

on a site intermittently 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) for purposes of applying the 12-month rule. 

These interpretations of the Article are based on the

Commentary to paragraph 3 of Article 5 of the OECD Model, which

contains language almost identical to that in the Convention
-26- Article 5

(except for the absence in the OECD Model of a rule for drilling

rigs). These interpretations are consistent with the generally

accepted international interpretation of the language in

paragraph 3 of Article 5 of the Convention. 

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 does not constitute a permanent establishment of that

enterprise. The maintenance of a stock of goods belonging to an

enterprise solely for the purpose of storage, display or delivery, or solely for the purpose of processing by another enterprise does not give rise to a permanent establishment of the

first-mentioned enterprise. The maintenance of a fixed place of

business solely for the purpose of purchasing goods or merchandise, or for collecting information, for the enterprise, or for

other activities that have a preparatory or auxiliary character

for the enterprise, such as advertising, or the supply of information do not constitute a permanent establishment of the

enterprise. Thus, as explained in paragraph 22 of the OECD

Commentaries, an employee of a news organization engaged merely

in gathering information would not constitute a permanent

establishment of the news organization. 

Further, a combination of these activities will not give

rise to a permanent establishment: unlike the OECD Model, the

Model provides that the maintenance of a fixed place of business

for a combination of the activities listed in subparagraphs (a)

through (e) of the paragraph does not give rise to a permanent

establishment, without the OECD Model’s qualification that the

overall combination of activities must 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

Paragraphs 5 and 6 specify when activities carried on by an

agent on behalf of an enterprise create a permanent establishment

of that enterprise. Under paragraph 5, a dependent agent of an

enterprise is deemed to be a permanent establishment of the

enterprise if the agent has and habitually exercises an authority
-27- Article 5

to conclude contracts that are binding on the enterprise. If,

however, for example, his activities are limited to those

activities specified in paragraph 4 which would not constitute a

permanent establishment if carried on by the enterprise through a

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

The OECD Model uses the term “in the name of that

enterprise” rather than “binding on the enterprise.” This

difference is intended to be a clarification rather than a

substantive difference. As indicated in paragraph 32 to the OECD

Commentaries on Article 5, paragraph 5 of the Article is intended

to encompass persons who have “sufficient authority to bind the

enterprise’s participation in the business activity in the State

concerned.”

The contracts referred to in paragraph 5 are those relating

to the essential business operations of the enterprise, rather

than ancillary activities. For example, if the agent has no

authority to conclude contracts in the name of the enterprise

with its customers for, say, the sale of the goods produced by

the enterprise, but it can enter into service contracts in the

name of the enterprise for the enterprise's business equipment

used in the agent's office, this contracting authority would not

fall within the scope of the paragraph, even if exercised

regularly. 

Paragraph 6

Under paragraph 6, an enterprise is not deemed to have a

permanent establishment in a Contracting State merely because it

carries on business in that State through an independent agent,

including a broker or general commission agent, if the agent is

acting in the ordinary course of his business as an independent

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

the agent must be both legally and economically independent of

the enterprise, and the agent must be acting in the ordinary

course of its business in carrying out activities on behalf of

the enterprise

Whether the agent and the enterprise are independent is a

factual determination. Among the questions to be considered are

the extent to which the agent operates on the basis of instructions from the enterprise. An agent that is subject to detailed

instructions regarding the conduct of its operations or

comprehensive control by the enterprise is not legally

independent.
-28- Article 5

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 that 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. 

Paragraph 7

This paragraph clarifies that a company that is a resident

of a Contracting State is not deemed to have a permanent establishment in the other Contracting State merely because it controls, or is controlled by, a company that is a resident of that

other Contracting State, or that carries on business in that

other Contracting State. The determination whether a permanent

establishment exists is made solely on the basis of the factors

described in paragraphs 1 through 6 of the Article. Whether a

company is a permanent establishment of a related company,

therefore, is based solely on those factors and not on the

ownership or control relationship between the companies.
-29- Article 6

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

Paragraph 1

The first paragraph of Article 6 states the general rule

that income of a resident of a Contracting State derived from

real property situated in the other Contracting State may be

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

The paragraph specifies that income from real property includes

income from agriculture and forestry. Income from agriculture

and forestry are dealt with in Article 6 rather than in Article 7

(Business Profits) in order to conform the U.S. Model to the OECD

Model. Given the availability of the net election in paragraph

5, taxpayers generally should be able to obtain the same tax

treatment in the situs country regardless of whether the income

is treated as business profits or real property income. 

Paragraph 3 clarifies that the income referred to in paragraph 1

also means income from any use of real property, including, but

not limited to, income from direct use by the owner (in which

case income may be imputed to the owner for tax purposes) and

rental income from the letting of real property. 

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 impose any limitation in terms of rate

or form of tax on the situs State, except that, as provided in

paragraph 5, the situs State must allow the taxpayer an election

to be taxed on a net basis. 

Paragraph 2

The term "real property" is defined in paragraph 2 by

reference to the internal law definition in the situs State. In

the case of the United States, the term has the meaning given to

it by Reg. § 1.897-1(b). The OECD Model, and many other countries, use the term "immovable property" instead. It is to be

understood from the parenthetical use of the term "immovable

property" in the title to the Article and in paragraphs 1 and 2,

that the two terms are synonymous. Thus the statutory definition

is to be used whether the statutory term is "real property" or

"immovable property".

Paragraph 3

Paragraph 3 makes clear that all forms of income derived
-30- Article 6

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, if a net election has not been

made, the gross rental payment (before deductible expenses

incurred by the lessee) is treated as income from the property. 

Income from the disposition of an interest in real property,

however, is not considered "derived" from real property and is

not dealt with in this article. The taxation of that income is

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

mortgage on real property and distributions by a U.S. Real Estate

Investment Trust are not dealt with in Article 6. Such payments

would fall under Articles 10 (Dividends), 11 (Interest) or 13

(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(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 14 (Independent Personal Services) that income must be

attributable to a permanent establishment or fixed base,

respectively, in order to be taxable in the situs state. 

Paragraph 5

The paragraph provides that a resident of one Contracting

State that derives real property income from the other may elect,

for any taxable year, to be subject to tax in that other State on

a net basis, as though the income were attributable to a permanent establishment in that other State. The election may be

terminated with the consent of the competent authority of the

situs State. In the United States, revocation will be granted in

accordance with the provisions of Treas. Reg. section 1.871-

10(d)(2).
-31- Article 7

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

(as defined in paragraph 7) of an enterprise of one Contracting

State may not be taxed by the other Contracting State unless the

enterprise carries on business in that other Contracting State

through a permanent establishment (as defined in Article 5

(Permanent Establishment)) situated there. When that condition

is met, the State in which the permanent establishment is

situated may tax the enterprise, but only on a net basis and only

on the income that is attributable to the permanent establishment. This paragraph is identical to paragraph 1 of Article 7 of

the OECD Model. 

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. 

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.

Paragraph 2 also provides that the business profits

attributed to a permanent establishment include only those

derived from that permanent establishment’s assets or activities. 

This rule is consistent with the “asset-use” and “business

activities” test of Code section 864(c)(2). The OECD Model does

not expressly provide such a limitation, although it generally is

understood to be implicit in paragraph 1 of Article 7 of the OECD
-32- Article 7

Model. This provision was included in the U.S. Model to make it

clear that the limited force of attraction rule of Code section

864(c)(3) is not incorporated into paragraph 2. 

This Article does not contain a provision corresponding to

paragraph 4 of Article 7 of the OECD Model. That paragraph

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. This paragraph has not been included in the Model

because it is unnecessary. The OECD Commentaries to paragraphs 2

and 3 of Article 7 authorize the use of such approaches

independently of paragraph 4 of Article 7 of the OECD Model. Any

such approach, however, must be designed to approximate an arm’s

length result.

Paragraph 3

 This paragraph is in substance the same as paragraph 3 of

Article 7 of the OECD Model, although it is in some respects more

detailed. 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

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 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 in

Treas. Reg. sections 1.861-8 and 1.882-5). 

Paragraph 3 does not permit a deduction for expenses charged

to a permanent establishment by another unit of the enterprise. 

Thus, a permanent establishment may not deduct a royalty deemed
-33- Article 7

paid to the head office. Similarly, a permanent establishment

may not increase its business profits by the amount of any

notional fees for ancillary services performed for another unit

of the enterprise, but also should not receive a deduction for

the expense of providing such services, since those expenses

would be incurred for purposes of a business unit other than the

permanent establishment.

Paragraph 4

Paragraph 4 provides that no business profits can be attributed to a permanent establishment merely because it purchases

goods or merchandise for the enterprise of which it is a part. 

This paragraph is essentially identical to paragraph 5 of Article

7 of the OECD Model. This rule applies only to an office that

performs functions for the enterprise in addition to purchasing. 

The income attribution issue does not arise if the sole activity

of the 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 4 is

relevant is one in which a permanent establishment purchases raw

materials for the enterprise's manufacturing operation conducted

outside the United States and sells the manufactured product. 

While business profits may be attributable to the permanent

establishment with respect to its sales activities, no profits

are attributable to it with respect to its purchasing activities. 

Paragraph 5

This paragraph tracks paragraph 6 of Article 7 of the OECD

Model, providing that profits shall be determined by the same

method of accounting 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.

Paragraph 6

Paragraph 6 coordinates the provisions of Article 7 and
-34- Article 7

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 or fixed base. In the

latter case the provisions of Articles 7 or 14 (Independent

Personal Services) 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’s full corporate tax rate, rather than on a gross basis

under Article 10 (Dividends).

As provided in Article 8 (Shipping and Air Transport),

income derived from shipping and air transport activities in

international traffic described in that Article is taxable only

in the country of residence of the enterprise regardless of

whether it is attributable to a permanent establishment situated

in the source State. 

Paragraph 7

The term "business profits" is defined generally in

paragraph 7 to mean income derived from any trade or business. 

In the absence of evidence to the contrary the lack of this

definition in a bilateral Convention should not be construed to

indicate that any different meaning should be attributed to the

term. 

In accordance with this broad definition, the term "business

profits" includes income attributable to notional principal

contracts and other financial instruments to the extent that the

income is attributable to a trade or business of dealing in such

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

in the case of a notional principal contract entered into for the

purpose of hedging currency risk arising from an active trade or

business). Any other income derived from such instruments is,

unless specifically covered in another article, dealt with under

Article 21 (Other Income). 
-35- Article 7

The first sentence of the paragraph states the longstanding

U.S. view that income earned by an enterprise from the furnishing

of personal services is business profits. Thus, a consulting

firm resident in one State whose employees perform services in

the other State through a permanent establishment may be taxed in

that other State on a net basis under Article 7, and not under

Article 14 (Independent Personal Services), which applies only to

individuals. The salaries of the employees would be subject to

the rules of Article 15 (Dependent Personal Services).

The paragraph also specifies that the term "business profits" includes income derived by an enterprise from the rental of

tangible personal property. In the 1977 OECD Model Convention

this class of income was treated as a royalty, subject to the

rules of Article 12. This rule was changed in the 1992 OECD

Model, and the U.S. Model reflects this change in policy. The

inclusion of income derived by an enterprise from the rental of

tangible personal property in business profits means that such

income earned by a resident of a Contracting State can be taxed

by the other Contracting State only if the income is attributable

to a permanent establishment maintained by the resident in that

other State, and, if the income is taxable, it can be taxed only

on a net basis. Income from the rental of tangible personal

property that is not derived in connection with a trade or

business is dealt with in Article 21 (Other Income).

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 6 of Article 10 (Dividends), paragraph 3 of Articles 11

(Interest), 12 (Royalties) and 13 (Gains), Article 14 (Independent Personal Services) and paragraph 2 of Article 21 (Other

Income). 

The effect of this rule can be illustrated by the following

example. Assume a company that is a resident of the other

Contracting State 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
-36- Article 7

U.S. buyer at the end of year 1 in exchange for an interestbearing 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 4

of Article 1 (General Scope) of the Model. Thus, if a citizen of

the United States who is a resident of the other Contracting

State under the treaty derives business profits from the United

States that are not attributable to a permanent establishment in

the United States, the United States may, subject to the special

foreign tax credit rules of paragraph 3 of Article 23 (Relief

from Double Taxation), tax those profits, notwithstanding the

provision of paragraph 1 of this Article which would exempt the

income from U.S. tax. 

The benefits of this Article are also subject to Article 22

(Limitation on Benefits). Thus, an enterprise of the other

Contracting State and 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 22. 
-37- Article 8

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(d) of

Article 3 (General Definitions). 

Paragraph 1

Paragraph 1 provides that profits derived by an enterprise

of a Contracting State from the operation in international

traffic of ships or aircraft are taxable only in that Contracting

State. Because paragraph 6 of Article 7 (Business Profits)

defers to Article 8 with respect to shipping income, such income

derived by a resident of one of the Contracting States may not be

taxed in the other State even if the enterprise has a permanent

establishment in that other State. Thus, if a U.S. airline has a

ticket office in the other State, that State may not tax the

airline's profits attributable to that office under Article 7. 

Since entities engaged in international transportation activities

normally will have many permanent establishments in a number of

countries, the rule avoids difficulties that would be encountered

in attributing income to multiple permanent establishments if the

income were covered by Article 7 (Business Profits). 

Paragraph 2

The income from the operation of ships or aircraft in international traffic that is exempt from tax under paragraph 1 is

defined in paragraph 2. This paragraph is not found in the OECD

Model, but the effect of the paragraph is generally consistent

with the description of the scope of Article 8 in the Commentary

to Article 8 of the OECD Model. Most of the income items that

are described in paragraph 2 of the U.S. Model are described in

the OECD Commentary as being included within the scope of the

exemption in paragraph 1. Unlike the OECD Model, however,

paragraph 2 also covers non-incidental bareboat leasing. See,

paragraph 5 of the OECD Commentaries.

In addition to income derived directly from the operation of

ships and aircraft in international traffic, this definition also

includes certain items of rental income that are closely related

to those activities. First, income of an enterprise of a

Contracting State from the rental of ships or aircraft on a full

basis (i.e., with crew) when such ships or aircraft are used in

international traffic is income of the lessor from the operation
-38- Article 8

of ships and aircraft in international traffic and, therefore, is

exempt from tax in the other Contracting State under paragraph 1. 

