DEPARTMENT OF THE TREASURY

TECHNICAL EXPLANATION OF THE CONVENTION BETWEEN

THE GOVERNMENT OF THE UNITED STATES OF AMERICA AND 

THE GOVERNMENT OF THE ITALIAN REPUBLIC

FOR THE AVOIDANCE OF DOUBLE TAXATION WITH RESPECT TO

TAXES ON INCOME AND THE PREVENTION OF FRAUD OR FISCAL EVASION

This is a technical explanation of the Convention and the Protocol between the United

States and the Italian Republic signed on August 25, 1999 (the “Convention” and the “Protocol”). 

References are made to the Convention between the United States and Italy for the Avoidance of

Double Taxation with Respect to Taxes on Income and the Prevention of Fraud or Fiscal Evasion,

signed on April 17, 1984 (the “prior Convention”). The Convention replaces the prior

Convention.

Negotiations took into account the U.S. Treasury Department’s current tax treaty policy,

as reflected in the U.S. Treasury Department’s Model Income Tax Convention of September 20,

1996 (the “U.S. Model”) and its recently negotiated tax treaties, the Model Income Tax

Convention on Income and on Capital, published by the OECD in 1992 and amended in 1994,

1995 and 1997 (the “OECD Model”), and recent tax treaties concluded by Italy.

In connection with the negotiation of the Convention and the Protocol, the negotiators

developed and agreed upon a Memorandum of Understanding. The Memorandum of

Understanding is a statement of intent setting forth a common understanding and interpretation of

certain provisions of the Convention and Protocol reached by the delegations of the United States

and Italy acting on behalf of their respective governments. These understandings and

interpretations are intended to give guidance both to the taxpayers and the tax authorities of both

Contracting States in interpreting the relevant provisions of the Convention and Protocol.

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

the policies behind particular Convention and Protocol provisions, as well as understandings

reached with respect to the application and interpretation of the Convention and Protocol. 

References in the Technical Explanation to “he” or “his” should be read to mean “he or she” and

“his or her.”

ARTICLE 1 (PERSONAL SCOPE)

Paragraph 1

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

States or Italy except where the terms of the Convention provide otherwise. Under Article 4

(Resident) a person is generally treated as a resident of a Contracting State if that person is, under

the laws of that State, liable to tax therein by reason of his domicile or other similar criteria. If,

however, a person is considered a resident of both Contracting States, Article 4 provides rules for

determining a single state of residence. This determination governs for all purposes of the

Convention. 
- 2 -

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), information may be exchanged with respect to residents of third states.

Paragraph 1 of Article 3 of the Protocol, which is analogous to paragraph 2 of Article 1 of

the U.S. Model, 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). The list in paragraph 2 contains examples of benefits not to be

restricted and is not intended to be exhaustive. The relationship between the non-discrimination

provisions of the Convention and other agreements is not addressed in this provision, but in

paragraph 2 of Article 3 of the Protocol. 

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 Italy, the deduction also is allowed

to that person in computing taxable income under the Convention. Paragraph 1 of Article 3 of the

Protocol 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. 

It follows that under the principle of paragraph 1 of Article 3 of the Protocol 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 Italy has three separate businesses in the United States. One is a profitable

permanent establishment and the other two are trades or businesses that would earn taxable

income under the Code but that do not meet the permanent establishment threshold tests of the

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

the permanent establishment is taxable, 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 Italy. For example, if certain benefits are provided for
- 3 -

military personnel or military contractors under a Status of Forces Agreement between the United

States and Italy, 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 2 of Article 3 of the Protocol, which is analogous to paragraph 3 of Article 1 of

the U.S. Model, specifically relates to non-discrimination obligations of the Contracting States

under other agreements. The provisions of this paragraph are an exception to the rule provided in

paragraph 1 of Article 3 of the Protocol 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 2 of the Protocol’s Article 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. 

Subparagraph (b) of that paragraph 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 that paragraph defines a "measure" broadly. It would include, for

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

other form of governmental action or guidance.

Paragraph 2

Paragraph 2 of Article 1 of the Convention contains the traditional saving clause found in

U.S. tax treaties. The Contracting States reserve their rights, except as provided in paragraph 3,

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 Italy 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

by its terms prevent the United States from taxing the income. If, however, the resident of Italy is
- 4 -

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)). However, paragraph 3(a) of this Article

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

U.S. income of its citizens resident in Italy. See paragraph 4 of Article 23 (Relief from Double

Taxation). 

For purposes of the saving clause, "residence" is determined under Article 4 (Resident). 

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 Italy under its law, and that individual has a permanent home available to

him in Italy and not in the United States, he would be treated as a resident of Italy under Article 4

and for purposes of the saving clause. The United States would not be permitted to apply its

statutory rules to that person if they are inconsistent with the treaty. Thus, an individual who is a

U.S. resident under the Internal Revenue Code but who is deemed to be a resident of Italy under

the tie-breaker rules of Article 4 (Resident) 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 1 of Article 1 of the Protocol, 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 generally

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

long-term resident is taxable in accordance with the provisions of section 877 of the Code.

Paragraph 3

Some provisions are intended to provide benefits to citizens and residents even if such

benefits do not exist under internal law. Paragraph 3 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
- 5 -

residents of a Contracting State, despite the general saving clause rule of paragraph 2: (1)

Paragraph 2 of Article 9 (Associated Enterprises) grants the right to a correlative adjustment with

respect to income tax due on profits reallocated under Article 9. (2) Paragraphs 5 and 6 of

Article 18 (Pensions, Etc.) deal with child support and alimony payments, and pension fund

contributions, respectively. The inclusion of paragraph 5, which exempts child support payments

and alimony from taxation by the State of residence of the recipient, means that if a resident of

Italy pays child support or alimony 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. (4) 

Article 24 (Non-Discrimination) requires one Contracting State to grant national treatment to

residents and citizens of Italy 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

Italy even if that person is a citizen of the United States. (5) 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. In addition, as in the prior Convention, paragraph 2 of Article 1 of the Protocol

provides that the saving clause does not override the exemption from tax of social security

benefits provided in paragraph 2 of Article 18 of the Convention for individuals who are citizens

of the residence State even if they are citizens of both States; and it does not override the special

rule of Article 4 of the Protocol relating to U.S. citizens resident in Italy who are partners of a

U.S. partnership. The exception to the saving clause with respect to social security benefits

means that if the United States makes a social security payment to a resident of Italy who is a

citizen of both the United States and Italy, only Italy can tax that payment.

Subparagraph (b) of paragraph 3 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: tax treatment of government service salaries and pensions under Article 19

(Government Service); certain income of visiting professors and teachers under Article 20

(Professors and Teachers) and students and trainees under Article 21 (Students and Trainees); and

the income of diplomatic agents and consular officers under Article 27 (Diplomatic Agents and

Consular Officials).

ARTICLE 2 (TAXES COVERED)
- 6 -

This Article specifies the U.S. and Italian taxes to which the Convention applies. With

two exceptions, the taxes specified in Article 2 are the covered taxes for all purposes of the

Convention. A broader coverage applies, however, for purposes of Articles 24 (NonDiscrimination) and 26 (Exchange of Information). Article 24 applies with respect to all taxes,

including those imposed by state and local governments. Article 26 applies with respect to all

taxes imposed at the national level.

Paragraph 1

Paragraph 1 is based on the OECD Model and explains that the Convention applies to

income taxes imposed on behalf of either Contracting State; this covers taxes on total income or

any part of income and includes tax on gains derived from property. The Convention does not

apply to payroll taxes. Nor does it apply to property taxes, except with respect to Article 24

(Non-Discrimination). 

Paragraph 2 

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

income taxes imposed by the Code, together with the excise taxes imposed with respect to

insurance premiums paid to foreign insurers (Code sections 4371 through 4374) and with respect

to private foundations (Code sections 4940 through 4948). With respect to the excise tax on

insurance premiums, paragraph 3 of Article 1 of the Protocol provides that the Convention applies

only to the extent that the Italian insurer does not reinsure those risks with a resident of a country

with which the United States does not have an income tax convention providing an exemption

from this tax. Although they may be regarded as income taxes, social security taxes (Code

sections 1401, 3101, 3111 and 3301) are specifically excluded from coverage. Except with

respect to Article 24 (Non-Discrimination), state and local taxes in the United States are not

covered by the Convention. 

In this Convention, unlike the prior Convention, 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. 

Subparagraph 2(b) specifies that the existing Italian covered taxes are the individual

income tax; the corporation income tax; and that portion of the regional tax on productive

activities (commonly known as IRAP) that is considered to be an income tax pursuant to

paragraph 2(c) of Article 23 (Relief from Double Taxation) of the Convention.

Under paragraph 3, the Convention will apply to any taxes that are identical, or

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

in place of, the existing taxes after the date of signature of the Convention. The paragraph also
- 7 -

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.