Also, paragraph 2 encompasses income from the lease of ships or

aircraft on a bareboat basis (i.e., without crew), either when

the ships or aircraft are operated in international traffic by

the lessee, or when the income is incidental to other income of

the lessor from the operation of ships or aircraft in international traffic. As discussed above, of these classes of rental

income, only non-incidental, bareboat lease income is not covered

by Article 8 of the OECD Model. 

Paragraph 2 also clarifies, consistent with the Commentary

to Article 8 of the OECD Model, that income earned by an enterprise from the inland transport of property or passengers within

either Contracting State falls within Article 8 if the transport

is undertaken as part of the international transport of property

or passengers by the enterprise. Thus, if a U.S. shipping

company contracts to carry property from the other State to a

U.S. city and, as part of that contract, it transports the

property by truck from its point of origin to an airport in the

other State (or it contracts with a trucking company to carry the

property to the airport) the income earned by the U.S. shipping

company from the overland leg of the journey would be taxable

only in the United States. Similarly, Article 8 also would apply

to income from lighterage undertaken as part of the international

transport of goods. 

Finally, certain non-transport activities that are an

integral part of the services performed by a transport company

are understood to be covered in paragraph 1, though they are not

specified in paragraph 2. These include, for example, the

performance of some maintenance or catering services by one

airline for another airline, if these services are incidental to

the provision of those services by the airline for itself. 

Income earned by concessionaires, however, is not covered by

Article 8. These interpretations of paragraph 1 also are

consistent with the Commentary to Article 8 of the OECD Model. 

Paragraph 3

Under this paragraph, profits of an enterprise of a Contracting State from the use, maintenance or rental of containers

(including equipment for their transport) that are used for the

transport of goods in international traffic are exempt from tax

in the other Contracting State. This result obtains under

paragraph 3 regardless of whether the recipient of the income is

engaged in the operation of ships or aircraft in international
-39- Article 8

traffic, and regardless of whether the enterprise has a permanent

establishment in the other Contracting State. Only income from

the use, maintenance or rental of containers that is incidental

to other income from international traffic is covered by Article

8 of the OECD Model.

Paragraph 4

This paragraph clarifies that the provisions of paragraphs 1

and 3 also apply to profits derived by an enterprise of a

Contracting State from participation in a pool, joint business or

international operating agency. This refers to various

arrangements for international cooperation by carriers in shipping and air transport. For example, airlines from two countries

may agree to share the transport of passengers between the two

countries. They each will fly the same number of flights per

week and share the revenues from that route equally, regardless

of the number of passengers that each airline actually

transports. Paragraph 4 makes clear that with respect to each

carrier the income dealt with in the Article is that carrier's

share of the total transport, not the income derived from the

passengers actually carried by the airline. This paragraph

corresponds to paragraph 4 of Article 8 of the OECD Model.

Relation to Other Articles

The taxation of gains from the alienation of ships, aircraft

or containers is not dealt with in this Article but in paragraph

4 of Article 13 (Gains).

As with other benefits of the Convention, the benefit of

exclusive residence country taxation under Article 8 is available

to an enterprise only if it is entitled to benefits under Article

22 (Limitation on Benefits).

This Article also is subject to the saving clause of paragraph 4 of Article 1 (General Scope) of the Model. Thus, if a

citizen of the United States who is a resident of the other

Contracting State derives profits from the operation of ships or

aircraft in international traffic, notwithstanding the exclusive

residence country taxation in paragraph 1 of Article 8, the

United States may, subject to the special foreign tax credit

rules of paragraph 3 of Article 23 (Relief from Double Taxation),

tax those profits as part of the worldwide income of the citizen.

(This is an unlikely situation, however, because non-tax

considerations (e.g., insurance) generally result in shipping
-40- Article 8

activities being carried on in corporate form.)
-41- Article 9

ARTICLE 9 (ASSOCIATED ENTERPRISES)

This Article incorporates in the Convention the arm's-length

principle reflected in the U.S. domestic transfer pricing

provisions, particularly Code section 482. It provides that when

related enterprises engage in a transaction on terms that are not

arm's-length, the Contracting States may make appropriate adjustments to the taxable income and tax liability of such related

enterprises to reflect what the income and tax of these enterprises with respect to the transaction would have been had there

been an arm's-length relationship between them. 

Paragraph 1

 

This paragraph is essentially the same as its counterpart in

the OECD Model. It addresses the situation where an enterprise

of a Contracting State is related to an enterprise of the other

Contracting State, and there are arrangements or conditions

imposed between the enterprises in their commercial or financial

relations that are different from those that would have existed

in the absence of the relationship. Under these circumstances,

the Contracting States may adjust the income (or loss) of the

enterprise to reflect what it would have been in the absence of

such a relationship. 

The paragraph identifies the relationships between enterprises that serve as a prerequisite to application of the Article. As the Commentary to the OECD Model makes clear, the

necessary element in these relationships is effective control,

which is also the standard for purposes of section 482. Thus,

the Article applies if an enterprise of one State participates

directly or indirectly in the management, control, or capital of

the enterprise of the other State. Also, the Article applies if

any third person or persons participate directly or indirectly in

the management, control, or capital of enterprises of different

States. For this purpose, all types of control are included,

i.e., whether or not legally enforceable and however exercised or

exercisable.

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.
-42- Article 9

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 recharacterizing 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.

Article 9 does not contain a version of paragraph 3 of

Article 9 of the 1981 Model providing that the adjustments to

income provided for in paragraph 1 do not replace, but complement, the adjustments provided for under the internal laws of the

Contracting States. This language was not included in Article 9

because it had proven to be confusing. The 1981 Model language

does not grant authority not otherwise present. Regardless of

whether a particular convention includes a version of paragraph

3, 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 of the

Article, 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

Commentaries to Article 9. 
-43- Article 9

This Article also permits tax authorities to deal with thin

capitalization issues. They may, in the context of Article 9,

scrutinize more than the rate of interest charged on a loan

between related persons. They also may examine the capital

structure of an enterprise, whether a payment in respect of that

loan should be treated as interest, and, if it is treated as

interest, under what circumstances interest deductions should be

allowed to the payor. Paragraph 2 of the Commentaries to Article

9 of the OECD Model, together with the U.S. observation set forth

in paragraph 15, sets forth a similar understanding of the scope

of Article 9 in the context of thin capitalization. 

Paragraph 2

When a Contracting State has made an adjustment that is

consistent with the provisions of paragraph 1, and the other

Contracting State agrees that the adjustment was appropriate to

reflect arm's-length conditions, that other Contracting State is

obligated to make a correlative adjustment (sometimes referred to

as a “corresponding adjustment”) to the tax liability of the

related person in that other Contracting State. Although the

OECD Model does not specify that the other Contracting State must

agree with the initial adjustment before it is obligated to make

the correlative adjustment, the Commentary makes clear that the

paragraph is to be read that way. 

As explained in the OECD Commentaries, 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 the funds at arm's

length, and to establish an account payable pending restoration

of the funds. See, Rev. Proc. 65-17, 1965-1 C.B. 833.

The Contracting State making a secondary adjustment will

take the other provisions of the Convention, where relevant, into

account. For example, if the effect of a secondary adjustment is

to treat a U.S. corporation as having made a distribution of

profits to its parent corporation in the other Contracting State,

the provisions of Article 10 (Dividends) will apply, and the

United States may impose a 5 percent withholding tax on the

dividend. Also, if under Article 23 the other State generally
-44- Article 9

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 2 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 25 (Mutual

Agreement Procedure), notwithstanding any time limits or other

procedural limitations in the law of the Contracting State making

the adjustment. If a taxpayer has entered a closing agreement

(or other written settlement) with the United States prior to

bringing a case to the competent authorities, the U.S. competent

authority will endeavor only to obtain a correlative adjustment

from the other Contracting State. See, Rev. Proc. 96-13, 1996-13

I.R.B. 31, Section 7.05.

Relationship to Other Articles

The saving clause of paragraph 4 of Article 1 (General

Scope) does not apply to paragraph 2 of Article 9 by virtue of

the exceptions to the saving clause in paragraph 5(a) of Article

1. Thus, even if the statute of limitations has run, a refund of

tax can be made in order to implement a correlative adjustment. 

Statutory or procedural limitations, however, cannot be

overridden to impose additional tax, because paragraph 2 of

Article 1 provides that the Convention cannot restrict any

statutory benefit. 
-45- Article 10

ARTICLE 10 (DIVIDENDS) 

Article 10 provides rules for the taxation of dividends paid

by 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. Article 10 also provides rules for the imposition of a tax on branch profits by the

State of source. Finally, the article prohibits a State from

imposing a tax on dividends paid by companies resident in the

other Contracting State and from imposing taxes, other than a

branch profits tax, on undistributed earnings.

Paragraph 1

The right of a shareholder's country of residence to tax

dividends arising in the source country is preserved by paragraph

1, which permits a Contracting State to tax its residents on

dividends paid to them by a resident of the other Contracting

State. For dividends from any other source paid to a resident, 

Article 21 (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 may also 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. If, however,

the beneficial owner of the dividends is a company resident in

the other State that holds at least 10 percent of the voting

shares of the company paying the dividend, then the source

State's tax is limited to 5 percent of the gross amount of the

dividend. Indirect ownership of voting shares (through tiers of

corporations) and direct ownership of non-voting shares are not

taken into account for purposes of determining eligibility for

the 5 percent direct dividend rate. Shares are considered voting

shares if they provide the power to elect, appoint or replace any

person vested with the powers ordinarily exercised by the board

of directors of a U.S. corporation. The Convention does not

require that the 10-percent voting interest be held for a minimum

period prior to the dividend payment date. 

The benefits of paragraph 2 may be granted at the time of

payment by means of reduced withholding at source. It also is

consistent with the paragraph for tax to be withheld at the time
-46- Article 10

of payment at full statutory rates, and the treaty benefit to be

granted by means of a subsequent refund. 

Paragraph 2 does not affect the taxation of the profits out

of which the dividends are paid. The taxation by a Contracting

State of the income of its resident companies is governed by the

internal law of the Contracting State, subject to the provisions

of paragraph 4 of Article 24 (Nondiscrimination).

The “beneficial owner” of a dividend is understood generally

to refer to any person resident in Contracting State to whom

that State attributes the dividend for purposes of its tax. 

Paragraph 1(d) of Article 4 (Residence) makes this point

explicitly with regard to income derived by fiscally transparent

persons. Further, in accordance with paragraph 12 of the OECD

Commentaries to Article 10, the source State may disregard as

beneficial owner certain persons that nominally may receive a

dividend but in substance do not control it. See also, paragraph

24 of the OECD Commentaries to Article 1 (General Scope).

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. As a result, companies holding

shares through such entities may be able to claim the benefits of

subparagraph (a) under certain circumstances. The lower rate

applies when the company's proportionate share of the shares held

by the intermediate entity meets the 10 percent voting stock

threshold. Whether this ownership threshold is satisfied may be

difficult to determine and often will require an analysis of the

partnership or trust agreement.

Paragraph 3

Paragraph 3 provides rules that modify the maximum rates of

tax at source provided in paragraph 2 in particular cases. The

first sentence of paragraph 3 denies the lower direct investment

withholding rate of paragraph 2(a) for dividends paid by a U.S.

Regulated Investment Company (RIC) or a U.S. Real Estate Investment Trust (REIT). The second sentence denies the benefits of

both subparagraphs (a) and (b) of paragraph 2 to dividends paid

by REITs in certain circumstances, allowing them to be taxed at

the U.S. statutory rate (30 percent). The United States limits

the source tax on dividends paid by a REIT to the 15 percent rate

when the beneficial owner of the dividend is an individual resident of the other State that owns a less than 10 percent interest

in the REIT. These exceptions to the general rules of paragraph

2 became part of U.S. tax treaty policy subsequent to the
-47- Article 10

publication of the 1981 Model.

The denial of the 5 percent withholding rate at source to

all RIC and REIT shareholders, and the denial of the 15 percent

rate to all but small individual shareholders of REITs is intended to prevent the use of these entities to gain unjustifiable

source taxation benefits for certain shareholders resident in the

other Contracting State. For example, a corporation resident in

the partner that wishes to hold a diversified portfolio of U.S.

corporate shares may hold the portfolio directly and pay a U.S.

withholding tax of 15 percent on all of the dividends that it

receives. Alternatively, it may acquire a diversified portfolio

by purchasing shares in a RIC. Since the RIC may be a pure

conduit, there may be no U.S. tax costs to interposing the RIC in

the chain of ownership. Absent the special rule in paragraph 2,

use of the RIC could transform portfolio dividends, taxable in

the United States under the Convention at 15 percent, into direct

investment dividends taxable only at 5 percent. 

Similarly, a resident of the partner directly holding U.S.

real property would pay U.S. tax either at a 30 percent rate on

the gross income or at graduated rates on the net income. As in

the preceding example, by placing the real property in a REIT,

the investor could transform real estate income into dividend

income, taxable at the rates provided in Article 10,

significantly reducing the U.S. tax burden that otherwise would

be imposed. To prevent this circumvention of U.S. rules

applicable to real property, most REIT shareholders are subject

to 30 percent tax at source. However, since a relatively small

individual investor who might be subject to a U.S. tax of 15

percent of the net income even if he earned the real estate

income directly, individuals who hold less than a 10 percent

interest in the REIT remain taxable at source at a 15 percent

rate.

Paragraph 4

Exemption from tax in the state of source is provided for

dividends paid to qualified governmental entities in paragraph 3. 

Although there is no analogous provision in the OECD Model, the

exemption of paragraph 4 is analogous to that provided to foreign

governments under section 892 of the Code. Paragraph 4 makes

that exemption reciprocal. A qualified governmental entity is

defined in paragraph 1(j) of Article 3 (General Definitions), and

it includes a government pension plan. The definition does not

include a governmental entity that carries on commercial activity. Further, a dividend paid by a company engaged in commercial
-48- Article 10

activity that is controlled (within the meaning of Treas. Reg.

section 1.892-5T) by a qualified governmental entity that is the

beneficial owner of the dividend is not exempt at source under

paragraph 4 because ownership of a controlled company is viewed

as a substitute for carrying on a business directly. 

Paragraph 5

Paragraph 5 defines the term dividends broadly and flexibly. 