ARTICLE 3 (GENERAL DEFINITIONS)

Paragraph 1

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

defined in other articles of the Convention. For example, the term "resident of a Contracting

State" is defined in Article 4 (Resident). The term "permanent establishment" is defined in Article

5 (Permanent Establishment). The terms "dividends," "interest" and "royalties" are defined in

Articles 10, 11 and 12, respectively. The introduction to paragraph 1 makes clear 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 unintended

results. 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). 

The term "company" is defined in subparagraph 1(b) as a body corporate or an entity

treated as a body corporate for tax purposes. Although the Convention does not add “in the State

in which it is organized,” as does the U.S. Model, the result should be the same, as the

Commentaries to the OECD Model interpret language identical to that of the Convention in a

manner consistent with the U.S. Model.

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

State" are defined in subparagraph 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 for the term "enterprise," the term is

understood to refer to any activity or set of activities that constitute a trade or business.
- 8 -

Although subparagraph 1(c) does not include the U.S. Model’s explicit reference to

fiscally transparent enterprises, the negotiators understood that the terms “enterprise of a

Contracting State” and “enterprise of the other Contracting State” encompass an enterprise

conducted through an entity (such as a partnership) that is treated as fiscally transparent in the

Contracting State where the entity’s owner is resident. In accordance with Article 4 (Resident),

entities that are fiscally transparent in the 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).

This treatment ensures 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 Italy 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 transport is solely between places within a Contracting State. 

This definition is applicable principally in the context of Article 8 (Shipping and Air Transport). 

The definition 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 paragraph 1 of Article 8

and paragraph 7 of Article 1 of the Protocol to exempt from tax by the source State income from

the rental of containers that is earned both by lessors that are operators of ships and aircraft and

by those lessors that are not (e.g., banks or container leasing companies). 

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

Italy (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

Italy 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
- 9 -

vehicle, from a ship to a lighter, or even if the overland portion of the trip in the United States

was handled by an independent carrier under contract with the original international carrier, so

long as both parts of the trip were reflected in original bills of lading. For this reason, the

Convention refers, in the definition of "international traffic," to "such transport" being solely

between places in the other Contracting State, while the OECD Model refers to the ship or

aircraft being operated solely between such places. The Convention’s definition 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 Italy, 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 Italian competent authority is the Ministry of Finance.

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. For certain purposes, the definition is extended to include the sea bed, subsoil, and

superjacent waters 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 term “Italy” is defined in subparagraph 1(g) to mean the Republic of Italy, including

the territorial sea. As with the definition of United States, the definition of Italy is extended for

certain purposes to include the sea bed, subsoil, and superjacent waters of undersea areas adjacent

to the territorial sea of Italy to the extent that Italy exercises sovereignty in accordance with

international law for the purpose of natural resource exploration and exploitation of such areas. 

The term "national," as it relates to the United States and to Italy, 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
- 10 -

individual who is a citizen 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.

The inclusion of juridical persons in the definition may have significance in relation to

paragraph 1 of Article 24 (Non-Discrimination), which provides that nationals of one Contracting

State may not be subject in the other to any taxes or connected requirements that are more

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

circumstances. 

Subparagraph 1(i) defines the term "qualified governmental entity". This definition is

relevant for purposes of Articles 4 (Resident), 10 (Dividends), and 11 (Interest), and Article 2 of

the Protocol, regarding limitation on benefits. The term means: (i) the Government of a

Contracting State or of a political subdivision or local authority of the Contracting State; (ii) a

person wholly owned by a governmental entity described in subparagraph (i), that satisfies certain

organizational and funding standards; and (iii) a pension fund of a person that meets the standards

of subparagraphs (i) and (ii) and that provides 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 4 of Article 1 of the Protocol

provides a non-exclusive list of entities that constitute qualified governmental entities. In the case

of the United States, the list includes the Federal Reserve Banks, the Export-Import Bank, and the

Overseas Private Investment Corporation. In the case of Italy, the list includes La Banca d’Italia

(the Central Bank), L’Istituto per il Commercio con l’Estero (the Foreign Trade Institute), and

L’Istituto per l’Assicurazione del Credito all’Esportazione (the Official Insurance Institute for

Export Credits).

Paragraph 2

Paragraph 2 provides that in the application of the Convention, any term used but not

defined in the Convention will have the meaning that it has under the law of the Contracting State

whose tax is being applied, unless the context requires otherwise. 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, pursuant to 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.

Although paragraph 2 does not explicitly state 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 result is understood to apply.
- 11 -

This 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. Thus, flexibility

in defining terms is necessary and permitted.

ARTICLE 4 (RESIDENT)

This Article sets forth rules for determining whether a person is a resident of a Contracting

State for purposes of the Convention. As a general matter only residents of the Contracting

States may 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

2 of the Protocol, regarding limitation on benefits, in order to receive benefits conferred on

residents of a Contracting State.

The determination of residence for treaty purposes looks first to a person's liability to tax

as a resident under the respective taxation laws of the Contracting States. As a general matter, a

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

look no further. For purposes of the Convention, that person is a resident of the State in which he

is resident under internal law. If, however, a person is resident in both Contracting States under

their respective taxation laws, the Article proceeds, where possible, to use tie-breaker rules to

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

Paragraph 1

The term "resident of a Contracting State" is defined in paragraph 1. In general, this

definition incorporates the definitions of residence in U.S. and Italian law by referring to a resident

as a person who, under the laws of a Contracting State, is subject to tax there by reason of his

domicile, residence, place of management, place of incorporation or any other similar criterion. 

Except as provided in subparagraph 5(c) of Article 1 of the Protocol, residents of the United

States include aliens who are considered U.S. residents under Code section 7701(b). 

Subparagraph 5(c) of Article 1 of the Protocol provides that a U.S. citizen or alien

lawfully admitted for permanent residence (i.e., a “green card” holder) is, notwithstanding

paragraph 1, to be treated as a U.S. resident for purposes of the Convention and, thereby, entitled

to treaty benefits, only if he has a substantial presence (see Code section 7701(b)(3)), permanent

home, or habitual abode in the United States. If such a person is a resident both of the United

States and Italy, whether or not he is to be treated as a resident of the United States for purposes
- 12 -

of the Convention is determined by the tie-breaker rules of paragraph 2. If, however, he is

resident in the United States and not Italy but has ties to a third State, in the absence of the

Protocol subparagraph he would always be a resident of the United States, no matter how

tenuous his relationship with the United States relative to that with the third State. Thus, for

example, an individual resident of Mexico who is a U.S. citizen by birth, or who is a Mexican

citizen and holds a U.S. green card, but who, in either case, has never lived in the United States,

would not be entitled to Italian benefits under the Convention. On the other hand, a U.S. citizen

employed by a U.S. corporation who is transferred to Mexico for two years but who maintains a

permanent home or habitual abode in the United States would be entitled to treaty benefits. The

fact that a U.S. citizen who does not have close ties to the United States may not be treated as a

U.S. resident under the Convention does not alter the application of the saving clause of

paragraph 2 of Article 1 (Personal Scope) to that citizen. For example, a U.S. citizen who

pursuant to the “citizen/green card holder” rule is not considered to be a resident of the United

States still is taxable on his worldwide income under the generally applicable rules of the Code.

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 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) of paragraph 1 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

Italy 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, although not stated explicitly in this Article, an enterprise of Italy 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 it would be if it were a U.S. resident.

Subparagraph 5(a) of Article 1 of the Protocol, which is analogous to subparagraph 1(b)

of Article 4 of the U.S. Model, 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. 
- 13 -

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 of Article 4. 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.

Subparagraph 5(b) of Article 1 of the Protocol, which is analogous to subparagraph 1(c)

of Article 4 of the U.S. Model, specifies that a qualified governmental entity (as defined in Article

3) is to be treated as a resident of that State.

Fiscally transparent entities such as partnerships and certain estates and trusts present

special issues. Subparagraph (b) of paragraph 1 of Article 4 addresses income derived or paid by

a partnership, estate, or trust. Subparagraph 5(c) of Article 1 of the Protocol clarifies that the

provisions of subparagraph 1(b) of Article 4 apply to determine the residence of an entity that is

treated as fiscally transparent under the laws of either Contracting State. Thus, although the

language of subparagraph (b) of paragraph 1 of Article 4, as clarified by the Protocol, differs from

the language of subparagraph 1(d) of Article 4 of the U.S. Model, the results are intended to be

the same.

In general, subparagraph (b) of paragraph 1 of Article 4, as clarified by the Protocol,

relates to entities that are not subject to tax at the entity level, as distinct from entities that are

subject to tax, but with respect to which tax may be relieved under an integrated system. 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 subparagraph also applies to U.S.

limited liability companies ("LLC"s) that are treated as partnerships for U.S. tax purposes.

 This subparagraph provides that an item of income derived by such a fiscally transparent

entity 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 corporation resident in Italy distributes a dividend to an entity that is treated as

fiscally transparent for U.S. tax purposes, the dividend will be considered derived by a resident of

the United States only to the extent that the taxation laws of the United States treat one or more

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

laws) as deriving the dividend income for U.S. tax purposes. In the case of a partnership, the

persons who are, under U.S. tax laws, treated as partners of the entity would normally be the

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

partnership. Thus, it also follows that persons whom the U.S. treats as partners but who are not
- 14 -

U.S. residents for U.S. tax purposes may not claim a benefit for the dividend paid to the entity

under the Convention. Although these partners are treated as deriving the income for U.S. tax

purposes, they are not residents of the United States for purposes of the treaty. If, however, they

are treated as residents of a third country under the provisions of an income tax convention which

that country has with Italy, they may be entitled to claim a benefit under that convention. In

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

purposes, dividends paid by a corporation resident in Italy to the U.S. entity will be considered

derived by a resident of the United States since the U.S. corporation is treated under U.S.

taxation laws as a resident of the United States and as deriving the income. 

These results would obtain even if the entity were viewed differently under the tax laws of 

Italy (e.g., as not fiscally transparent in the first example above where the entity is treated as a

partnership for U.S. tax purposes or as fiscally transparent in the second example where the entity

is viewed as not fiscally transparent for U.S. tax purposes). These results also follow regardless

of where the entity is organized, i.e., in the United States, Italy, or in a third country. For

example, income from sources in Italy received by an entity organized under the laws of Italy,

which is treated for U.S. tax purposes as a corporation and is owned by a U.S. shareholder who is

a U.S. resident for U.S. tax purposes, is not considered derived by the shareholder of that

corporation even if, under the tax laws of Italy, the entity is treated as fiscally transparent. 

Rather, for purposes of the treaty, the income is treated as derived by an entity resident in Italy. 

These results also follow regardless of whether the entity is disregarded as a separate entity under

the laws of one jurisdiction but not the other, such as a single owner entity that is viewed as a

branch for U.S. tax purposes and as a corporation for tax purposes of Italy. 

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, under the taxation laws of that State, 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. 

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. 

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

Contracting State. For example, if X, a resident of Italy, 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 Italy has no

rules comparable to those in sections 671 through 679 then it is possible that under Italy's law

neither X nor the trust would be taxed on the income derived from the United States. In these
- 15 -

cases subparagraph (d) provides that the trust's income would be regarded as being derived by a

resident of Italy only to the extent that the laws of Italy treat residents of Italy 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 2 to determine a single State of residence for that individual. These tests

are to be applied in the order in which they are stated. The first test is based on where the

individual has a permanent home. If that test is inconclusive because the individual has a

permanent home available to him in both States, he will be considered to be a resident of the

Contracting State where his personal and economic relations are 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 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

Dual residents other than individuals (such as companies, 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. 

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 (Capital Gains) and certain "other income" under Article 22 (Other

Income).
- 16 -

Paragraph 1

The basic definition of the term "permanent establishment" is contained in paragraph 1. 

As used in the Convention, the term means a fixed place of business through which the business of

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

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, quarry or other place of extraction of natural resources (including an oil or

gas well). 

Subparagraph 2(g) of Article 5, in combination with paragraph 6 of Article 1 of the

Protocol, provides rules (found in paragraph 3 of Article 5 of the U.S. Model) to determine

whether a building site or a construction, assembly or installation project, or an installation or

drilling rig or ship used for the exploration or development of natural resources constitutes a

permanent establishment for the contractor, driller, etc. An activity does not create a permanent

establishment unless the site, project, etc. lasts or continues for more than twelve months. It is

only necessary to refer to "exploration and development" 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
- 17 -

purposes of determining whether the general contractor has a permanent establishment. 

However, for the sub-contractor itself to be treated as having a permanent establishment, the subcontractor's activities at the site must last for more than 12 months. If a sub-contractor is on a

site intermittently, then, for purposes of applying the 12-month rule, time is measured from the

first day the sub-contractor is on the site until the last day (i.e., intervening days that the subcontractor is not on the site are counted)

These interpretations of the Article are based on the Commentary to paragraph 3 of

Article 5 of the OECD Model, which contains language that is substantially the same as that in the

Convention (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

relevant language in this provision. 

Paragraph 3

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, the news bureau of a newspaper would not constitute a permanent

establishment of the newspaper. 

Subparagraph (f) of the U.S. Model, regarding a combination of the above activities, was

not included in the Convention. Italy is unwilling to make a commitment that all or several of the

activities enumerated in subparagraphs (a) through (e) may be undertaken in combination without

constituting a permanent establishment. Nor do they accept the OECD Model on this point. 

Rather, they follow the 1963 OECD Model and judge actual cases on the relevant facts and

circumstances as to whether the combination of activities constitutes a permanent establishment. 

Paragraph 4

Paragraphs 4 and 5 specify when activities carried on by an agent on behalf of an

enterprise create a permanent establishment of that enterprise. Under paragraph 4, 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 to conclude contracts in the name of the enterprise. If,
- 18 -

however, the agent’s activities are limited to the purchase of goods or merchandise for the

enterprise, the agent is not a permanent establishment of the enterprise.

The Convention uses the OECD Model term “in the name of that enterprise” rather than

the U.S. Model term “binding on the enterprise”. There is no substantive difference. As

indicated in paragraph 32 to the OECD Commentaries on Article 5, the application of the

provision is not limited to “an agent who enters into contracts literally in the name of the

enterprise; the paragraph applies equally to an agent who concludes contracts which are binding

on the enterprise, even if those contracts are not actually in the name of the enterprise.”

The contracts referred to in paragraph 4 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 5

Under paragraph 5, 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.

In determining whether the agent is economically independent, a relevant factor is the

extent to which the agent bears business risk. Business risk refers primarily to risk of loss. An

independent agent typically bears risk of loss from its own activities. In the absence of other

factors that would establish dependence, an agent that shares business risk with the enterprise, or

has its own business risk, is economically independent because its business activities are not

integrated with those of the principal. Conversely, an agent that bears little or no risk from the

activities it performs is not economically independent and therefore is not described in paragraph

5. 

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
- 19 -

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 6

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 5

of the Article. Whether a company is a permanent establishment of a related company, therefore,

is based solely on those factors and not on the ownership or control relationship between the

companies.

ARTICLE 6 (INCOME FROM IMMOVABLE PROPERTY)

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). 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. 

The Convention does not include paragraph 5 of Article 6 of the U.S. Model, regarding a

taxpayer’s ability to be taxed on a net basis on income from real property. However, U.S. internal

law provides for such an election and Italian internal law contains a provision that approximates

net basis taxation for income from real property.
- 20 -

Paragraph 2

The terms “immovable property” and "real property" are defined in paragraph 2 by

reference to the internal law definition in the situs State. In the case of the United States, the term

“real property” has the meaning given to it by Reg. § 1.897-1(b). The Convention includes the

term “immovable property” as that is the term used in the domestic laws of Italy.

Paragraph 3

Paragraph 3 makes clear that all forms of income derived from the exploitation of real

property are taxable in the Contracting State in which the property is situated. In the case of a net

lease of real property, if a net taxation 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 (Capital 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 (Capital Gains). Finally,

dividends paid by a United States Real Property Holding Corporation are not considered to be

income from the exploitation of real property: such payments would fall under Article 10

(Dividends) or 13 (Capital Gains).

Paragraph 4

This paragraph specifies that the basic rule of paragraph 1 (as elaborated in paragraph 3)

applies to income from real property of an enterprise and to income from real property used for

the performance of independent personal services. This clarifies that the situs country may tax the

real property income (including rental income) of a resident of the other Contracting State in the

absence of attribution to a permanent establishment or fixed base in the situs State. This provision

represents an exception to the general rule under Articles 7 (Business Profits) and 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. 

ARTICLE 7 (BUSINESS PROFITS)

This Article provides rules for the taxation by a Contracting State of the business profits

of an enterprise of the other Contracting State. 

Paragraph 1

Paragraph 1 states the general rule that business profits of an enterprise of one

Contracting State may not be taxed by the other Contracting State unless the enterprise carries on

business in that other Contracting State through a permanent establishment (as defined in Article
- 21 -

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. 

Although the Convention does not include a definition of “profits”, the term is intended to

have the same meaning as under paragraph 7 of Article 7 of the U.S. Model (except for income

from the rental of tangible personal property, which is addressed under Article 12 (Royalties)). 

Thus, the term "profits" generally means income derived from any trade or business. 

In accordance with this broad definition, the term "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 22 (Other

Income). 

The term also includes income earned by an enterprise from the furnishing of personal

services. 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 or groups of individuals. The salaries of the employees would be subject to the rules

of Article 15 (Dependent Personal Services).

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.