The definition is intended to cover all arrangements that yield a

return on an equity investment in a corporation as determined

under the tax law of the state of source, as well as arrangements

that might be developed in the future. 

The term dividends includes income from 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 nonarm's length transaction between a corporation and a related

party is a dividend. In the case of the United States the term

dividend includes amounts treated as a dividend under U.S. law

upon the sale or redemption of shares or upon a transfer of

shares in a reorganization. See, e.g., Rev. Rul. 92-85, 1992-2

C.B. 69 (sale of foreign subsidiary’s stock to U.S. sister

company is a deemed dividend to extent of 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

taxable by the United States under Article 10, provided the

limited liability company is not characterized as an association

taxable as a corporation under U.S. law. Finally, a payment

denominated as interest that is made by a thinly capitalized

corporation may be treated as a dividend to the extent that the

debt is recharacterized as equity under the laws of the source

State.

Paragraph 6

Paragraph 6 excludes from the general source country

limitations under paragraph 2 dividends paid with respect to

holdings that form part of the business property of a permanent

establishment or a fixed base. 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
-49- Article 10

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.

Paragraph 7

A State's right to tax dividends paid by a company that is a

resident of the other State is restricted by paragraph 7 to cases

in which the dividends are paid to a resident of that State or

are attributable to a permanent establishment or fixed base in

that State. Thus, a State may not impose a "secondary"

withholding tax on dividends paid by a nonresident company out of

earnings and profits from that State. In the case of the United

States, paragraph 7, therefore, overrides the taxes imposed by

sections 871 and 882(a) on dividends paid by foreign corporations

that have a U.S. source under section 861(a)(2)(B). 

The paragraph also restricts a State's right to impose

corporate level taxes on undistributed profits, other than a

branch profits tax. The accumulated earnings tax and the personal holding company taxes are taxes covered in Article 2. Accordingly, under the provisions of Article 7 (Business Profits), the

United States may not impose those taxes on the income of a

resident of the other State except to the extent that income is

attributable to a permanent establishment in the United States. 

Paragraph 7 also confirms the denial of the U.S. authority to

impose those taxes. The paragraph does not restrict a State's

right to tax its resident shareholders on undistributed earnings

of a corporation resident in the other State. Thus, the U.S.

authority to impose the foreign personal holding company tax, its

taxes on subpart F income and on an increase in earnings invested

in U.S. property, and its tax on income of a Passive Foreign

Investment Company that is a Qualified Electing Fund is in no way

restricted by this provision.

Paragraph 8

Paragraph 8 permits a State to impose a branch profits tax

on a corporation resident in the other State. The tax is in

addition to other taxes permitted by the Convention. Since the

term “corporation” is not defined in the Convention, it will be

defined for this purpose under the law of the first-mentioned

(i.e., source) State.
-50- Article 10

A State may impose a branch profits tax on a corporation if

the corporation has income attributable to a permanent establishment in that State, derives income from real property in that

State that is taxed on a net basis under Article 6, or realizes

gains taxable in that 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."

Paragraph 8 permits the United States generally to impose

its branch profits tax on a corporation resident in the other

State to the extent of the corporation's (i) business profits

that are attributable to a permanent establishment in the United

States (ii) income that is subject to taxation on a net basis

because the corporation has elected under section 882(d) of the

Code to treat income from real property not otherwise taxed on a

net basis as effectively connected income and (iii) gain from the

disposition of a United States Real Property Interest, other than

an interest in a United States Real Property Holding Corporation. 

The United States may not impose its branch profits tax on the

business profits of a corporation resident in the other State

that are effectively connected with a U.S. trade or business but

that are not attributable to a permanent establishment and are

not otherwise subject to U.S. taxation under Article 6 or paragraph 1 of Article 13. 

The term "dividend equivalent amount" used in paragraph 8

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. 

Paragraph 9

Paragraph 9 provides that the branch profits tax permitted
-51- Article 10

by paragraph 8 shall not be imposed at a rate exceeding the

direct investment dividend withholding rate of five percent. 

Relation to Other Articles

Notwithstanding the foregoing limitations on source country

taxation of dividends, the saving clause of paragraph 3 of

Article 1 permits the United States to tax dividends received by

its residents and citizens, subject to the special foreign tax

credit rules of paragraph 3 of Article 23 (Relief from Double

Taxation), as if the Convention had not come into effect.

The benefits of this Article are also subject to the provisions of Article 22 (Limitation on Benefits). Thus, if a resident of the other Contracting State is the beneficial owner of

dividends paid by a U.S. corporation, the shareholder must

qualify for treaty benefits under at least one of the tests of

Article 22 in order to receive the benefits of this Article. 
-52- Article 11

ARTICLE 11 (INTEREST)

Article 11 specifies the taxing jurisdictions over interest

income of the States of source and residence and defines the

terms necessary to apply the article.

Paragraph 1

This paragraph grants to the State of residence the exclusive right, subject to exceptions provided in paragraphs 3 and 5,

to tax interest beneficially owned by its residents and arising

in the other Contracting State. The “beneficial owner” of a

payment of interest is understood generally to refer to any

person resident in a Contracting State to whom that State

attributes the payment for purposes of its tax. Paragraph 1(d)

of Article 4 (Residence) makes this point explicitly with regard

to income derived by fiscally transparent persons. Further, in

accordance with paragraph 8 of the OECD Commentaries to Article

11, the source State may disregard as beneficial owner certain

persons that nominally may receive an interest payment but in

substance do not control it. See also, paragraph 24 of the OECD

Commentaries to Article 1 (General Scope).

Paragraph 2

The term "interest" as used in Article 11 is defined in

paragraph 2 to include, inter alia, income from debt claims of

every kind, whether or not secured by a mortgage. Penalty

charges for late payment of taxes 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 OID under the stripped

bond rules (section 1286), (iv) amounts treated as original issue
-53- Article 11

discount under the below-market interest rate rules (section

7872), (v) a partner's distributive share of a partnership's

interest income (section 702), (vi) the interest portion of

periodic payments made under a "finance lease" or similar

contractual arrangement that in substance is a borrowing by the

nominal lessee to finance the acquisition of property, (vii)

amounts included in the income of a holder of a residual interest

in a REMIC (section 860E), because these amounts generally are

subject to the same taxation treatment as interest under U.S. tax

law, and (viii) imbedded interest with respect to notional

principal contracts. 

Paragraph 3

Paragraph 3 provides an exception to the exclusive residence

taxation rule of paragraph 1 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 paragraph 3 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.

Paragraph 4

Paragraph 4 provides that in cases involving special relationships between persons, Article 11 applies only to that

portion of the total interest payments that would have been made

absent such special relationships (i.e., an arm's-length interest

payment). Any excess amount of interest paid remains taxable

according to the laws of the United States and the other Contracting State, respectively, with due regard to the other

provisions of the Convention. Thus, if the excess amount would

be treated under the source country's law as a distribution of

profits by a corporation, such amount could be taxed as a dividend rather than as interest, but the tax would be subject, if

appropriate, to the rate limitations of paragraph 2 of Article 10
-54- Article 11

(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,

which in turn corresponds 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. The United States would apply section 482 or

7872 of the Code to determine the amount of imputed interest in

those cases. 

Paragraph 5

Paragraph 5 provides anti-abuse exceptions to the sourcecountry exemption in paragraph 1 for two classes of interest

payments.

The first exception, in subparagraph (a) of paragraph 5,

deals with so-called "contingent interest." Under this provision

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 to a related person, and 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, but if the

beneficial owner is a resident of the other Contracting State,

the gross amount of the interest may be taxed at a rate not

exceeding the rate prescribed in subparagraph b) of paragraph 2

of Article 10 (Dividends).

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
-55- Article 11

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.

Relation to Other Articles

Notwithstanding the foregoing limitations on source country

taxation of interest, the saving clause of paragraph 4 of Article

1 permits the United States to tax its residents and citizens,

subject to the special foreign tax credit rules of paragraph 3 of

Article 23 (Relief from Double Taxation), as if the Convention

had not come into force.

As with other benefits of the Convention, the benefits of

exclusive residence State taxation of interest under paragraph 1

of Article 11, or limited source taxation under paragraph 5(b),

are available to a resident of the other State only if that

resident is entitled to those benefits under the provisions of

Article 22 (Limitation on Benefits).
-56- Article 12

ARTICLE 12 (ROYALTIES)

Article 12 specifies the taxing jurisdiction over royalties

of the States of residence and source and defines the terms

necessary to apply the article. 

Paragraph 1

Paragraph 1 grants to the state of residence of the beneficial owner of royalties the exclusive right to tax royalties

arising in the other Contracting State, subject to exceptions

provided in paragraph 3 (for royalties taxable as business

profits and independent personal services). 

The “beneficial owner” of a royalty payment is understood

generally to refer to any person resident in a Contracting State

to whom that State attributes the payment for purposes of its

tax. Paragraph 1(d) of Article 4 (Residence) makes this point

explicitly with regard to income derived by fiscally transparent

persons. Further, in accordance with paragraph 4 of the OECD

Commentaries to Article 12, the source State may disregard as

beneficial owner certain persons that nominally may receive a

royalty payment but in substance do not control it. See also,

paragraph 24 of the OECD Commentaries to Article 1 (General

Scope).

Paragraph 2

 The term "royalties" as used in Article 12 is defined in

paragraph 2 to include 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. It does not include income from leasing personal

property. Unlike the OECD Model, paragraph 1 does not refer to

an amount “paid” to a resident of the other Contracting State. 

The deletion of this term is intended to eliminate any inference

that an amount must actually be paid to the resident before it is

subject to the provisions of Article 12. Under paragraph 1, an

amount that is accrued but not paid also would fall within

Article 12.

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
-57- Article 12

these may be defined under domestic tax law. For example, the

term "secret process or formulas" is found in the Code, and its

meaning has been elaborated in the context of sections 351 and

367. See Rev. Rul. 55-17, 1955-1 C.B. 388; Rev. Rul. 64-56,

1964-1 C.B. 133; Rev. Proc. 69-19, 1969-2 C.B. 301.

Consideration for the use or right to use cinematographic

films, or works on film, tape, or other means of reproduction in

radio or television broadcasting is specifically included in the

definition of royalties. It is intended that subsequent technological advances in the field of radio and television broadcasting will not affect the inclusion of payments relating to the use

of such means of reproduction 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).

Computer software generally is protected by copyright laws

around the world. Under the Convention consideration received

for the use or the right to use computer software is treated

either as royalties or as income from the alienation of tangible

personal property, depending on the facts and circumstances of

the transaction giving rise to the payment. It is also

understood that payments received in connection with the transfer

of so-called “shrink-wrap” computer software are treated as

business profits.

The term "royalties" also includes gain derived from the

alienation of any right or property that would give rise to

royalties, to the extent the gain is contingent on the productivity, use, or further alienation thereof. Gains that are not

so contingent are dealt with under Article 13 (Gains).

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 Convention. 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
-58- Article 12

services. It does not include general educational training of

the user's employees, nor does it include information developed

especially for the user, for example, a technical plan or design

developed according to the user's specifications. Thus, as

provided in paragraph 11 of the Commentaries 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, 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 14 (Independent Personal Services) or Article 15

(Dependent Personal Services). 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 3

This paragraph provides an exception to the rule of paragraph 1 that gives the state of residence exclusive taxing

jurisdiction in cases where the beneficial owner of the royalties

carries 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 14 (Independent Personal Services) will apply.

The provisions of paragraph 8 of Article 7 (Business

Profits) apply to 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 14

(Independent Personal Services), respectively, and not under this

Article. 
-59- Article 12

Paragraph 4

Paragraph 4 provides that in cases involving special relationships between the payor and beneficial owner of royalties,

Article 12 applies only to the extent the royalties would have

been paid absent such special relationships (i.e., an arm'slength 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

Notwithstanding the foregoing limitations on source country

taxation of royalties, the saving clause of paragraph 4 of

Article 1 (General Scope) permits the United States to tax its

residents and citizens, subject to the special foreign tax credit

rules of paragraph 3 of Article 23 (Relief from Double Taxation),

as if the Convention had not come into force.

As with other benefits of the Convention, the benefits of

exclusive residence State taxation of royalties under paragraph 1

of Article 12 are available to a resident of the other State only

if that resident is entitled to those benefits under Article 22

(Limitation on Benefits).
-60- Article 13

ARTICLE 13 (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 the other

Contracting State 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." The term includes real property

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

itself), a "United States real property interest" (when the

United States is the other Contracting State under paragraph 1),

and an equivalent interest in real property situated in the other

Contracting State. The OECD Model does not refer to real

property interests other than the real property itself, and the

United States has entered a reservation on this point with

respect to the OECD Model, reserving the right to apply its tax

under FIRPTA to all real estate gains encompassed by that

provision.

Under section 897(c) of the Code the term "United States

real property interest" includes shares in a U.S. corporation

that owns sufficient U.S. real property interests to satisfy an

asset-ratio test on certain testing dates. The term also includes certain foreign corporations that have elected to be

treated as US corporations for this purpose. Section 897(i). In

applying paragraph 1 the United States will look through 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. 
-61- Article 13

Paragraph 3

Paragraph 3 of Article 13 deals with the taxation of certain

gains from the alienation of movable property forming part of the

business property of a permanent establishment that an enterprise

of a Contracting State has in the other Contracting State or of

movable 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 the other Contracting State 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 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,

aircraft, or containers operated in international traffic or

movable property pertaining to the operation of such ships,

aircraft, or containers. Under paragraph 4 when such income is

derived by an enterprise of a Contracting State it is taxable

only in that Contracting State. 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

general rule under Article 8 (Shipping and Air Transport) that

confers exclusive taxing rights over international shipping and

air transport income on the state of residence of the enterprise

deriving such income.