Unlike the U.S. Model, paragraph 2 does not explicitly provide that the business profits

attributed to a permanent establishment include only those profits derived from that permanent

establishment’s assets or activities. This rule nevertheless is understood to apply since, even
- 22 -

though the OECD Model also does not expressly provide such a limitation, it generally is

understood to be implicit in paragraph 1 of Article 7 of the OECD Model. 

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. Any such approach, however, must be designed to

approximate an arm’s length result. This paragraph has not been included in the Convention

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

of such approaches independently of paragraph 4 of Article 7 of the OECD Model because total

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

enterprises under Article 9 (Associated Enterprises). Accordingly, it is understood that, under

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

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

practical reasons, such as when the affairs of the permanent establishment are so closely bound up

with those of the head office that it would be impossible to disentangle them on any strict basis of

accounts. 

Paragraph 3

 This paragraph is in substance the same as paragraph 3 of Article 7 of the U.S. Model. 

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.

As in the prior Convention, but unlike the U.S. Model, the paragraph does not explicitly

state 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. 

However, Italy accepts the principle of a reasonable allocation (such as in Treas. Reg. sections

1.861-8 and 1.882-5). It is understood that any issues which might arise in practice may be

discussed through the competent authority mechanism.

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 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
- 23 -

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

the Code section on which it is based, paragraph 6 provides that any income or gain attributable

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

State where the permanent establishment or fixed base is situated, even if the payment of that

income or gain is deferred until after the permanent establishment or fixed base ceases to exist. 

This rule applies with respect to paragraphs 1 and 2 of Article 7 (Business Profits), paragraph 4 of

Article 10 (Dividends), paragraph 5 of Article 11 (Interest), paragraph 5 of Article 12 (Royalties),

paragraph 2 of Article 13 (Capital Gains), Article 14 (Independent Personal Services) and

paragraph 2 of Article 22 (Other Income). 

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

is a resident Italy and that maintains a permanent establishment in the United States winds up the
- 24 -

permanent establishment's business and sells the permanent establishment's inventory and assets to

a U.S. buyer at the end of year 1 in exchange for an interest-bearing installment obligation payable

in full at the end of year 3. Despite the fact that Article 13's threshold requirement for U.S. taxation is not met in year 3 because the company has no permanent establishment in the United

States, the United States may tax the deferred income payment recognized by the company in year

3. 

Paragraph 7

Paragraph 7 coordinates the provisions of Article 7 and other provisions of the

Convention. Under this paragraph, when business profits include items of income that are dealt

with separately under other articles of the Convention, the provisions of those articles will, except

when they specifically provide to the contrary, take precedence over the provisions of Article 7. 

For example, the taxation of dividends will be determined by the rules of Article 10 (Dividends),

and not by Article 7, except where, as provided in paragraph 4 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), profits from the operation in

international traffic of ships or aircraft described in that Article are taxable only in the country of

residence of the enterprise regardless of whether they are attributable to a permanent

establishment situated in the source State.

Relation to Other Articles

This Article is subject to the saving clause of paragraph 2 of Article 1 (Personal Scope) of

the Model. Thus, if a citizen of the United States who is a resident of Italy under the treaty

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

establishment in the United States, the United States may, subject to the special foreign tax credit

rules of paragraph 4 of Article 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 2 of the Protocol, regarding

limitation on benefits. Thus, an enterprise of Italy 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 2 of the Protocol. 
- 25 -

Article 4 of the Protocol, regarding relief from Italian tax with respect to non-Italian

partnerships, is discussed below in connection with Article 14 (Independent Personal Services).

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). The taxation of gains from the alienation of ships, aircraft or containers is

not dealt with in this Article but in paragraph 3 of Article 13 (Capital Gains).

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 7 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 Italy, Italy 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). 

The income from the operation of ships or aircraft in international traffic that is exempt

from tax under paragraph 1 is defined in paragraph 7 of Article 1 of the Protocol. This paragraph

is identical to the corresponding paragraph of the prior Convention. Subparagraph 7(a),

consistent with paragraph 3 of Article 8 of the U.S. Model, explains that such income includes

profits from the use, maintenance, or rental of containers (including trailers, barges, and related

equipment for the transport of containers) used for the transport in international traffic of goods

or merchandise. For example, if a U.S. resident leases containers for the international traffic of

goods or merchandise, the rental income therefrom is exempt from tax in Italy, regardless of

whether or not the leasing is incidental to the U.S. lessor’s operation of ships or aircraft in

international traffic. 

 Subparagraph 7(b) of Article 1 of the Protocol provides that income from the operation

of ships or aircraft in international traffic also includes profits derived from the rental of ships or

aircraft on a full (time or voyage) basis. As in the prior Convention and the OECD Model (see

paragraph 5 of the OECD Commentary to Article 8), but unlike the U.S. Model, profits derived

from the rental of ships or aircraft on a bareboat basis are treated as income from the operation in

international traffic of ships or aircraft only if such rental profits are incidental to other profits

from the operation of ships or aircraft in international traffic. For example, if a U.S. airline which

operates internationally leases a plane on a bareboat basis to an Italian airline, the rental income

derived by the U.S. company is exempt from Italian tax under Article 8. However, if the U.S.
- 26 -

airline otherwise operates only within the United States, or if a U.S. bank leases the plane to the

Italian airline, that rental income is not exempt under this Article.

Income from the rental of ships, aircraft or containers which is not exempt from tax under

this Article is taxable in accordance with Article 12 (Royalties) or, if attributable to a permanent

establishment, in accordance with Article 7 (Business Profits). Under Article 12, the rental

income is considered to have its source in a Contracting State if the payer of the rental is a

resident of that State or if the rental payment is for the use of the property in that State. For

example, if a U.S. bank leases a plane on a bareboat basis to an Italian airline, the rental payment

is of Italian source. If the bank leases the plane to a U.S. airline for use between New York and

Rome, the portion of the rental payment attributable to the use of the plane within Italian territory

is of Italian source. The tax at source on such leasing income is limited under subparagraph 2(a)

of Article 12 to 5 percent of the gross rental.

Although not explicitly stated, consistent with the Commentary to Article 8 of the OECD

Model, it is understood 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 Italy 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 Italy (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. 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 8 of Article 1 of the Protocol, which is carried over from the prior Convention,

provides that Italy will provide an exemption for profits which a national of the United States not

resident in Italy or a United States corporation derives from operating ships documented or

aircraft registered under the laws of the United States. This exception would apply without

regard to whether the income was derived from the operation of such ships or aircraft in

“international traffic”. 

Paragraph 2

This paragraph clarifies that the provisions of paragraph 1 also apply to profits derived by

an enterprise of a Contracting State from participation in a pool, joint business or international
- 27 -

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 2 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

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 2

of the Protocol, regarding limitation on benefits.

This Article also is subject to the saving clause of paragraph 2 of Article 1 (Personal

Scope) of the Model. Thus, if a citizen of the United States who is a resident of Italy derives

profits from the operation of ships or aircraft in international traffic, notwithstanding the exclusive

residence country taxation in paragraph 1 of Article 8, the United States may, subject to the

special foreign tax credit rules of paragraph 4 of Article 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 activities

being carried on in corporate form.)

Article 8 of the Protocol is similar to a provision in an exchange of notes signed in

connection with the signing of the prior Convention. It reflects the fact that the Italian regional

tax on productive activities (IRAP) is, in part, treated as a covered tax under the Convention,

thereby providing certain benefits to U.S. residents with respect to such tax, while no United

States state or local taxes are covered by the treaty. The article provides that, if a U.S. state or

local government should impose tax on the profits of Italian enterprises from the operation of

ships or aircraft in international traffic, Italy may impose IRAP on the profits of U.S. enterprises

from such activities, notwithstanding the provisions of subparagraph 2(b)(iii) of Article 2 (Taxes

Covered) and Article 8 (Shipping and Air Transport) of the Convention. 

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. 
- 28 -

Paragraph 1

 

This paragraph is identical to the corresponding paragraph of the OECD Model and the

prior convention, and is essentially the same as its counterpart in the U.S. 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.

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.
- 29 -

Paragraph 9 of Article 1 of the Protocol, which was also in the prior Convention, clarifies

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. It is the position of

the U.S. Treasury Department that, regardless of whether a particular convention includes such a

provision, 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. 

Article 9 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 payer. Paragraph 2 of the

Commentaries to Article 9 of the OECD Model, together with the U.S. observation set forth in

paragraph 15 thereof, sets forth a similar understanding of the scope of Article 9 in the context of

thin capitalization. 

Paragraph 2

When a Contracting State has made an adjustment that is consistent with the provisions of

paragraph 1, and the other Contracting State agrees that the adjustment was appropriate to reflect

arm's-length conditions, that other Contracting State is obligated to make a correlative adjustment

(sometimes referred to as a “corresponding adjustment”) to the tax liability of the related person

in that other Contracting State. Although paragraph 2, which is based on 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 OECD Commentaries make 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. 99-32, 1999-34 I.R.B. 296.
- 30 -

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

Italy, 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 (Relief from Double Taxation)

Italy generally gives a credit for taxes paid with respect to such dividends, it would also be

required to do so in this case. 

Any correlative adjustment to be made under paragraph 2 must be made only in

accordance with the mutual agreement procedure in Article 25 (Mutual Agreement Procedure). 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 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 Italy. See, Rev. Proc. 96-13, 1996-13 I.R.B. 31, Section 7.05.

Relationship to Other Articles

The saving clause of paragraph 2 of Article 1 (Personal Scope) does not apply to

paragraph 2 of Article 9 by virtue of the exceptions to the saving clause in paragraph 3(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 1 of Article 3 of the Protocol provides

that the Convention cannot restrict any statutory benefit. 

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 22 (Other Income) grants the residence country exclusive taxing
- 31 -

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

dividend is a company resident in the other State that has owned at least 25 percent of the voting

stock of the company paying the dividend for a 12 month period ending on the date the dividend

is declared, 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 nonvoting 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 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

of payment at full statutory rates, and the treaty benefit to be granted by means of a subsequent

refund so long as such procedures are applied in a reasonable manner. See Article 5 of the

Protocol, discussed below, regarding Italy’s existing practice for implementing these benefits. 

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

under the internal law of the country imposing tax (i.e., the source country). The beneficial owner

of the dividend for purposes of Article 10 is the person to which the dividend income is

attributable for tax purposes under the laws of the source State. Thus, if a dividend paid by a

corporation that is a resident of one of the States (as determined under Article 4 (Resident)) is

received by a nominee or agent that is a resident of the other State on behalf of a person that is

not a resident of that other State, the dividend is not entitled to the benefits of this Article.

However, a dividend received by a nominee on behalf of a resident of that other State would be

entitled to benefits. These limitations are confirmed by paragraph 12 of the OECD Commentaries

to Article 10. See also, paragraph 24 of the OECD Commentaries to Article 1 (Personal 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
- 32 -

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.

The provisions of paragraphs 3 and 4 of Article 10 of the U.S. Model, which modify the

paragraph 2 maximum rates of tax at source in certain cases, appear in revised form in paragraphs

9 and 8, respectively, of Article 10 of the Convention, discussed below. 

Paragraph 3

Paragraph 3 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 non-arm's

length transaction between a corporation and a related party is a dividend. In the case of the

United States the term dividend includes amounts treated as a dividend under U.S. law upon the

sale or redemption of shares or upon a transfer of shares in a reorganization. See, e.g., Rev. Rul.

92-85, 1992-2 C.B. 69 (sale of foreign subsidiary’s stock to U.S. sister company is a deemed

dividend to extent of subsidiary's and sister's earnings and profits). Further, a distribution from a

U.S. publicly traded limited partnership, which is taxed as a corporation under U.S. law, is a

dividend for purposes of Article 10. However, a distribution by a limited liability company is not

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

Article 10, provided the limited liability company is not characterized as an association taxable as

a corporation under U.S. law. 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 4

Paragraph 4, in combination with paragraph 10 of Article 1 of the Protocol, is

substantially the same as paragraph 6 of Article 10 of the U.S. Model. It 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 establishment or fixed base is located, as modified by the

Convention. Paragraph 10 of Article 1 of the Protocol clarifies that the provisions of Article 7

(Business Profits) or Article 14 (Independent Personal Services), as the case may be, apply to

such dividends. An example of dividends paid with respect to the business property of a
- 33 -

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. 

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 4 also apply, by virtue of paragraph 6 of Article

7 (Business Profits), to dividends 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 6 of Article 7.

Paragraph 5

A State's right to tax dividends paid by a company that is a resident of the other State is

restricted by paragraph 5 to cases in which the dividends are paid to a resident of that State or the

holding in respect of which the dividends are paid is effectively connected with 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 5, therefore, overrides the ability to impose taxes under

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 Italy except to the extent that income is attributable to a permanent establishment in

the United States. Paragraph 5 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 6

Paragraph 6 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.

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
- 34 -

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 6 permits the United States generally to impose its branch profits tax on a

corporation resident in Italy 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 Italy 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 6 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 or 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 Italy also enacts a branch profits

tax, the base of its tax is limited to an amount that is analogous to the dividend equivalent amount. 

Paragraph 7

Paragraph 7 provides that the branch profits tax permitted by paragraph 6 shall not be

imposed at a rate exceeding the direct investment dividend withholding rate of five percent. 

Paragraph 8

Exemption from tax in the state of source is provided for dividends paid to qualified

governmental entities in paragraph 8. Although there is no analogous provision in the OECD

Model, the exemption of paragraph 8 is analogous to that provided to foreign governments under

section 892 of the Code. Paragraph 8 makes that exemption reciprocal. A qualified governmental entity is defined in paragraph 1(i) 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. As in the U.S. Model, the exemption at source does not apply if the qualified

governmental entity’s ownership of the payer exceeds a certain level. Paragraph 8 does not allow

the exemption at source if the qualified governmental entity holds, directly or indirectly, 25
- 35 -

percent or more of the voting stock of the company paying the dividend, whereas the U.S. Model

does not allow the exemption at source if the qualified governmental entity controls (within the

meaning of Treas. Reg. Section 1.892-5T) the company paying the dividend.

Paragraph 9

Paragraph 9 provides rules that modify the maximum rates of tax at source provided in

paragraph 2 in particular cases. The first sentence of paragraph 9 denies the lower direct

investment withholding rate of subparagraph 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 states

that dividends paid by a RIC will qualify for the 15% rate provided by subparagraph 2(b). 

The third 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 only when the beneficial owner of the dividend satisfies one or more of three criteria. 

First, the dividend may qualify if the beneficial owner is an individual resident of Italy who holds

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

15% rate if it is paid with respect to a class of stock that is publicly traded and the beneficial

owner of the dividends is a person holding an interest of not more than 5 percent of any class of

the REIT's stock. Finally, the dividend may qualify for the 15% rate if the beneficial owner of the

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

diversified.

For this purpose, a REIT will be considered diversified if the value of no single interest in

the REIT's real property exceeds 10 percent of the REIT’s total interests in real property. For

purposes of this rule, foreclosure property and mortgages will not be considered an interest in real

property unless, in the case of a mortgage, it has substantial equity components. With respect to

partnership interests held by a REIT, the REIT will be treated as owning directly the interests in

real property held by the partnership.

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 REIT shareholders that do not meet one of the 3 tests

described above, is intended to prevent the use of these entities to gain unjustifiable source

taxation benefits for certain shareholders resident in Italy. For example, a corporation resident in

Italy 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 10 percent or more of the

interests 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 9, such 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. 
- 36 -

Similarly, a resident of Italy 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. This policy avoids a disparity

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

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

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

Paragraph 10

Paragraph 10 provides that the benefits of this Article will be denied in cases in which the

main purpose, or one of the main purposes, for the creation or assignment of shares or other

rights in respect of which dividends are paid is to take advantage of this Article. 

This provision addresses abusive transactions that would not be caught by the Limitation

on Benefits provision of Article 2 of the Protocol because the purported recipient of the income

qualifies under that Article. For example, an abuse that would not be caught by the Limitation on

Benefits provisions involves “dividend washing”. A bank that is a resident of Italy and that easily

can meet any of the tests under a limitation on benefits provision may decide to “sell” its treaty

qualification to a customer that does not so qualify because it is a resident of a third country. One

way that it could do so would be for the bank to purchase shares in a U.S. company that are

owned by the customer immediately before the record date for dividends to be paid on the shares. 

At the same time, the bank would enter into a “repurchase” agreement under which it agreed with

the customer to “resell” the shares to the customer on a certain date at a certain price. The main

purpose of the agreement would be to qualify for reduced withholding tax under the Convention,

without the bank incurring any actual market risk.

Similarly, taxpayers that qualify for Convention benefits could enter into transactions that

are intended to increase the benefits that they otherwise would receive under the Convention. For

example, an Italian government pension fund would qualify for an exemption from U.S.

withholding tax with respect to a dividend if it owns less than 25 percent of the company paying

the dividend. If the pension fund held more than 25 percent of a company paying the dividend, it

could enter into a transaction to decrease temporarily its holding mainly for the purpose of

securing the dividend withholding exemption under the Convention. Because the Italian pension

fund would qualify for benefits as a qualified governmental entity, the Limitation on Benefits

provision would not address this transaction. 