Paragraph 5

Paragraph 5 grants to the State of residence of the alien-
-62- Article 13

ator the exclusive right to tax gains from the alienation of

property other than property referred to in paragraphs 1 through

4. For example, gain derived from shares, other than shares described in paragraphs 2 or 3, debt instruments and various

financial instruments, may be taxed only in the State of residence, to the extent such income is not otherwise characterized

as income taxable under another article (e.g., Article 10 (Dividends) or Article 11 (Interest)). Similarly gain derived from

the alienation of tangible personal property, other than tangible

personal property described in paragraph 3, may be taxed only in

the State of residence of the alienator. Gain derived from the

alienation of any property, such as a patent or copyright, that

produces income taxable under Article 12 (Royalties) is taxable

under Article 12 and not under this article, provided that such

gain is of the type described in paragraph 2(b) of Article 12

(i.e., it is contingent on the productivity, use, or disposition

of the property). Thus, under either article such gain is

taxable 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

Notwithstanding the foregoing limitations on taxation of

certain gains by the State of source, the saving clause of

paragraph 4 of Article 1 (General Scope) permits the United

States to tax its citizens and residents as if the Convention had

not come into effect. Thus, any limitation in this Article on

the right of the United States to tax gains does not apply to

gains of a U.S. citizens or resident. The benefits of this

Article are also subject to the provisions of Article 22

(Limitation on Benefits). Thus, only a resident of a Contracting

State that satisfies one of the conditions in Article 22 is

entitled to the benefits of this Article. 
-63- Article 14

ARTICLE 14 (INDEPENDENT PERSONAL SERVICES)

The Convention deals in separate articles with different

classes of income from personal services. Article 14 deals with

the general class of income from independent personal services

and Article 15 deals with the general class of income from

dependent personal services. Articles 16 through 20 provide

exceptions and additions to these general rules for directors'

fees (Article 16); performance income of artistes and sportsmen

(Article 17); pensions in respect of personal service income,

social security benefits, annuities, alimony, and child support

payments (Article 18); government service salaries and pensions

(Article 19); and certain income of students and trainees (Article 20).

Paragraph 1

Paragraph 1 of Article 14 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 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 14. 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 15

(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
-64- Article 14

example, a U.S. resident partner in a law firm that has offices

in the other Contracting State would be considered to have a

fixed base regularly available to him in the other State if the

law firm had an office in the other State that was available to

him whenever he wished to conduct business in the other State,

regardless of 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 14 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 17 (Artistes and Athletes) rather than

Article 14.
-65- Article 14

This Article applies to income derived by a partner in a

partnership that provides independent personal services to the

extent that the income received by such partner is attributable

to personal services performed by the partner. For example, if a

partnership agreement provides that each partner will receive a

share of the partnership's income in exchange for performing

independent personal services, taxation of the partner's share of

that income will be governed by Article 14. In such a case, the

partner would be taxable solely in his state of residence if he

performed all his activities there. On the other hand, if he

traveled to the other State and the partnership made an office

available to him for the purpose of conducting his activities,

that portion of his income attributable to the services performed

in the other State would be taxable in that other State. If the

partner received income in addition to that paid as remuneration

for his services, the taxation of that income would not be

governed by Article 14. For example, if the partner has the

right to an annual payment from the partnership with respect to

profits generated by employees of the firm, or with respect to

his capital account in the partnership, the taxation of such

payments would not be governed by Article 14.

Paragraph 8 of Article 7 (Business Profits) refers to

Article 14. 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 14, 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 4 of Article 1 (General Scope) tax his income

without regard to the restrictions of this Article, subject to

the special foreign tax credit rules of paragraph 3 of Article 23

(Relief from Double Taxation). 

Paragraph 2

This paragraph incorporates the principles of paragraph 3 of

Article 7 into Article 14. Thus, all relevant expenses,

including expenses not incurred in the Contracting State where
-66- Article 14

the fixed base is located, must be allowed as deductions in

computing the net income from services subject to tax in the

Contracting State where the fixed base is located.
-67- Article 15

ARTICLE 15 (DEPENDENT PERSONAL SERVICES)

Article 15 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 15 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 that other Contracting State to the

extent derived from employment exercised (i.e., services

performed) in the other Contracting State. Paragraph 1 also

provides that the more specific rules of Articles 16 (Directors'

Fees), 18 (Pensions, Social Security, Annuities, Alimony and

Child Support), and 19 (Government Service) apply in the case of

employment income described in one of these articles. Thus, even

though the State of source has a right to tax employment income

under Article 15, it may not have the right to tax that income

under the Convention if the income is described, e.g., in Article

18 (Pensions, Social Security, Annuities, Alimony and Child Support) and is not taxable in the State of source under the

provisions of that article.

 Article 15 of the OECD Model applies to "salaries, wages

and other similar remuneration." The U.S. Model applies to

"salaries, wages and other remuneration." The deletion of

"similar" is intended to make it clear that Article 15 applies to

any form of compensation for employment, including payments in

kind, regardless of whether the remuneration is "similar" to

salaries and wages. 

Consistently with section 864(c)(6), Article 15 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 15 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 15 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
-68- Article 15

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: (a) the individual is present in the

other Contracting State for a period or periods not exceeding 183

days in any 12-month period that begins or ends during the

relevant (i.e., the year in which the services are performed)

calendar year; (b) the remuneration is paid by, or on behalf of,

an employer who is not a resident of that other Contracting

State; and (c) the remuneration is not borne as a deductible

expense by a permanent establishment 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 identical to that set forth

in the OECD Model.

The 183-day period in condition (a) is to be measured using

the "days of physical presence" method. Under this method, the

days that are counted include any day in which a part of the day

is spent in the host country. (Rev. Rul. 56-24, 1956-1 C.B.

851.) Thus, days that are counted include the days of arrival

and departure; weekends and holidays on which the employee does

not work but is present within the country; vacation days spent

in the country before, during or after the employment period,

unless the individual's presence before or after the employment

can be shown to be independent of his presence there for

employment purposes; and time during periods of sickness,

training periods, strikes, etc., when the individual is present

but not working. If illness prevented the individual from

leaving the country in sufficient time to qualify for the benefit, those days will not count. Also, any part of a day spent in

the host country while in transit between two points outside the

host country is not counted. 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 payor for compensation paid and at the same time to exempt

the employee on the amount received. Accordingly, if a foreign

person pays the salary of an employee who is employed in the host

State, but a host State corporation or permanent establishment

reimburses the payor with a payment that can be identified as a
-69- Article 15

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 payor is exempt from tax. 

Paragraph 3

Paragraph 3 contains a special rule applicable to remuneration for services performed by a resident of a Contracting State

as an employee aboard a ship or aircraft operated in

international traffic. Such remuneration may be taxed only in

the State of residence of the employee if the services are

performed as a member of the regular complement of the ship or

aircraft. The "regular complement" includes the crew. In the

case of a cruise ship, for example, it may also include others,

such as entertainers, lecturers, etc., employed by the shipping

company to serve on the ship throughout its voyage. The use of

the term "regular complement" is intended to clarify that a

person who exercises his employment as, for example, an insurance

salesman while aboard a ship or aircraft is not covered by this

paragraph. This paragraph is inapplicable to persons dealt with

in Article 14 (Independent Personal Services).

The comparable paragraph in the OECD Model provides that

such income may be taxed (on a non-exclusive basis) in the

Contracting State in which the place of effective management of

the employing enterprise is situated. This rule has not been

adopted by the United States because the United States exercises

its taxing jurisdiction over an employee only if the employee is

a U.S. citizen or resident, or the services are performed by the

employee in the United States. Tax cannot be imposed simply

because an employee works for an enterprise that is a resident of

the United States. The U.S. Model ensures that, given U.S. law,

each employee will be subject to one level of tax. 

If a U.S. citizen who is resident in the other Contracting

State performs services as an employee in the United States and

meets the conditions of paragraph 2 for source country exemption,
-70- Article 15

he nevertheless is taxable in the United States by virtue of the

saving clause of paragraph 4 of Article 1 (General Scope),

subject to the special foreign tax credit rule of paragraph 3 of

Article 23 (Relief from Double Taxation).
-71- Article 16

ARTICLE 16 (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 in his capacity as a director of

the company. This rule is an exception to the more general

rules of Article 14 (Independent Personal Services) and Article

15 (Dependent Personal Services). Thus, for example, in

determining whether a director's fee paid to a non-employee

director is subject to tax in the country of residence of the

corporation, it is not relevant to establish whether the fee is

attributable to a fixed base in that State.

The analogous OECD and U.S. provisions reach different

results in certain cases. Under the OECD Model provision, a

resident of one Contracting State who is a director of a

corporation that is resident in the other Contracting State is

subject to tax in that other State in respect of his directors'

fees regardless of where the services are performed. The United

States has entered a reservation with respect to the OECD

provision. The provision in Article 16 of the U.S. Model

represents a compromise between the U.S. position reflected in

the 1981 Model and the OECD Model. Under this Model provision,

the State of residence of the corporation may tax nonresident

directors with no time or dollar threshold, but only with respect

to remuneration for services performed in that State. 

This Article is subject to the saving clause of paragraph 4

of Article 1 (General Scope). Thus, if a U.S. citizen who is a

resident of the other Contracting State is a director of a U.S.

corporation, the United States may tax his full remuneration

regardless of where he performs his services.
` -72- Article 17

ARTICLE 17 (ARTISTES AND SPORTSMEN)

This Article deals with the taxation in a Contracting State

of artistes (i.e., performing artists and entertainers) and

sportsmen resident in the other Contracting State from the

performance of their services as such. The Article applies both

to the income of an entertainer or sportsman who performs services on his own behalf and one who performs services on behalf of

another person, either as an employee of that person, or pursuant

to any other arrangement. The rules of this Article take

precedence, in some circumstances, over those of Articles 14

(Independent Personal Services) and 15 (Dependent Personal

Services). 

This Article applies only with respect to the income of

performing artists and sportsmen. Others involved in a

performance or athletic event, such as producers, directors,

technicians, managers, coaches, etc., remain subject to the

provisions of Articles 14 and 15. In addition, except as

provided in paragraph 2, income earned by legal persons is not

covered by Article 17.

Paragraph 1

Paragraph 1 describes the circumstances in which a Contracting State may tax the performance income of an entertainer or

sportsman who is a resident of the other Contracting State. 

Under the paragraph, income derived by an individual resident of

a Contracting State from activities as an entertainer or

sportsman exercised in the other Contracting State may be taxed

in that other State if the amount of the gross receipts derived

by the performer exceeds $20,000 (or its equivalent in the

currency of the other Contracting State) for the taxable year. 

The $20,000 includes expenses reimbursed to the individual or

borne on his behalf. If the gross receipts exceed $20,000, the

full amount, not just the excess, may be taxed in the State of

performance. 

The OECD Model provides for taxation by the country of

performance of the remuneration of entertainers or sportsmen with

no dollar or time threshold. The United States introduces 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
` -73- Article 17

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 14 (Independent

Personal Services) or 15 (Dependent Personal Services). On the

other hand, if the performer would be exempt from host-country

tax under Article 17, but would be taxable under either Article

14 or 15, 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, he may be taxed by the host

State in accordance with Article 17 if his remuneration exceeds

$20,000 annually, despite the fact that he generally would be

exempt from host State taxation under Article 14. However, a

performer who receives less than the $20,000 threshold amount and

therefore is not taxable under Article 17, nevertheless may be

subject to tax in the host country under Articles 14 or 15 if the

tests for host-country taxability under those Articles are met. 

For example, if an entertainer who is an independent contractor

earns $19,000 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 14. This interpretation is consistent with the

prevailing understanding under Article 17 of the 1981 Model, but

has been clarified by amendments to the text of paragraph 1 in

this Model.

Since it frequently is not possible to know until year-end

whether the income an entertainer or sportsman derived from a

performance in a Contracting State will exceed $20,000, nothing

in the Convention precludes that Contracting State from withholding tax during the year and refunding after the close of the year

if the taxability threshold has not been met. 

As explained in paragraph 9 of the OECD Commentaries to

Article 17, Article 17 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 14 (Independent Personal Services). For example, if an

entertainer receives royalty income from the sale of live

recordings, the royalty income would be exempt from source
` -74- Article 17

country tax under Article 12, even if the performance was

conducted in the source country, although he could be taxed in

the source country with respect to income from the performance

itself under this Article if the dollar threshold is exceeded.

In determining whether income falls under Article 17 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 17. 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 17 as well. 

As indicated in paragraph 9 of the Commentaries to Article 17 of

the OECD Model, a cancellation fee would not be considered to

fall within Article 17 but would be dealt with under Article 7,

14 or 15.

As indicated in paragraph 4 of the Commentaries 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 actordirector), 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.

Consistently with Article 15 (Dependent Personal Services),

Article 17 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 17 for that year even if it was paid after

the close of the year.

Paragraph 2

Paragraph 2 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

commonly 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,
` -75- Article 17

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 2, the income arguably could escape host-country tax

because it 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 2 seeks to prevent this type of abuse while at the

same time protecting the taxpayers' rights to the benefits of the

Convention when there is a legitimate employee-employer relationship between the performer and the person providing his services. 

Under paragraph 2, when the income accrues to a person other than

the performer, and the performer or related persons participate,

directly or indirectly, in the receipts or profits of that other

person, the income may be taxed in the Contracting State where

the performer's services are exercised, without regard to the

provisions of the Convention concerning business profits (Article

7) or independent personal services (Article 14). 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 2. Taxation under paragraph 2 is on

the person providing the services of the performer. This

paragraph does not affect the rules of paragraph 1, which apply

to the performer himself. The income taxable by virtue of

paragraph 2 is reduced to the extent of salary payments to the

performer, which fall under paragraph 1.

For purposes of paragraph 2, income is deemed to accrue to

another person (i.e., the person providing the services of the

performer) if that other person has control over, or the right to

receive, gross income in respect of the services of the performer. Direct or indirect participation in the profits of a person

may include, but is not limited to, the accrual or receipt of

deferred remuneration, bonuses, fees, dividends, partnership

income or other income or distributions. 

Paragraph 2 does not apply if it is established that neither
` -76- Article 17

the performer nor any persons related to the performer

participate directly or indirectly in the receipts or profits of

the person providing the services of the performer. Assume, for

example, that a circus owned by a U.S. corporation performs in

the other Contracting State, and promoters of the performance in

the other State pay the circus, which, in turn, pays salaries to

the circus performers. The circus is determined to have no

permanent establishment in that State. Since the circus

performers do not participate in the profits of the circus, but

merely receive their salaries out of the circus' gross receipts,

the circus is protected by Article 7 and its income is not

subject to host-country tax. Whether the salaries of the circus

performers are subject to host-country tax under this Article

depends on whether they exceed the $20,000 threshold in paragraph

1. 

Since pursuant to Article 1 (General Scope) the Convention

only applies to persons who are residents of one of the

Contracting States, if the star company is not a resident of one

of the Contracting States then taxation of the income is not

affected by Article 17 or any other provision of the Convention.