The Commentary to Article 1 of the OECD Model and the OECD Report on Harmful Tax

Competition make clear that countries can impose their internal anti-abuse rules to deny claims for

treaty benefits. The United States has a number of such rules and doctrines and they may reach

the above cases. Because some have argued that these internal rules and doctrines do not apply in

the above cases, paragraph 10 clarifies that anti-abuse rules can be applied to deny treaty benefits
- 37 -

to transactions entered into with a main purpose of taking advantage of the Article. The provision

has been added because of a proliferation of such schemes in recent years, but the lack of the

provision in other treaties does not imply that internal anti-abuse rules do not apply. Although the

provision uses the term “main purpose”, which has gained international acceptance, it is intended

to have the same meaning as the term “principal purpose”, and the United States will interpret it

that way.

The provision has gained international currency because other countries may not have as

many domestic tools to prevent abuse as the United States. For them, the explicit inclusion of a

main purpose standard in a treaty may be necessary to prevent abuses of the treaty. Even in the

United States, taxpayers frequently have argued that a transaction qualifies for treaty benefits

unless there is specific guidance to the contrary.

The provision is narrower, and provides a more definitive standard to taxpayers, than antiabuse provisions that are included in certain of Italy’s other bilateral treaties. In the broadest of

those provisions, the competent authorities have unfettered discretion to deny the benefits of the

treaty with respect to any transaction if, in their opinion, the receipt of those benefits, under the

circumstances, would constitute an abuse of the Convention according to its purposes. 

The provisions of paragraph 10 are self-executing and will apply even if guidance

addressing a particular transaction has not yet been issued. Taxpayers therefore will be expected

to determine whether one of the principal purposes of a particular transaction was to take

advantage of the provision. The tax authorities of one of the Contracting States may, on review,

however, deny the benefits of this Article. Moreover, the competent authorities of both

Contracting States may together agree that this standard has been met in a particular case or with

respect to a specific transaction entered into by a number of taxpayers. See Technical

Explanation to paragraph 19 of Article 1 of the Protocol, relating to Article 25 (Mutual

Agreement Procedure) of the Convention. Such agreements, along with U.S. statutory,

regulatory, and common law, will provide guidance to taxpayers regarding the scope of the

provision.

Relation to Other Articles

Notwithstanding the foregoing limitations on source country taxation of dividends, the

saving clause of paragraph 2 of Article 1 permits the United States to tax dividends received by its

residents and citizens, subject to the special foreign tax credit rules of paragraph 4 of Article 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 2 of the Protocol,

regarding limitation on benefits. Thus, if a resident of Italy 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 2 of the Protocol in order to receive the benefits of this Article. 
- 38 -

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

The right of a beneficial owner’s country of residence to tax interest arising in the source

country is preserved by paragraph 1, which permits a Contracting State to tax its residents on

interest paid to them by a resident of the other Contracting State. For interest from any other

source paid to a resident, Article 22 (Other Income) grants the residence country exclusive taxing

jurisdiction (other than for interest attributable to a permanent establishment or fixed base in the

other State).

Paragraph 2

Paragraph 2 grants to the source State the right to tax interest payments beneficially

owned by a resident of the other State. The general rate of source country tax applicable to

interest payments under paragraph 2 is limited to 10 percent. Under the provisions of paragraph

3, the rate is modified and certain classes of interest payments are exempt from source country

tax.

The benefits of paragraphs 2 and 3 may be granted at the time of payment by means of

reduced withholding at source. It also is consistent with the paragraphs for tax to be withheld at

the time of payment at full statutory rates, and the treaty benefit to be granted by means of a

subsequent refund so long as such procedures are applied in a reasonable manner. See Article 5

of the Protocol, discussed below, regarding Italy’s existing practice for implementing these

benefits. 

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

under the internal law of the country imposing tax (i.e., the source country). The beneficial owner

of the interest for purposes of Article 11 is the person to which the interest income is attributable

for tax purposes under the laws of the source State. Thus, if interest arising in a Contracting State

is received by a nominee or agent that is a resident of the other State on behalf of a person that is

not a resident of that other State, the interest is not entitled to the benefits of this Article.

However, interest received by a nominee on behalf of a resident of that other State would be

entitled to benefits. These limitations are confirmed by paragraph 8 of the OECD Commentaries

to Article 11. See also paragraph 24 of the OECD Commentaries to Article 1 (Personal Scope).

Paragraph 11 of Article 1 of the Protocol provides an anti-abuse exception to the

limitations on source-country taxation of interest in paragraphs 1, 2, and 3 of Article 11. This

exception is consistent with the policy of Code sections 860E(e) and 860G(b) that excess

inclusions with respect to a real estate mortgage investment conduit (REMIC) should bear full
- 39 -

U.S. tax in all cases. Without a full tax at source foreign purchasers of residual interests would

have a competitive advantage over U.S. purchasers at the time these interests are initially offered. 

Also, absent this rule the U.S. fisc would suffer a revenue loss with respect to mortgages held in a

REMIC because of opportunities for tax avoidance created by differences in the timing of taxable

and economic income produced by these interests.

Paragraph 3

Paragraph 3 specifies certain categories of interest that are exempt from source State

taxation. Subparagraph 3(a) exempts interest arising in one Contracting State that is beneficially

owned by a resident of the other Contracting State that is a qualified governmental entity that

holds, directly or indirectly, less than 25 percent of the capital of the person paying the interest. 

Subparagraph 3(b) exempts interest arising in a Contracting State if it is paid with respect to debt

obligations guaranteed or insured by a qualified governmental entity of either Contracting State

and is beneficially owned by a resident of the other Contracting State. A qualified governmental

entity is defined in paragraph 1(i) of Article 3 (General Definitions). The definition does not

include a governmental entity that carries on commercial activity. 

Subparagraph 3(c) exempts from source State taxation interest paid or accrued with

respect to credit between enterprises for the sale of goods, merchandise, or services. 

Subparagraph 3(d) exempts from source State taxation interest paid or accrued in connection with

the sale on credit of industrial, commercial, or scientific equipment. Unlike the exemption in

subparagraph 3(c), the exemption in subparagraph 3(d) does not require that the sale be between

enterprises. 

Paragraph 4

Paragraph 4 defines the term “interest” as used in Article 11. The term "interest" includes,

inter alia, income from debt claims of every kind, whether or not secured by a mortgage. 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) or penalty

charges for late payment.

The term interest also includes amounts subject to the same tax treatment as income from

money lent under the law of the State in which the income arises. Thus, for purposes of the

Convention amounts that the United States will treat as interest include (i) the difference between

the issue price and the stated redemption price at maturity of a debt instrument, i.e., original issue

discount (OID), which may be wholly or partially realized on the disposition of a debt instrument

(section 1273), (ii) amounts that are imputed interest on a deferred sales contract (section 483), 

(iii) amounts treated as interest or OID under the stripped bond rules (section 1286), (iv) amounts

treated as original issue discount under the below-market interest rate rules (section 7872), (v) a

partner's distributive share of a partnership's interest income (section 702), (vi) the interest portion
- 40 -

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) embedded interest with respect to notional principal contracts. 

Paragraph 5

Paragraph 5 provides an exception to the limitations on source State taxation of

paragraphs 1, 2, and 3 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 debt-claim in respect of which the interest

is paid is effectively connected with that permanent establishment or fixed base. In such cases the

State of source will retain the right to impose tax on such interest income. Paragraph 10 of

Article 1 of the Protocol clarifies that the provisions of Article 7 (Business Profits) or Article 14

(Independent Personal Services), as the case may be, apply to such interest.

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 5 also apply, by virtue of paragraph 6 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 6 of Article 7.

Paragraph 6

Paragraph 6 provides rules for sourcing interest. Generally, interest is deemed to arise in a

Contracting State when the payer is a resident of that State. When the payer of the interest has a

permanent establishment or fixed base in a Contracting State in connection with which the

indebtedness on which the interest is paid was incurred, and the interest is borne by the permanent

establishment or fixed base, then the interest is deemed to arise in the State where the permanent

establishment or fixed base is located. This rule applies whether or not the person paying the

interest is a resident of a Contracting State. Thus, for example, if an enterprise of a third state had

a permanent establishment in the United States, the United States could impose tax on interest

paid by the permanent establishment to a resident of Italy, but only at the rates provided by

paragraph 2 and 3. 

Paragraph 7

Paragraph 7 provides that in cases involving special relationships between persons, Article

11 applies only to that portion of the total interest payments 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 Italy, respectively, with due

regard to the other provisions of the Convention. Thus, if the excess amount would be treated
- 41 -

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 (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 correspond to the definition of "control" for purposes of section 482 of the Code. 

This paragraph does not address cases where, owing to a special relationship between the

payer and the beneficial owner or between both of them and some other person, the amount of the

interest is less than an arm's-length amount. In those cases a transaction may be characterized to

reflect its substance and interest may be imputed consistent with the definition of interest in

paragraph 4. Consistent with Article 9 (Associated Enterprises), the United States would apply

section 482 or 7872 of the Code to determine the amount of imputed interest in those cases. 