This exception from paragraph 2 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. 

Relationship to other articles

This Article is subject to the provisions of the saving

clause of paragraph 4 of Article 1 (General Scope). Thus, if an

entertainer or a sportsman who is resident in the other Contracting State is a citizen of the United States, the United States

may tax all of his income from performances in the United States

without regard to the provisions of this Article, subject,

however, to the special foreign tax credit provisions of paragraph 3 of Article 23 (Relief from Double Taxation). In addition, benefits of this Article are subject to the provisions of

Article 22 (Limitation on Benefits). 
-77- Article 18

ARTICLE 18 (PENSIONS, SOCIAL SECURITY, ANNUITIES, ALIMONY, AND

CHILD SUPPORT)

This Article deals with the taxation of private (i.e.,

non-government service) pensions and annuities, social security

benefits, alimony and child support payments and with the tax

treatment of contributions to pension plans.

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. This Model,

unlike the OECD Model and the 1981 Model, makes explicit the fact

that the term "pension distributions and other similar

remuneration" includes both periodic and single sum payments. 

The same result is understood to apply in U.S. treaties that do

not make this point explicitly. 

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 408(k), individual retirement accounts and

section 408(p) accounts), non-discriminatory section 457 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. In the United States, these

criteria are as follows:

a) The plan must be written;

b) In the case of an employer-maintained plan, the plan

must be nondiscriminatory insofar as it (alone or in combination

with other comparable plans) must cover a wide range of

employees. including rank and file employees, and actually

provide significant benefits for the entire range of covered

employees;

c) In the case of an employer-maintained plan the plan must

contain provisions that severely limit the employees’ ability to

use plan assets for purposes other than retirement, and in all
-78- Article 18

cases be subject to tax provisions that discourage participants

from using the assets for purposes other than retirement; and

d) The plan must provide for payment of a reasonable level

of benefits at death, a stated age, or an event related to work

status, and otherwise require minimum distributions under rules

designed to ensure that any death benefits provided to the

participants’ survivors are merely incidental to the retirement

benefits provided to the participants.

In addition, certain distribution requirements must be met

before distributions from these plans would fall under paragraph

1. To qualify as a pension distribution or similar remuneration

from a U.S. plan the employee must have been either employed by

the same employer for five years or be at least 62 years old at

the time of the distribution. In addition, the distribution must

be made either (A) on account of death or disability, (B) as part

of a series of substantially equal payments over the employee’s

life expectancy (or over the joint life expectancy of the

employee and a beneficiary), or (C) after the employee attained

the age of 55. Finally, the distribution must be made either

after separation from service or on or after attainment of age

65. A distribution from a pension plan solely due to termination

of the pension plan is not a distribution falling under 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 paragraph 2 of Article 19 (Government Service). Thus, Article

19 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 19 solely because the service

is not “in the discharge of functions of a governmental nature,”

the pension is covered by this article.

The exclusive residence-based taxation provided under this

paragraph is limited to taxation of amounts that were not

previously included in taxable income in the other Contracting

State. For example, if a Contracting State had imposed tax on

the resident with respect to some portion of a pension plan’s

earnings, subsequent distributions to a resident of the other

State would not be taxable in that State to the extent the

distributions were attributable to such amounts. In determining

the amount of a distribution that is attributable to previously

taxed amounts, the ordering rules of the residence State will be

applied. The United States will treat any amount that has

increased the recipient’s “investment in the contract” (as
-79- Article 18

defined in section 72) as having been previously included in

taxable income.

Paragraph 2

The treatment of social security benefits is dealt with in

paragraph 2. This paragraph provides that, notwithstanding the

provision of paragraph 1 under which private pensions are taxable

exclusively in the State of residence of the beneficial owner,

payments made by one of the Contracting States under the provisions of its social security or similar legislation to a resident

of the other Contracting State or to a citizen of the United

States 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.

The phrase "similar legislation" is intended to refer to

United States tier 1 Railroad Retirement benefits. The reference

to U.S. citizens is necessary to insure that a social security

payment by the other Contracting State to a U.S. citizen who is

not resident in the United States will not be taxable by the

United States. 

Paragraph 3

Under paragraph 3, annuities that are derived and beneficially owned by a resident of a Contracting State are taxable

only in that State. An annuity, as the term is used in this

paragraph, means a stated sum paid periodically at stated times

during a specified number of years, under an obligation to make

the payment in return for adequate and full consideration (other

than for services rendered). An annuity received in

consideration for services rendered would be treated as deferred

compensation and generally taxable in accordance with Article 15

(Dependent Personal Services).

Paragraphs 4 and 5

Paragraphs 4 and 5 deal with alimony and child support

payments. Both alimony, under paragraph 4, and child support

payments, under paragraph 5, are defined as periodic payments

made pursuant to a written separation agreement or a decree of

divorce, separate maintenance, or compulsory support. Paragraph

4, however, deals only with payments of that type that are

deductible to the payor and taxable to the payee. Under that
-80- Article 18

paragraph, alimony (i.e., a deductible payment that is taxable in

the hands of the recipient) paid by a resident of a Contracting

State to a resident of the other Contracting State is taxable

under the Convention only in the State of residence of the

recipient. Paragraph 5 deals with those periodic payments that

are for the support of a child and that are not covered by

paragraph 4 (i.e., those payments that either are not deductible

to the payor or not taxable to the payee). These types of

payments by a resident of a Contracting State to a resident of

the other Contracting State are taxable in neither Contracting

State. 

Paragraph 6

Paragraph 6 deals with various aspects of cross-border

pension contributions. There is no such rule in the OECD or U.N.

Models, nor was there one in any of the previous U.S. Models. 

The 1992 OECD Model, however, deals extensively in the Commentary

with this matter, providing both a model text and a discussion of

the issues. Paragraph 6 has been included in this Model to

ensure that certain differences between the two Contracting

States' laws regarding pension contributions and pension plans

will not inhibit the flow of personal services between the

Contracting States.

Paragraph 6 essentially provides three types of benefits: 

deductions (or exclusions) at the employee and employer level for

contributions to a pension plan (subparagraph (a)), exemption

from tax on undistributed earnings realized by the plan

(subparagraph (b)), and exemption from tax on rollovers from one

plan to another (subparagraph (c)).

Subparagraph 6(a) allows for the deductibility (or

excludibility) in one State of contributions to a plan in the

other State if certain conditions are satisfied. Subparagraph

6(a) also provides that contributions to the plan will be

deductible for purposes of computing the employer's taxable

income in the State where the individual renders services to the

extent allowable in that State for contributions to plans

established and recognized under that State's laws.

Where the United States is the host country, the exclusion

of employee contributions from the employee’s income under this

paragraph is limited to elective contributions not in excess of

the amount specified in section 402(g). Deduction of employer

contributions is subject to the limitations of sections 415 and

404. The section 404 limitation on deductions would be
-81- Article 18

calculated as if the individual were the only employee covered by

the plan.

Subparagraph 6(b) provides that income earned by the plan

will not be taxable in the other State until the earnings are

distributed.

Subparagraph 6(c) permits the individual to withdraw funds

from the plan in the first-mentioned (home) State for the purpose

of rolling over the amounts to a plan established in the other

(host) Contracting State without being subjected to tax in the

other State with respect to such amounts. This benefit is

subject to any restrictions on rollovers under the laws of the

other State. For instance, in the United States a rollover

ordinarily must be made within 60 days of the withdrawal from the

first plan under section 408(d)(3)(A)(i) and section 402(c). 

Rollovers from plans covered by Article 19 (Government Service)

would not be covered by this provision. It is understood that,

for the purposes of maintaining the tax-exempt status of a

pension arrangement receiving rolled-over amounts, the assets

received will be treated as assets rolled over from a qualified

plan.

The benefits of this paragraph are allowed to an individual

who is present in one of the Contracting States to perform either

dependent or independent personal services. The individual,

however, must be a visitor to the host country. Subparagraph

6(d) provides that the individual can receive the benefits of

this paragraph only if he was contributing to the plan in his

home country, or to a plan that was replaced by the plan to which

he is contributing, before coming to the host country. The

allowance of a successor plan would apply if, for example, the

employer has been taken over by another corporation that replaces

the existing plan with its own plan, rolling membership in the

old plan over into the new plan. 

In addition, the host-country competent authority must

determine that the recognized plan to which a contribution is

made in the home country of the individual generally corresponds

to the plan in the host country. It is understood that United

States plans eligible for the benefits of paragraph 6 include

qualified plans under section 403(a), individual retirement plans

(including individual retirement plans that are part of a

simplified employee pension plan that satisfies section 408(k),

IRAs and section 408(p) accounts), section 403(a) qualified

annuity plans, individual retirement accounts, and section 403(b)

plans. Finally, the benefits under this paragraph are limited to

the benefits that the host country accords under its law, to the
-82- Article 18

host country plan most similar to the home country plan, even if

the home country would have afforded greater benefits under its

law. Thus, for example, if the host country has a cap on

contributions equal to, say, five percent of the remuneration,

and the home country has a seven percent cap, the deduction is

limited to five percent, even though if the individual had

remained in his home country he would have been allowed to take

the larger deduction.

Relationship to other Articles

Paragraphs 1, 3 and 4 of Article 18 are subject to the

saving clause of paragraph 4 of Article 1 (General Scope). Thus,

a U.S. citizen who is resident in the other Contracting State,

and receives either a pension, annuity or alimony payment from

the United States, may be subject to U.S. tax on the payment,

notwithstanding the rules in those three paragraphs that give the

State of residence of the recipient the exclusive taxing right. 

Paragraphs 2 and 5 are excepted from the saving clause by virtue

of paragraph 5(a) of Article 1. Thus, the United States will

allow U.S. citizens and residents the benefits of paragraph 5.

Paragraph 6 is excepted from the saving clause with respect to

permanent residents and citizens by virtue of paragraph 5(b) of

Article 1.
-83- Article 19

ARTICLE 19 (GOVERNMENT SERVICE)

Paragraph 1

Subparagraphs (a) and (b) of paragraph 1 deal with the

taxation of government compensation (other than a pension

addressed in paragraph 2). Subparagraph (a) provides that

remuneration paid from the public funds of one of the States or

its political subdivisions or local authorities to any individual

who is rendering services to that State, political subdivision or

local authority, which are in the discharge of governmental

functions, is exempt from tax by the other State. Under

subparagraph (b), such payments are, however, taxable exclusively

in the other State (i.e., the host State) if the services are

rendered in that other State and the individual is a resident of

that State who is either a national of that State or a person who

did not become resident of that State solely for purposes of

rendering the services. The paragraph applies both to government

employees and to independent contractors engaged by governments

to perform services for them.

The remuneration described in paragraph 1 is subject to the

provisions of this paragraph and not to those of Articles 14

(Independent Personal Services), 15 (Dependent Personal

Services), 16 (Director's Fees) or 17 (Artistes and Sportsmen). 

If, however, the conditions of paragraph 1 are not satisfied,

those other Articles will apply. Thus, if a local government

sponsors a basketball team in an international tournament, and

pays the athletes from public funds, the compensation of the

players is covered by Article 17 and not Article 19, because the

athletes are not engaging in a governmental function when they

play basketball.

Paragraph 2

Paragraph 2 deals with the taxation of a pension paid from

the public funds of one of the States or a political subdivision

or a local authority thereof to an individual in respect of

services rendered to that State or subdivision or authority in

the discharge of governmental functions. Subparagraph (a)

provides that such a pension is taxable only in that State. 

Subparagraph (b) provides an exception under which such a pension

is taxable only in the other State if the individual is a resident of, and a national of, that other State. Pensions paid to

retired civilian and military employees of a Government of either

State are intended to be covered under paragraph 2. When benefits paid by a State in respect of services rendered to that

State or a subdivision or authority are in the form of social
-84- Article 19

security benefits, however, those payments are covered by paragraph 2 of Article 18 (Pensions, Social Security, Annuities,

Alimony, and Child Support). As a general matter, the result

will be the same whether Article 18 or 19 applies, since social

security benefits are taxable exclusively by the source country

and so are government pensions. The result will differ only when

the payment is made to a citizen and resident of the other

Contracting State, who is not also a citizen of the paying State. 

In such a case, social security benefits continue to be taxable

at source while government pensions become taxable only in the

residence country.

The phrase "functions of a governmental nature" is not

defined. In general it is understood to encompass functions

traditionally carried on by a government. It would not include

functions that commonly are found in the private sector (e.g.,

education, health care, utilities). Rather, it is limited to

functions that generally are carried on solely by the government

(e.g., military, diplomatic service, tax administrators) and

activities that directly support the carrying out of those

functions.

The use of the phrase "paid from the public funds of a

Contracting State" is intended to clarify that remuneration and

pensions paid by such entities as government-owned corporations

are covered by the Article, as long as the other conditions of

the Article are satisfied. 

Relation to other Articles

Under paragraph 5(b) of Article 1 (General Scope), the

saving clause (paragraph 4 of Article 1) does not apply to the

benefits conferred by one of the States under Article 19 if the

recipient of the benefits is neither a citizen of that State, nor

a person who has been admitted for permanent residence there

(i.e., in the United States, a "green card" holder). Thus, a

resident of a Contracting State who in the course of performing

functions of a governmental nature becomes a resident of the

other State (but not a permanent resident), would be entitled to

the benefits of this Article. However, an individual who

receives a pension paid by the Government of the other

Contracting State in respect of services rendered to that

Government shall be taxable on this pension only in the other

Contracting State unless the individual is a U.S. citizen or

acquires a U.S. green card.
-85- Article 20

ARTICLE 20 (STUDENT AND TRAINEES)

This Article provides rules for host-country taxation of

visiting students, apprentices or business trainees. Persons who

meet the tests of the Article will be exempt from tax in the

State that they are visiting with respect to designated classes

of income. Several conditions must be satisfied in order for an

individual to be entitled to the benefits of this Article.

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 part-time

student, he would not be entitled to the benefits of this

Article, even with respect to 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 at which he is studying. Similarly, a

person who visits the host State for the purpose of obtaining

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.

Third, a student must be studying at an accredited

educational institution. (This requirement does not apply to

business trainees or apprentices.) An educational institution is

understood to be an institution that normally maintains a regular

faculty and normally has a regular body of students in attendance

at the place where the educational activities are carried on. An

educational institution will be considered to be accredited if it

is accredited by an authority that generally is responsible for

accreditation of institutions in the particular field of study. 

The host-country exemption in the Article applies only to

payments received by the student, apprentice or business trainee

for the purpose of his maintenance, education or training that

arise outside the host State. A payment will be considered to

arise outside the host State if the payor 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 host-country tax. In all

cases substance over form should prevail in determining the
-86- Article 20

identity of the payor. Consequently, payments made directly or

indirectly by the U.S. person with whom the visitor is training,

but which have been routed through a non-host-country source,

such as, for example, a foreign bank account, should not be

treated as arising outside the United States for this purpose.

In the case of an apprentice or business trainee, the

benefits of the Article will extend only for a period of one year

from the time that the visitor first arrives in the host country. 

If, however, an apprentice or trainee remains in the host country

for a second year, thus losing the benefits of the Article, he

would not retroactively lose the benefits of the Article for the

first year. 

The saving clause of paragraph 4 of Article 1 (General

Scope) does not apply to this Article with respect to an individual who is neither a citizen of the host State nor has been

admitted for permanent residence there. The saving clause,

however, does apply with respect to citizens and permanent

residents of the host State. Thus, a U.S. citizen who is a

resident of the other Contracting State and who visits the United

States as a full-time student at an accredited university will

not be exempt from U.S. tax on remittances from abroad that

otherwise constitute U.S. taxable income. A person, however, who

is not a U.S. citizen, and who visits the United States as a

student and remains long enough to become a resident under U.S.

law, but does not become a permanent resident (i.e., does not

acquire a green card), will be entitled to the full benefits of

the Article.
-87- Article 21

ARTICLE 21 (OTHER INCOME)

Article 21 generally assigns taxing jurisdiction over income

not dealt with in the other articles (Articles 6 through 20) of

the Convention to the State of residence of the beneficial owner

of the income and defines the terms necessary to apply the

article. 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 21 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 21. 

Distributions from partnerships and distributions from

trusts are not generally dealt with under Article 21 because

partnership and trust 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. Also, under the Code, 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 21 is contained in paragraph 1. 

Items of income not dealt with in other articles and beneficially

owned by a resident of a Contracting State will be taxable only

in the State of residence. This exclusive right of taxation

applies whether or not the residence State exercises its right to

tax the income covered by the Article.
-88- Article 21

This paragraph differs in one respect from paragraph 1 in

the 1981 Model and the OECD Model, by referring to "items of

income beneficially owned by a resident of a Contracting State"

rather than simply "items of income of a resident of a Contracting State." This is not a substantive change. It is intended

merely to make explicit the implicit understanding in other

treaties that the exclusive residence taxation provided by paragraph 1 applies only when a resident of a Contracting State is

the beneficial owner of the income. This should also be understood from the phrase "income of a resident of a Contracting

State." The addition of a reference to beneficial ownership

merely removes any possible ambiguity. Thus, source taxation of

income not dealt with in other articles of the Convention is not

limited by paragraph 1 if it is nominally paid to a resident of

the other Contracting State, but is beneficially owned by a

resident of a third State. 

Paragraph 2

This paragraph provides an exception to the general rule of

paragraph 1 for income, other than income from real property,

that is attributable to a permanent establishment or fixed base

maintained in a Contracting State by a resident of the other

Contracting State. The taxation of such income is governed by

the provisions of Articles 7 (Business Profits) and 14 (Independent Personal Services). Therefore, income arising outside the

United States that is attributable to a permanent establishment

maintained in the United States by a resident of the other

Contracting State generally would be taxable by the United States

under the provisions of Article 7. This would be true even if

the income is sourced in a third State.

There is an exception to this general rule with respect to

income a resident of a Contracting State derives from real

property located outside the other Contracting State (whether in

the first-mentioned Contracting State or in a third State) that

is attributable to the resident's permanent establishment or

fixed base in the other Contracting State. In such a case, only

the first-mentioned Contracting State (i.e., the State of

residence of the person deriving the income) and not the host

State of the permanent establishment or fixed base may tax that

income. This special rule for foreign-situs property is

consistent with the general rule, also reflected in Article 6

(Income from Real Property (Immovable Property)), that only the

situs and residence States may tax real property and real

property income. Even if such property is part of the property

of a permanent establishment or fixed base in a Contracting
-89- Article 21

State, that State may not tax if neither the situs of the

property nor the residence of the owner is in that State. 

Relation to Other Articles

This Article is subject to the saving clause of paragraph 4

of Article 1 (General Scope). Thus, the United States may tax

the income of a resident of the other Contracting State that is

not dealt with elsewhere in the Convention, if that resident is a

citizen of the United States. The Article is also subject to the

provisions of Article 22 (Limitation on Benefits). Thus, if a

resident of the other Contracting State earns income that falls

within the scope of paragraph 1 of Article 21, but that is

taxable by the United States under U.S. law, the income would be

exempt from U.S. tax under the provisions of Article 21 only if

the resident satisfies one of the tests of Article 22 for entitlement to benefits. 
-90- Article 22

ARTICLE 22 (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. This statement begs the question of who is to be treated

as a resident of a Contracting State for the purpose of being

granted treaty benefits. The Commentaries to the OECD Model

authorize a tax authority to deny benefits, under substance-overform 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 Commentaries to Article 1 contain an

extensive discussion approving the use 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. It is important to note that this definition

of 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 structure

would not fall within the definition of treaty shopping set forth

above. 

Of course, the fundamental problem presented by this

approach is that it is based on the taxpayer's intent, which a

tax administration is normally ill-equipped to identify. In

order to avoid the necessity of making this subjective

determination, Article 22 sets forth a series of objective tests. 

The assumption underlying each of these tests is that a taxpayer

that satisfies the requirements of any of the tests probably 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
-91- Article 22

connection outweighs any purpose to obtain the benefits of the

Treaty.

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 the other State 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

Treaty; it is presumed in such a case that the investor had a

valid business purpose for investing in the other State, and that

the link between that trade or business and the U.S. activity

that generates the treaty-benefitted income manifests a business

purpose for placing the U.S. investments in the entity in the

other State. It is considered unlikely that the investor would

incur the expense of establishing a substantial trade or business

in the other State simply to obtain the benefits of the

Convention. A similar rationale underlies the other tests in

Article 22. 

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 22 also includes a provision (paragraph 4) authorizing

the competent authority of a Contracting State to grant benefits. 

While an analysis under paragraph 4 may well differ from that

under one of the other tests of Article 22, 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 22 and the anti-abuse provisions of domestic law

complement each other, as Article 22 effectively determines

whether an entity has a sufficient nexus to the Contracting State

to be treated as a resident for treaty purposes, while domestic

anti-abuse provisions (e.g., business purpose, substance-overform, 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 22 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 22 follows the form used in other recent U.S. income

tax treaties. (See, e.g., the Convention between the United

State of America and the Federal Republic of Germany for the
-92- Article 22

Avoidance of Double Taxation and the Prevention of Fiscal Evasion

with Respect to Taxes on Income and Capital and to Certain Other

Taxes.) The structure of the Article is as follows: Paragraph 1

states the general rule that residents are entitled to benefits

otherwise accorded to residents only to the extent provided in

the Article. Paragraph 2 lists a series of attributes of a

resident of a Contracting State, the presence of any one of which

will entitle that person to all the benefits of the Convention. 

Paragraph 3 provides 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 sourcebased taxation under Articles 6 through 21, the treaty-based

relief from double taxation provided by Article 23 (Relief from

Double Taxation), and the protection afforded to residents of a

Contracting State under Article 24 (Non-Discrimination). 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 24 (Non-Discrimination), Article 25 (Mutual

Agreement Procedure), and Article 27 (Diplomatic Agents and

Consular Officers). Article 22 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
-93- Article 22

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(i) 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. This provision differs from corresponding

provisions in earlier treaties in that it states that “all of the

shares” in the principal class of shares must be regularly traded

on a recognized stock exchange. This language was added to make

it clear that all shares in the principal class or classes of

shares (as opposed to only a portion of such shares) must satisfy

the requirements of this subparagraph.

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 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
-94- Article 22

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, generally the source State. In the case of the United

States, this term is understood to have the meaning it has under

Treas. Reg. section 1.884-5(d)(4)(i)(B), relating to the branch

tax provisions of the Code. Under these regulations, a class of

shares is considered to be "regularly traded" if two requirements

are met: trades in the class of shares are made in more than de

minimis quantities on at least 60 days during the taxable year,

and the aggregate number of shares in the class traded during the

year is at least 10 percent of the average number of shares

outstanding during the year. Sections 1.884-5(d)(4)(i)(A), (ii)

and (iii) will not be taken into account for purposes of defining

the term "regularly traded" under the Convention.

The regular trading requirement can be met by trading on any

recognized exchange or exchanges located in either State. 

Trading on one or more recognized stock exchanges may be

aggregated for purposes of this requirement. Thus, a U.S.

company could satisfy the regularly traded requirement through

trading, in whole or in part, on a recognized stock exchange

located in 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
-95- Article 22

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)(ii) considers the ownership of every

class of shares outstanding, while the test under subparagraph

2(c)(i) only considers those classes that account for a majority

of the company's voting power and value.

Clause (ii) permits indirect ownership. Consequently, the

ownership by publicly-traded 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(b)(i) of Article 4 (Residence) 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(b)(ii) of Article 4 (Residence) 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 a two part test, the so-called

ownership and base erosion test. This test applies to any form

of legal entity that is a resident of a Contracting State. Both

prongs of the test must be satisfied for the resident to be

entitled to benefits under subparagraph 2(f). 
-96- Article 22

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 (Residence) 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 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 beneficiaries are persons

entitled to benefits under the other subparagraphs of paragraph

2.

The base erosion prong of the test under subparagraph 2(f)

requires that less than 50 percent of the person's gross income

for the taxable year be paid or accrued, directly or indirectly,

to non-residents of either State (unless income is attributable

to a permanent establishment located in either Contracting

State), in the form of payments that are deductible for tax

purposes in the entity's State of residence. To the extent they

are deductible from the taxable base, trust distributions would

be considered deductible payments. Depreciation and amortization

deductions, which are not "payments," are disregarded for this

purpose. This provision differs in some respects from analogous

provisions in other treaties. Its purpose is to determine

whether the income derived from the source State is in fact

subject to the tax regime of that other State. Consequently,

payments to any resident of either State, as well as payments

that are attributable to permanent establishments in either

State, are not considered base eroding payments for this purpose

(to the extent that these recipients do not themselves base erode

to non-residents).
-97- Article 22

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 3(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

business. Third, the trade or business must be substantial in

relation to the activity in the other State that generated the

item of income. These determinations are made separately for

each item of income derived from the other State. It therefore

is possible that a person would be entitled to the benefits of

the Convention with respect to one item of income but not with

respect to another. If a resident of a Contracting State is

entitled to treaty benefits with respect to a particular item of

income under paragraph 3, the resident is entitled to all

benefits of the Convention insofar as they affect the taxation of

that item of income in the other State. Set forth below is a

discussion of each of the three prongs of the test under

paragraph 3.

Trade or Business -- Subparagraphs 3(a)(i) and (b)
-98- Article 22

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 the other

State is entitled to the benefits of the Convention under

paragraph 3 with respect to income derived from U.S. sources, the

United States will ascribe to this term the meaning that it has

under the law of the United States. Accordingly, the United

States 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. See, Code section

367(a)(3) and the regulations thereunder.

Notwithstanding this general definition of trade or

business, subparagraph 3(b) provides that the business of making

or managing investments, when part of banking, insurance or

securities activities conducted by a bank, insurance company, or

registered securities dealer, will be considered to be a trade or

business. Conversely, 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 banking or

insurance company but not as part of the company's banking or

insurance 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. 

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 other State 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. Although no

definition of the terms "forms a part of" or "complementary" is

set forth in the Convention, it is intended that a business

activity generally will be considered to "form a part of" a

business activity conducted in the other State if the two
-99- Article 22

activities involve the design, manufacture or sale of the same

products or type of products, or the provision of similar

services. In order 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. In cases in which more than one trade or business

is conducted in the other State 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-benefitted 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. The following examples illustrate the

application of subparagraph 3(d).

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 FCo, a

corporation resident in the other Contracting State. FCo

distributes USCo products in the other Contracting State. Since

the business activities conducted by the two corporations involve

the same products, FCo's distribution business is considered to

form a part of USCo's manufacturing business within the meaning

of subparagraph 3(d).

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

FCo. FCo and other USCo affiliates then manufacture and market

the USCo-designed products in their respective markets. Since

the activities conducted by FCo and USCo involve the same product

lines, these activities are considered to form a part of the same

trade or business.

Example 3. Americair is a corporation resident in the

United States that operates an international airline. FSub is a

wholly-owned subsidiary of Americair resident in the other

Contracting State. FSub operates a chain of hotels in the other

Contracting State that are located near airports served by
-100- Article 22

Americair flights. Americair frequently sells tour packages that

include air travel to the other Contracting State and lodging at

FSub 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 FSub's business does not form a part of

Americair's business. However, FSub'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 FSub owns an office building in the other Contracting State

instead of a hotel chain. No part of Americair's business is

conducted through the office building. FSub's business is not

considered to form a part of or to be complementary to

Americair's business. They are engaged in distinct trades or

businesses in separate industries, and there is no economic

dependence between the two operations.

Example 5. USFlower is a corporation resident in the United

States. USFlower produces and sells flowers in the United States

and other countries. USFlower owns all the shares of ForHolding,

a corporation resident in the other Contracting State. 

ForHolding is a holding company that is not engaged in a trade or

business. ForHolding owns all the shares of three corporations

that are resident in the other Contracting State: ForFlower,

ForLawn, and ForFish. ForFlower distributes USFlower flowers

under the USFlower trademark in the other State. ForLawn markets

a line of lawn care products in the other State under the

USFlower trademark. In addition to being sold under the same

trademark, ForLawn and ForFlower products are sold in the same

stores and sales of each company's products tend to generate

increased sales of the other's products. ForFish imports fish

from the United States and distributes it to fish wholesalers in

the other State. For purposes of paragraph 3, the business of

ForFlower forms a part of the business of USFlower, the business

of ForLawn is complementary to the business of USFlower, and the

business of ForFish 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
-101- Article 22

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 other State. 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 the relative scale of the activities conducted in the two

States and the relative contributions made to the conduct of the

trade or businesses in the two States. 