Paragraph 8

Paragraph 8 permits the United States to impose its branch level interest tax on a

corporation resident in Italy. The base of this tax is the excess, if any, of the interest deductible in

the United States in computing the profits of the corporation that are subject to tax in the United

States and either attributable to a permanent establishment in the United States or subject to tax in

the United States under Article 6 or Article 13 of this Convention over the interest paid by or

from the permanent establishment or trade or business in the United States.

Paragraph 9

Paragraph 9 provides that the benefits of this Article will be denied in cases in which the

main purpose, or one of the main purposes, for the creation or assignment of the debt-claim in

respect of which the interest is paid is to take advantage of this Article. This provision is

analogous to paragraph 10 of Article 10 (Dividends), discussed above.

Relation to Other Articles

Notwithstanding the foregoing limitations on source country taxation of interest, the

saving clause of paragraph 2 of Article 1 permits the United States to tax its residents and

citizens, subject to the special foreign tax credit rules of paragraph 4 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 Article 11 are available to a

resident of the other State only if that resident is entitled to those benefits under the provisions of

Article 2 of the Protocol, regarding limitation on benefits.

ARTICLE 12 (ROYALTIES)
- 42 -

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

The right of a beneficial owner’s country of residence to tax royalties arising in the source

country is preserved by paragraph 1, which permits a Contracting State to tax its residents on

interest paid to them arising in the other Contracting State. For royalties from any other source

paid to a resident, Article 22 (Other Income) grants the residence country exclusive taxing

jurisdiction (other than for royalties attributable to a permanent establishment or fixed base in the

other State).

Paragraphs 2 and 3

The extent, if any, to which the source State may also tax a royalty payment beneficially

owned by a resident of the other Contracting State depends on the nature of the royalty payment. 

Paragraph 3 provides that the source State may not tax royalties arising in a State for the use of,

or right to use, a copyright of literary, artistic or scientific work (excluding royalties for computer

software, motion pictures, films, tapes or other means of reproduction used for radio or television

broadcasting) that are beneficially owned by a resident of the other Contracting State. 

Subparagraph 2(a) provides that the source State may tax royalties for the use of, or the

right to use, computer software or industrial, commercial, or scientific equipment that are

beneficially owned by a resident of the other Contracting State, but the tax may not exceed 5

percent of the gross amount of the royalty. Subparagraph 2(b) provides that the source State may

tax all other royalties beneficially owned by a resident of the other Contracting State at a

maximum rate of 8 percent of the gross amount of the royalty.

The benefits of paragraphs 2 and 3 may be granted at the time of payment by means of

reduced withholding at source. It also is consistent with the paragraphs for tax to be withheld at

the time of payment at full statutory rates, and the treaty benefit to be granted by means of a

subsequent refund so long as such procedures are applied in a reasonable manner. See Article 5

of the Protocol, discussed below, regarding Italy’s existing practice for implementing these

benefits

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

under the internal law of the country imposing tax (i.e., the source country). The beneficial owner

of the royalty for purposes of Article 12 is the person to which the royalty income is attributable

for tax purposes under the laws of the source State. Thus, if a royalty arising in a Contracting

State is received by a nominee or agent that is a resident of the other State on behalf of a person

that is not a resident of that other State, the royalty is not entitled to the benefits of this Article.

However, a royalty received by a nominee on behalf of a resident of that other State would be
- 43 -

entitled to benefits. These limitations are confirmed by paragraph 4 of the OECD Commentaries

to Article 12. See also paragraph 24 of the OECD Commentaries to Article 1 (Personal Scope).

Paragraph 4

 The term "royalties" as used in Article 12 is defined in paragraph 4 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 or scientific work including computer software, motion pictures, films, tapes or other

means of reproduction used for radio or television broadcasting, 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. As in the prior treaty, but unlike the

U.S. Model, rental income from industrial, commercial, or scientific equipment is also considered

royalties. 

The term royalties is defined in the Convention and therefore is generally independent of

domestic law. Certain terms used in the definition are not defined in the Convention, but these

may be defined under domestic tax law. For example, the term "secret process or formulas" is

found in the Code, and its meaning has been elaborated in the context of sections 351 and 367. 

See Rev. Rul. 55-17, 1955-1 C.B. 388; Rev. Rul. 64-56, 1964-1 C.B. 133; Rev. Proc. 69-19,

1969-2 C.B. 301.

Consideration for the use or right to use cinematographic films, or works on film, tape, or

other means of reproduction in radio or television broadcasting is specifically included in the

definition of royalties. It is intended that 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 business profits, depending on the facts and circumstances of the transaction giving rise to the payment.

The primary factor in determining whether consideration received for the use, or the right

to use, computer software is treated as royalties or as business profits, is the nature of the rights

transferred. See Treas. Reg. section 1.861-18. The fact that the transaction is characterized as a

license for copyright law purposes is not dispositive. For example, as was discussed and

understood among the negotiators, a typical retail sale of "shrink wrap" software generally will
- 44 -

not be considered to give rise to royalty income, even though for copyright law purposes it may

be characterized as a license.

The means by which the computer software is transferred are not relevant for purposes of

the analysis. Consequently, if software is electronically transferred but the rights obtained by the

transferee are substantially equivalent to rights in a program copy, the payment will be considered

business profits.

The United States will also treat as royalties under this Article gains 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 (Capital 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 services. It does not include general educational training of the

user's employees, nor does it include information developed especially for the user, such as a

technical plan or design developed according to the user's specifications. Thus, as provided in

paragraph 11 of the 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 5

This paragraph provides an exception to the limitations on source State taxation of paragraphs 1, 2, and 3 in cases where the beneficial owner of the royalties carries on business through

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

fixed base situated in that state and the right or property in respect of which the royalties are paid
- 45 -

is effectively connected with that permanent establishment or fixed base. In such cases the State

of source will retain the right to impose tax on such royalties. Paragraph 10 of Article 1 of the

Protocol clarifies that the provisions of Article 7 (Business Profits) or Article 14 (Independent

Personal Services), as the case may be, apply to such royalties.

The provisions of paragraph 6 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. 

Paragraph 6

Paragraph 6 defines the source of royalties. In general, a royalty is considered to arise in a

Contracting State if paid by the government or a resident of that State. However, if a permanent

establishment or fixed base of the payer in one of the States incurs the liability to pay the royalties

and bears the payment, the royalty is considered to arise in the State where the permanent

establishment or fixed base is located. And, notwithstanding those two rules, if a royalty relates

to the use of, or the right to use, property in a State, the royalty may be treated as arising in that

State. Thus, for example, if an Italian resident were to grant franchise rights to a resident of

Mexico for use in the United States, the royalty paid by the Mexican resident to the Italian

resident for those rights would be U.S. source income under this Article, subject to U.S.

withholding at the 8 percent rate provided in paragraph 2. 

The rules of this Article differ from those provided under U.S. domestic law. Under U.S.

domestic law, a royalty is considered to be from U.S. sources if it is paid for the use of, or the

privilege of using, an intangible within the United States; the residence of the payer is irrelevant. If

paid to a nonresident alien individual or other foreign person, a U.S. source royalty is generally

subject to withholding tax at a rate of 30 percent under U.S. domestic law. By reason of

paragraph 2 of Article 1 (Personal Scope), an Italian resident would be permitted to apply the

rules of U.S. domestic law to its royalty income if those rules produced a more favorable result in

its case than those of this Article. However, under a basic principle of tax treaty interpretation, the

prohibition against so-called "cherry-picking," the Italian resident would be precluded from

claiming selected benefits under the Convention (e.g., the tax rates only) and other benefits under

U.S. domestic law (e.g., the source rules only) with respect to its royalties. See, e.g., Rev. Rul.

84-17, 1984-1 C.B. 308. For example, if an Italian company granted franchise rights to a resident

of the United States for use 50 percent in the United States and 50 percent in Mexico, the

Convention would permit the Italian company to treat all of its royalty income from that single

transaction as U.S. source income entitled to the withholding tax reduction under paragraph 2. 

U.S. domestic law would permit the Italian company to treat 50 percent of its royalty income as

U.S. source income subject to a 30 percent withholding tax and the other 50 percent as foreign

source income exempt from U.S. tax. The Italian company could choose to apply either the
- 46 -

provisions of U.S. domestic law or the provisions of the Convention to the transaction, but would

not be permitted to claim both the U.S. domestic law exemption for 50 percent of the income and

the Convention's reduced withholding rate for the remainder of the income.

Paragraph 7

Paragraph 7 provides that in cases involving special relationships between the payer and

beneficial owner of royalties, Article 12 applies only to the extent the royalties would have been

paid absent such special relationships (i.e., an arm's-length royalty). Any excess amount of

royalties paid remains taxable according to the laws of the two Contracting States with due regard

to the other provisions of the Convention. If, for example, the excess amount is treated as a

distribution of corporate profits under domestic law, such excess amount will be taxed as a

dividend rather than as royalties, but the tax imposed on the dividend payment will be subject to

the rate limitations of paragraph 2 of Article 10 (Dividends). 