In addition to this 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

1998, the preceding year is 1997. If one of the ratios for 1997

is not greater than 7.5 percent, the average ratio for 1995,

1996, and 1997 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. §1.884-5(e)(3)(ii)(A).
-102- Article 22

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 payors. 

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
-103- Article 22

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 23 on the grounds that he was

not entitled to benefits of the article under Article 22.

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; and (ii) [certain exchanges located in the

other Contracting State].
-104- Article 23

ARTICLE 23 (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. The other Contracting State may also use a foreign tax

credit, or a combination of foreign tax credit and exemption

methods, depending on the nature of the income involved. In rare

cases of treaties with countries employing pure territorial

systems, the other Contracting State will use only an exemption

system for relieving double taxation. 

Paragraph 1

The United States agrees, in paragraph 1, to allow to its

citizens and residents a credit against U.S. tax for income taxes

paid or accrued to the other Contracting State. Paragraph 1 also

provides that the other Contracting State’s covered taxes are

income taxes for U.S. purposes. This provision is based on the

Treasury Department’s review of the other Contracting State’s

laws. 

The credit under the Convention is 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. 

Subparagraph (b) provides for a deemed-paid credit, consistent with section 902 of the Code, to a U.S. corporation in

respect of dividends received from a corporation resident in the

other Contracting State 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 the other Contracting State on the

profits out of which the dividends are considered paid.

As indicated, 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
-105- Article 23

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. Furthermore, nothing in the Convention prevents the limitation of the

U.S. credit from being applied on a per-country basis (should

internal law be changed), an overall basis, or to particular

categories of income (see, e.g., Code section 865(h)).

Paragraph 2

Specific rules will be provided in paragraph 2 of each

treaty under which the other Contracting State, in imposing tax

on its residents, provides relief for U.S. taxes paid by those

residents. Although the Model Article is drafted as though the

other Contracting State uses a credit system, in bilateral

Conventions the relief may be in the form of a credit, exemption,

or a combination of the two.

Paragraph 3

The rules of paragraph 3 were not in the 1981 Model, but

they are found in a number of U.S. treaties entered into after

publication of that Model. Paragraph 3 provides special rules

for the tax treatment in both States of certain types of income

derived from U.S. sources by U.S. citizens who are resident in

the other Contracting State. Since U.S. citizens, regardless of

residence, are subject to United States tax at ordinary progressive rates on their worldwide income, the U.S. tax on the U.S.

source income of a U.S. citizen resident in the other Contracting

State may exceed the U.S. tax that may be imposed under the

Convention on an item of U.S. source income derived by a resident

of the other Contracting State who is not a U.S. citizen. 

Subparagraph (a) of paragraph 3 provides special credit

rules for the other Contracting State with respect to items of

income that are either exempt from U.S. tax or subject to reduced

rates of U.S. tax under the provisions of the Convention when

received by residents of the other Contracting State who are not

U.S. citizens. The tax credit of the other Contracting State

allowed by paragraph 3(a) under these circumstances, to the

extent consistent with the law of that State, need not exceed the

U.S. tax that may be imposed under the provisions of the Convention, other than tax imposed solely by reason of the U.S. citizenship of the taxpayer under the provisions of the saving clause

of paragraph 4 of Article 1 (General Scope). Thus, if a U.S.

citizen resident in the other Contracting State receives U.S.

source portfolio dividends, the foreign tax credit granted by
-106- Article 23

that other State would be limited to 15 percent of the dividend -

- the U.S. tax that may be imposed under subparagraph 2(b) of

Article 10 (Dividends) -- even if the shareholder is subject to

U.S. net income tax because of his U.S. citizenship. With

respect to royalty or interest income, the other Contracting

State would allow no foreign tax credit, because its residents

are exempt from U.S. tax on these classes of income under the

provisions of Articles 11 (Interest) and 12 (Royalties). 

 Paragraph 3(b) eliminates the potential for double taxation

that can arise because subparagraph 3(a) provides that the other

Contracting State need not provide full relief for the U.S. tax

imposed on its citizens resident in the other Contracting State. 

The subparagraph provides that the United States will credit the

income tax paid or accrued to the other Contracting State, after

the application of subparagraph 3(a). It further provides that

in allowing the credit, the United States will not reduce its tax

below the amount that is taken into account in the other

Contracting State in applying subparagraph 3(a). Since the

income described in paragraph 3 is U.S. source income, special

rules are required to resource some of the income to the other

Contracting State in order for the United States to be able to

credit the other State’s tax. This resourcing is provided for in

subparagraph 3(c), which deems the items of income referred to in

subparagraph 3(a) to be from foreign sources to the extent

necessary to avoid double taxation under paragraph 3(b). The

rules of paragraph 3(c) apply only for purposes of determining

U.S. foreign tax credits with respect to taxes referred to in

paragraphs 2(b) and 3 of Article 2 (Taxes Covered). 

The following two examples illustrate the application of

paragraph 3 in the case of a U.S. source portfolio dividend

received by a U.S. citizen resident in the other Contracting

State. In both examples, the U.S. rate of tax on residents of

the other State under paragraph 2(b) of Article 10 (Dividends) of

the Convention is 15 percent. In both examples the U.S. income

tax rate on the U.S. citizen is 36 percent. In example I, the

income tax rate on its resident (the U.S. citizen) is 25 percent

(below the U.S. rate), and in example II, the rate on its

resident is 40 percent (above the U.S. rate). 

Example I Example II

Paragraph 3(a)

U.S. dividend declared $100.00 $100.00

Notional U.S. withholding tax

per Article 10(2)(b) 15.00 15.00
-107- Article 23

Other State taxable income 100.00 100.00

Other State tax before credit 25.00 40.00

Other State foreign tax credit 15.00 15.00

Net post-credit other State tax 10.00 25.00

Paragraphs 3(b) and (c)

U.S. pre-tax income $100.00 $100.00

U.S. pre-credit citizenship tax 36.00 36.00

Notional U.S. withholding tax 15.00 15.00

U.S. tax available for credit 21.00 21.00

Income resourced from U.S. to 

the other State 27.77 58.33

U.S. tax on resourced income 10.00 21.00

U.S. credit for other State tax 10.00 21.00

Net post-credit U.S. tax 11.00 0.00

Total U.S. tax 26.00 15.00

In both examples, in the application of paragraph 3(a), the

other Contracting State credits a 15 percent U.S. tax against its

residence tax on the U.S. citizen. In example I the net other

State tax after foreign tax credit is $10.00; in the second

example it is $25.00. In the application of paragraphs 3(b) and

(c), from the U.S. tax due before credit of $36.00, the United

States subtracts the amount of the U.S. source tax of $15.00,

against which no U.S. foreign tax credit is to be allowed. This

provision assures that the United States will collect the tax

that it is due under the Convention as the source country. In

both examples, the maximum amount of U.S. tax against which

credit for other State tax may be claimed is $21.00. Initially,

all of the income in these examples was U.S. source. In order

for a U.S. credit to be allowed for the full amount of the other

State tax, an appropriate amount of the income must be resourced. 

The amount that must be resourced depends on the amount of other

State tax for which the U.S. citizen is claiming a U.S. foreign

tax credit. In example I, the other State tax was $10.00. In

order for this amount to be creditable against U.S. tax, $27.77

($10 divided by .36) must be resourced as foreign source. When

the other State tax is credited against the U.S. tax on the

resourced income, there is a net U.S. tax of $11.00 due after

credit. In example II, other State tax was $25 but, because the

amount available for credit is reduced under subparagraph 3(c) by

the amount of the U.S. source tax, only $21.00 is eligible for

credit. Accordingly, the amount that must be resourced is

limited to the amount necessary to ensure a foreign tax credit

for $21 of other State tax, or $58.33 ($21 divided by .36). 

Thus, even though other State tax was $25.00 and the U.S. tax

available for credit was $21.00, there is no excess credit
-108- Article 23

available for carryover.

Relation to other articles

By virtue of the exceptions in subparagraph 5(a) of Article

1 this Article is not subject to the saving clause of paragraph 4

of Article 1 (General Scope). Thus, the United States will allow

a credit to its citizens and residents in accordance with the

Article, even if such credit were to provide a benefit not

available under the Code.
-109- Article 24

ARTICLE 24 (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, nondiscrimination

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.

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 more burdensome than the
-110- Article 24

taxes and connected requirements imposed upon a national of that

other State in the same circumstances. The OECD Model prohibits

taxation that is “other than or more burdensome” than that

imposed on U.S. persons. The U.S. Model omits the reference to

taxation that is “other than” U.S. persons because 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. 

As noted above, whether or not the two persons are both

taxable on worldwide income is a significant circumstance for

this purpose. The 1992 revision of the OECD Model added after

the words "in the same circumstances, the phrase "in particular

with respect to residence," reflecting the fact that under most

countries' laws residents are taxable on worldwide income and

nonresidents are not. Since in the United States nonresident

citizens are also taxable on worldwide income, this Model expands

the phrase to refer, not to residence, but to taxation on

worldwide income. The underlying concept, however, is

essentially the same in the two Models.

A national of a Contracting State is afforded protection

under this paragraph even if the national is not a resident of

either Contracting State. Thus, a U.S. citizen who is resident

in a third country is entitled, under this paragraph, to the same

treatment in the other Contracting State as a national of the

other Contracting State 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, paragraph 1 does not obligate the United States to apply

the same taxing regime to a national of the other Contracting

State who is not resident in the United States and a U.S.

national who is not resident in the United States. United States

citizens who are not residents of the United States but who are,

nevertheless, subject to United States tax on their worldwide

income are not in the same circumstances with respect to United

States taxation as citizens of the other Contracting State who

are not United States residents. Thus, for example, Article 24

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. 
-111- Article 24

The scope of paragraph 1 is broader than that in the 1981

Model, because of the expanded definition of the term "national"

in Article 3 (General Definitions). In order to conform the U.S.

Model definition to that in the OECD Model, the definition of

"national" extends beyond citizens to cover juridical persons

that are nationals of a Contracting State as well. This expanded

definition, however, generally may add little as a practical

matter to the scope of the Article. A corporation that is a

national of the other Contracting State and is doing business in

the United States is already protected, vis-a-vis a U.S. corporation, by paragraph 2. If a foreign corporation is not doing

business in the United States it is, in relevant respect, in

different circumstances from a U.S. corporation, and is,

therefore, not entitled to national treatment in the United

States. With respect to U.S. nationals claiming

nondiscrimination protection from the treaty partner, U.S.

juridical persons that are "nationals" of the United States are

also U.S. residents (e.g., U.S. corporations but not

partnerships), and are, therefore, protected by paragraphs 2 and

4 in any event. 

Paragraph 2

Paragraph 2 of the Article, like the comparable paragraphs

in the OECD and 1981 Models, provides that a Contracting State

may not tax a permanent establishment or fixed base of an

enterprise of the other Contracting State less favorably than an

enterprise of that first-mentioned State that is carrying on the

same activities. 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 the other Contracting State 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 the other Contracting State

the personal allowances for himself and his family that he would

be permitted to take if the permanent establishment were a sole

proprietorship owned and operated by a U.S. resident, despite the

fact that the individual income tax rates would apply.

The fact that a U.S. permanent establishment of an

enterprise of the other Contracting State 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,
-112- Article 24

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 nondiscrimination 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 Model Convention, this

obligation applies with respect to a share of the partnership

income of a partner resident in the other Contracting State, 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 overwithholding, file for a refund. (The relationship between

paragraph 2 and the imposition of the branch tax is dealt with

below in the discussion of paragraph 5.)

Paragraph 2 in this Model goes beyond the comparable paragraphs in other Models. It obligates the host State to provide

national treatment not only to permanent establishments of an

enterprise of the partner, but also to other residents of the
-113- Article 24

partner that are taxable in the host State on a net basis because

they derive income from independent personal services performed

in the host State that is attributable to a fixed base in that

State. Thus, an individual resident of the other Contracting

State who performs independent personal services in the U.S., and

who is subject to U.S. income tax on the income from those

services that is attributable to a fixed base in the United

States, is entitled to no less favorable tax treatment in the

United States than a U.S. resident engaged in the same kinds of

activities. With such a rule in a treaty, the host State cannot

tax its own residents on a net basis, but disallow deductions

(other than personal allowances, etc.) with respect to the income

attributable to the fixed base. Similarly, in accordance with

paragraph 5 of Article 6 (Income from Real Property (Immovable

Property)), the situs State would be required to allow deductions

to a resident of the other State with respect to income derived

from real property located in the situs State to the same extent

that deductions are allowed to residents of the situs State with

respect to income derived from real property located in the situs

State.

Paragraph 3

Paragraph 3 prohibits discrimination in the allowance of

deductions. When an enterprise of a Contracting State pays

interest, royalties or other disbursements to a resident of the

other Contracting State, the first-mentioned Contracting State

must allow a deduction for those payments in computing the

taxable profits of the enterprise as if the payment had been made

under the same conditions to a resident of the first-mentioned

Contracting State. An exception to this rule is provided for

cases where the provisions of paragraph 1 of Article 9 (Associated Enterprises), paragraph 4 of Article 11 (Interest) or paragraph 4 of Article 12 (Royalties) apply, because all of these

provisions permit the denial of deductions in certain circumstances in respect of transactions between related persons. This

exception would include the denial or deferral of certain interest deductions under Code section 163(j). 

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.

Paragraph 3 also provides that any debts of an enterprise

of a Contracting State to a resident of the other Contracting

State are deductible in the first-mentioned Contracting State for
-114- Article 24

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. Thus, this provision may be relevant for both

States. The other Contracting State may have capital taxes and

in the United States such taxes are imposed by local governments. 

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. As in paragraph 1, the OECD Model’s

reference to requirements “other” than those imposed with respect

to enterprises owned by domestic persons has not been included.

The Tax Reform Act of 1986 changed the rules for taxing

corporations on certain distributions they make in liquidation. 

Prior to 1986, corporations were not taxed on distributions of

appreciated property in complete liquidation, although nonliquidating distributions of the same property, with several

exceptions, resulted in corporate-level tax. In part to eliminate this disparity, the law now generally taxes corporations on

the liquidating distribution of appreciated property. The Code

provides an exception in the case of distributions by 80 percent

or more controlled subsidiaries to their parent corporations, on

the theory that the built-in gain in the asset will be recognized

when the parent sells or distributes the asset. This exception

does not apply to distributions to parent corporations that are

tax-exempt organizations or, except to the extent provided in

regulations, foreign corporations. The policy of the legislation

is to collect one corporate-level tax on the liquidating distribution of appreciated property. If, and only if, that tax can be

collected on a subsequent sale or distribution does the legislation defer the tax. It is understood that the inapplicability of

the exception to the tax on distributions to foreign parent

corporations under section 367(e)(2) does not conflict with

paragraph 4 of the Article. While a liquidating distribution to

a U.S. parent will not be taxed, and, except to the extent

provided in regulations, a liquidating distribution to a foreign
-115- Article 24

parent will, paragraph 4 merely prohibits discrimination among

corporate taxpayers on the basis of U.S. or foreign stock

ownership. Eligibility for the exception to the tax on

liquidating distributions for distributions to non-exempt, U.S.

corporate parents is not based upon the nationality of the owners

of the distributing corporation, but rather is based upon whether

such owners would be subject to corporate tax if they

subsequently sold or distributed the same property. Thus, the

exception does not apply to distributions to persons that would

not be so subject -- not only foreign corporations, but also

tax-exempt organizations. A similar analysis applies to the

treatment of section 355 distributions subject to section

367(e)(1).

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 35 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 provisions 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 paragraph 8 of Article 10 (Divi-
-116- Article 24

dends). Since imposition of the branch tax under the Model

Convention is specifically sanctioned by paragraph 8 of Article

10 (Dividends), its imposition could not be precluded by Article

24, even without paragraph 5. Under the generally accepted rule

of construction that the specific takes precedence over the more

general, the specific branch tax provision of Article 10 would

take precedence over the more general national treatment

provision of Article 24.

Paragraph 6

As noted above, notwithstanding the specification of taxes

covered by the Convention in Article 2 (Taxes Covered) for

general purposes, for purposes of providing nondiscrimination

protection this Article applies to taxes of every kind and

description imposed by a Contracting State or a political subdivision or local authority thereof. Customs duties are not

considered to be taxes for this purpose.

Relation to Other Articles

The saving clause of paragraph 4 of Article 1 (General

Scope) does not apply to this Article, by virtue of the exceptions in paragraph 5(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 22 (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

22.
-117- Article 25

ARTICLE 25 (MUTUAL AGREEMENT PROCEDURE)

This Article provides the mechanism for taxpayers to bring

to the attention of competent authorities issues and problems

that may arise under the Convention. It also provides 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 paragraph 1(e) of Article 3 (General Definitions).

Paragraph 1

This paragraph provides that where a resident of a

Contracting State considers that the actions of one or both

Contracting States will result in taxation that is not in

accordance with the Convention he may present his case to the

competent authority of either Contracting State. All standard

Models and nearly all current U.S. treaties allow taxpayers to

bring competent authority cases only to the competent authority

of their country of residence, or citizenship/nationality. 

Paragraph 16 of the OECD Commentary to Article 25 suggests,

however, that countries may agree to allow a case to be brought

to either competent authority. Because there seems to be no

apparent reason why a resident of a Contracting State must take

its case to the competent authority of its State of residence and

not to that of the partner, the Model adopts the approach

suggested in the OECD Commentary. Under this approach, a U.S.

permanent establishment of a corporation resident in the treaty

partner that faces inconsistent treatment in the two countries

would be able to bring its complaint to the competent authority

in either Contracting State. 

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 a Contracting State treats income

derived by a company resident in the other Contracting State as

attributable to a permanent establishment in the first-mentioned

Contracting State, and the resident believes that the income is

not attributable to a permanent establishment, or that no

permanent establishment exists, the resident may bring a

complaint under paragraph 1 to the competent authority of either

Contracting State.

 

It is not necessary for a person bringing a complaint first
-118- Article 25

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 previous U.S.

Models, but unlike the OECD Model, no time limit is provided

within which a case must be brought. 

Paragraph 2

This paragraph instructs the competent authorities in

dealing with cases brought by taxpayers under paragraph 1. It

provides that if the competent authority of the Contracting State

to which the case is presented judges the case to have merit, and

cannot reach a unilateral solution, it shall seek an agreement

with the competent authority of the other Contracting State

pursuant to which taxation not in accordance with the Convention

will be avoided. During the period that a proceeding under this

Article is pending, any assessment and collection procedures

shall be suspended. 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. In a case where the 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. 96-13, 1996-3 I.R.B. 31, section 7.05. Because, as

specified in paragraph 2 of Article 1 (General Scope), the

Convention cannot operate to increase a taxpayer's liability,

time 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
-119- Article 25

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. Subparagraph (g) makes clear that they may also

agree to apply this methodology and range of results prospectively to future transactions and time periods pursuant to advance

pricing agreements. 

As indicated in subparagraphs (c), (d), (e) and (f), 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 characterize entities in a particular way

(subparagraph (d)), to apply the same source rules to particular

items of income (subparagraph (e)), and to adopt a common meaning

of a term (subparagraph f)).

Subparagraph (h) makes clear that the competent authorities

can agree to the common application, consistent with the

objective of avoiding double taxation, of procedural provisions

of the internal laws of the Contracting States, including those

regarding penalties, fines and interest.

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.

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 the

other Contracting State. Since no resident of a Contracting

State is involved in the case, the Convention does not apply, but
-120- Article 25

the competent authorities nevertheless may use the authority of

the Convention to prevent the double taxation. 

Agreements reached by the competent authorities under

paragraph 3 need not conform to the internal law provisions of

either Contracting State. Paragraph 3 is not, however, intended

to authorize the competent authorities to resolve problems of

major policy significance that normally would be the subject of

negotiations between the Contracting States themselves. For

example, this provision would not authorize the competent

authorities to agree to allow a U.S. foreign tax credit under the

treaty for a tax imposed by the other country where that tax is

not otherwise a covered tax and is not an identical or

substantially similar tax imposed after the date of signature of

the treaty. Whether or not the tax is creditable under the Code

is a separate matter.

Paragraph 4

Paragraph 4 authorizes the competent authorities to

increase any dollar amounts referred to in the Convention to

reflect economic and monetary developments. Under the Model,

this refers only to Article 17 (Artistes and Sportsmen). The

rule under paragraph 4 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 $20,000 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 (General 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. 

Paragraph 5

Paragraph 5 provides that the competent authorities may

communicate with each other for the purpose of reaching an

agreement. This makes clear that the competent authorities of

the two Contracting States may communicate without going through

diplomatic channels. Such communication may be in various forms,

including, where appropriate, through face-to-face meetings of

representatives of the competent authorities. 
-121- Article 25

Other Issues

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 its law. 

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 three-sided

solution. Although country A may not be able to give information

received under Article 26 (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 4 of Article 1 (General Scope) by virtue of the

exceptions in paragraph 5(a) of that Article. Thus, rules,

definitions, procedures, etc. that are agreed upon by the

competent authorities under this Article may be applied by the

United States with respect to its citizens and residents even if
-122- Article 25

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 25 regardless of whether he is

generally entitled to benefits under Article 22 (Limitation on

Benefits). As in all other cases, the competent authority is

vested with the discretion to decide whether the claim for relief

is justified. 
-123- Article 26

ARTICLE 26 (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 of the other Contracting State concerning

the taxes covered by the Convention. Previous U.S. Models, and

the OECD Model, refer to information that is "necessary" for

carrying out the provisions of the Convention, etc. This term

consistently has been interpreted as being equivalent to

"relevant," and as not requiring a requesting State to

demonstrate that it would be disabled from enforcing its tax laws

unless it obtained a particular item of information. To remove

any potential misimpression that the term "necessary" created a

higher threshold than relevance, the Model adopts the term

"relevant." 

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 5, for purposes of exchange of information, covered taxes

include all taxes imposed by the Contracting States. Exchange of

information with respect to 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 the partner 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 states that information exchange is not restricted by Article 1 (General Scope). Accordingly, information
-124- Article 26

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 the other Contracting State which engages in

transactions with a U.S. enterprise, the United States could

request information with respect to that permanent establishment,

even though it is not a resident of either Contracting State. 

Similarly, if a third-country resident maintains a bank account

in the other Contracting State, and the Internal Revenue Service

has reason to believe that funds in that account should have been

reported for U.S. tax purposes but have not been so reported,

information can be requested from the other Contracting State

with respect to that person's account.

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, concerned

with the assessment, collection, enforcement or prosecution in

respect of the taxes to which the information relates, or to

persons concerned with the administration of these taxes. The

information must be used by these persons in connection with

these designated functions. Persons in the United States concerned with the administration of taxes include legislative

bodies, such as the tax-writing committees of Congress and the

General Accounting Office. Information received by these bodies

must be for use in the performance of their role in overseeing

the administration of U.S. tax laws. Information received may be

disclosed in public court proceedings or in judicial decisions.

 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 is identical to paragraph 2 of Article 26 of

the OECD Model. It 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
-125- Article 26

which would be contrary to public policy. Thus, a requesting

State cannot obtain 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. 

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 does not have an analog in the OECD Model. It

sets forth two exceptions from the dispensations described in

paragraph 2. First, the first sentence of the paragraph provides

that information must be provided to the requesting State

notwithstanding the fact that disclosure of the information is

precluded by bank secrecy or similar legislation relating to

disclosure of financial information by financial institutions or

intermediaries. This includes the disclosure of information

regarding the beneficial owner of an interest in a person, such

as the identity of a beneficial owner of bearer shares.

Second, 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 requested

information as if the tax in question were the tax of the

requested State, even if that State has no direct tax interest in

the case to which the request relates. The OECD Model does not

state explicitly in the Article that the requested State is

obligated to respond to a request even if it does not have a

direct tax interest in the information. The OECD Commentary,

however, makes clear that this is to be understood as implicit in

the OECD Model. (See paragraph 16 of the OECD Commentary to

Article 26.)

Paragraph 3 further provides that the requesting State may

specify the form in which information is to be provided (e.g.,

depositions of witnesses and authenticated copies of original

documents) 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.
-126- Article 26

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 a U.S. source dividend is paid to an addressee in a

treaty partner, the withholding agent probably will withhold at

the treaty's portfolio dividend rate of 15 percent. If, however,

the addressee is merely acting as a nominee on behalf of a thirdcountry resident, paragraph 4 would obligate the other

Contracting State to withhold and remit to the United States the

additional tax that should have been collected by the U.S.

withholding agent.

This paragraph also makes clear that the Contracting State

asked to collect the tax is not obligated, in the process of

providing collection assistance, to carry out administrative

measures that are different from those used in the collection of

its own taxes, or that would be contrary to its sovereignty,

security or public policy.

Paragraph 5

As noted above in the discussion of paragraph 1, the

exchange of information provisions of the Convention apply to all

taxes imposed by a Contracting State, not just to those taxes

designated as covered taxes under Article 2 (Taxes Covered). The

U.S. competent authority may, therefore, request information for

purposes of, for example, estate and gift taxes or federal excise

taxes.

Paragraph 6

Finally, paragraph 6 provides that the competent authority

of the requested State shall allow representatives of the

applicant State to enter the requested State to interview

individuals and examine books and records with the consent of the

persons subject to examination.

Treaty effective dates and termination in relation to competent
-127- Article 26

authority dispute resolution

A tax administration may 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.

The competent authority also may seek information 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 a treaty was not in force when the transactions at issue

occurred, and the competent authorities have available to them

the full range of information exchange provisions afforded under

this Article. Where a prior treaty was in effect during the

years in which the transaction at issue occurred, the exchange of

information provisions of the current treaty apply. 
-128- Article 27

ARTICLE 27 (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 text of this Article is identical to the

corresponding provision of the OECD Model. 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 19 (Government

Service) does so, as do Code section 893 and a number of

bilateral and multilateral agreements. Rather, the Article

specifically reconfirms in this context the statement in

paragraph 2 of Article 1 (General Scope) that nothing in the tax

treaty will operate to restrict any benefit accorded by the

general rules of international law or with any of the other

agreements referred to above. In the event that there is a

conflict between the tax treaty 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 5(b) of Article 1, the saving

clause of paragraph 4 of Article 1 (General 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. 
-129- Article 28

ARTICLE 28 (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. Each State must notify the other as soon

as its requirements for ratification have been complied with. 

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 on the date on which the second of the two notifications of

the completion of ratification requirements has been received.

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 as soon as possible, without waiting until the
-130- Article 28

following year. The delay of one to two months is required to

allow sufficient time for withholding agents to be informed about

the change in withholding rates. 

For all other taxes, 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 following

entry into force. 

As discussed under Articles 25 (Mutual Agreement Procedure)

and 26 (Exchange of Information), the powers afforded the

competent authority under these articles apply retroactively to

taxable periods preceding entry into force.
-131- Article 29

ARTICLE 29 (TERMINATION)

This provision generally corresponds to its counterpart in

the OECD Model. The Convention is to remain in effect

indefinitely, unless terminated by one of the Contracting States

in accordance with the provisions of Article 29. The Convention

may be terminated at any time after the year in which the

Convention enters into force. If notice of termination is given,

the provisions of the Convention with respect to withholding at

source will cease to have effect after the expiration of a period

of 6 months beginning with the delivery of notice of termination. 

For other taxes, the Convention will cease to have effect as of

taxable periods beginning after the expiration of this 6 month

period.

A treaty performs certain specific and necessary functions

regarding information exchange and mutual agreement. In the case

of information exchange the treaty's function is to override

confidentiality rules relating to taxpayer information. In the

case of mutual agreement its function is to allow competent

authorities to modify internal law in order to prevent double

taxation and tax avoidance. With respect to the effective termination dates for these aspects of the treaty, therefore, if a

treaty is terminated as of January 1 of a given year, no otherwise confidential information can be exchanged after that date,

regardless of whether the treaty was in force for the taxable

year to which the request relates. Similarly, no mutual agreement departing from internal law can be implemented after that

date, regardless of the taxable year to which the agreement

relates. Therefore, for the competent authorities to be allowed

to exchange otherwise confidential information or to reach a

mutual agreement that departs from internal law, a treaty must be

in force at the time those actions are taken and any existing

competent authority agreement ceases to apply.

Article 29 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.