Paragraph 8

Paragraph 8 provides that the benefits of this Article will be denied in cases in which the

main purpose, or one of the main purposes, for the creation or assignment of the rights in respect

of which the royalties are paid is to take advantage of this Article. This provision is analogous to

paragraph 10 of Article 10 (Dividends), discussed above. 

Relation to Other Articles

Notwithstanding the foregoing limitations on source country taxation of royalties, the

saving clause of paragraph 2 of Article 1 (Personal Scope) permits the United States to tax its

residents and citizens, subject to the special foreign tax credit rules of paragraph 4 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 Article 12 are available to a

resident of the other State only if that resident is entitled to those benefits under Article 2 of the

Protocol, regarding limitation on benefits.

ARTICLE 13 (CAPITAL GAINS)

Article 13 assigns either primary or exclusive taxing jurisdiction over gains from the

alienation of property to the State of residence or the State of source 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 immovable (real) property situated in that State. The
- 47 -

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

immovable property situated in the United States (as defined in paragraph 12 of Article 1 of the

Protocol). Gains attributable to the alienation of immovable property include gain from any other

property that is treated as immovable property within the meaning of paragraph 12 of Article 1 of

the Protocol.

Paragraph 12 of Article 1 of the Protocol provides that, in the case of the United States,

the term “immovable property” includes a United States real property interest and, in the case of

Italy, it includes immovable property referred to in Article 6 (Income from Immovable Property),

shares or comparable interests in a company or other body of persons, the assets of which consist

wholly or principally of real property situated in Italy, and an interest in an estate the assets of

which consist wholly or principally of real property situated in Italy.

Under section 897(c) of the Code the term "United States real property interest" includes

real property described in Article 6 (Income from Immovable Property) as well as shares in a U.S.

corporation that owns sufficient U.S. real property interests to satisfy an asset-ratio test on certain

testing dates. The term also includes certain foreign corporations that have elected to be treated

as U.S. corporations for this purpose. Section 897(i). 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. 

Paragraph 2

Paragraph 2 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 Italy 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 2, 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.
- 48 -

Paragraph 6 of Article 7 (Business Profits) refers to paragraph 2 of Article 13. 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 13, gains derived by a resident of a Contracting State from the sale

of movable property forming part of the business property of a permanent establishment in the

other Contracting State may be taxed by that other State even if the income is deferred and

received after the permanent establishment no longer exists. 

Paragraph 3

This paragraph limits the taxing jurisdiction of the state of source with respect to gains

from the alienation of ships or aircraft operated in international traffic or movable property

pertaining to the operation of such ships or aircraft. The term “international traffic” is defined in

subparagraph 1(d) of Article 3. Under paragraph 3, when such gains are derived by an enterprise

of a Contracting State they are taxable only in that Contracting State. Notwithstanding paragraph

2, 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.

The gains from the alienation of ships or aircraft operated in international traffic that are

exempt from source State tax under paragraph 3 are defined in paragraph 13 of Article 1 of the

Protocol. This paragraph is identical to the corresponding paragraph of the prior Convention. 

Subparagraph 13(a), consistent with paragraph 4 of the U.S. Model, explains that the exemption

applies to gains from the alienation of containers (including trailers, barges, and related equipment

for the transport of containers) used for the transport in international traffic of goods or

merchandise. For example, if a U.S. resident leases containers for use in the international traffic

of goods or merchandise, gains from the alienation of those containers by the lessor are exempt

from tax in Italy.

Subparagraph 13(b) of Article 1 of the Protocol provides that gains from the alienation of

ships or aircraft rented on a full (time or voyage) basis are also exempt from source State tax

under paragraph 3. As in the prior Convention and the OECD Model, but unlike the U.S. Model,

paragraph 3 applies to gains from the alienation of ships or aircraft rented on a bareboat basis only

if the rental profits were incidental to other profits from the operation of ships or aircraft in

international traffic. For example, if a U.S. airline which operates internationally leases a plane on

a bareboat basis to an Italian airline, gains derived by the U.S. company from the alienation of that

plane are exempt from Italian tax under paragraph 3. However, if the U.S. airline otherwise

operates only within the United States, or if a U.S. bank leases the plane to the Italian airline,

gains derived from the alienation of the plane are not exempt under this Article.
- 49 -

Paragraph 4

Paragraph 4 grants to the State of residence of the alienator the exclusive right to tax

gains from the alienation of property other than property referred to in paragraphs 1 through 3. 

For example, gain derived from shares, other than shares described in paragraphs 1 or 2, 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 2, 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 contingent on the

productivity, use, or disposition of the property. 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 2 of Article 1 ((Personal Scope)) permits the United States

to tax its citizens and residents as if the Convention had not come into effect. Thus, any limitation

in this Article on the right of the United States to tax gains does not apply to gains of a U.S.

citizen or resident. The benefits of this Article are also subject to the provisions of Article 2 of

the Protocol, regarding limitation on benefits. Thus, only a resident of a Contracting State that

satisfies one of the conditions in Article 2 of the Protocol is entitled to the benefits of this Article. 

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 21 provide exceptions and additions to these general rules for directors' fees (Article 16);

performance income of artistes and athletes (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); certain income of professors and teachers

(Article 20), and certain income of students and trainees (Article 21).

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
- 50 -

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

example, a U.S. resident partner in a law firm that has offices in Italy would be considered to have

a fixed base regularly available to him in Italy if work space in those offices (whether or not the

same space) were made available to him whenever he wished to conduct business in Italy,

regardless of how frequently he conducted business in Italy. On the other hand, an individual who

had no office in Italy 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.

Although the Convention does not explicitly include a provision similar to paragraph 3 of

Article 7 (Business Profits) of the U.S. Model, it is understood that the principles of that

provision apply. See paragraph 3 of the OECD Commentaries to Article 14. Thus, all relevant

expenses, including expenses not incurred in the Contracting State where 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.
- 51 -

Paragraph 2

Paragraph 2 contains a list of activities that constitute "personal services in an independent

capacity". The term includes 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 21 is governed by the provisions of those articles. For example, taxation of the income of

a corporate director would be governed by Article 16 (Directors’ Fees) rather than Article 14.

This Article applies to income derived by a partner resident in the Contracting State that is

attributable to personal services of an independent character performed in the other State through

a partnership that has a fixed base in that other Contracting State. Income which may be taxed

under this Article includes all income attributable to the fixed base in respect of the performance

of the personal services carried on by the partnership (whether by the partner himself, other

partners in the partnership, or by employees assisting the partners) and any income from activities

ancillary to the performance of those services (for example, charges for facsimile services). 

Income that is not derived from the performance of personal services and that is not ancillary

thereto (for example, rental income from subletting office space), will be governed by other

Articles of the Convention. 

The application of Article 14 to a service partnership may be illustrated by the following

example: a partnership formed in the Contracting State has five partners (who agree to split

profits equally), four of whom are resident and perform personal services only in the Contracting

State at Office A, and one of whom performs personal services from Office B, a fixed base in the

other State. In this case, the four partners of the partnership resident in the Contracting State may

be taxed in the other State in respect of their share of the income attributable to the fixed base,

Office B. The services giving rise to income which may be attributed to the fixed base would

include not only the services performed by the one resident partner, but also, for example, if one

of the four other partners came to the other State and worked on an Office B matter there, the

income in respect of those services also. As noted above, this would be the case regardless of

whether the partner from the Contracting State actually visited or used Office B when performing

services in the other State.

Paragraph 6 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
- 52 -

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. 

Relation to other Articles

If an individual resident of Italy 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 2

of Article 1 (Personal Scope) tax his income without regard to the restrictions of this Article,

subject to the special foreign tax credit rules of paragraph 4 of Article 23 (Relief from Double

Taxation). 

Article 4 of the Protocol is the same as the corresponding provision in the protocol to the

prior Convention. It provides special relief for U.S. citizens resident in Italy from an otherwise

discriminatory feature of Italian law concerning the taxation of income from foreign partnerships. 

Under Italian law, the partners (whether or not residents of Italy) of an Italian partnership are

taxed on their share of the partnership income under the individual income tax (IRPF). The

national corporation income tax (IRPG) is not imposed. In the case of a non-Italian partnership,

the partnership as such is subject to IRPG on the profits of its Italian operations and the partners

are taxed individually on their share of the profits. A partnership is considered Italian under

Italian law if it has its legal seat or principal place of business activity in Italy.

Resident partners are taxable on their share of partnership income from all sources while

nonresident partners (e.g., those resident in the United States) would be taxed on their share of

the after-tax profits of the Italian office.

Under the Convention, Italy will continue to tax the income of a U.S. partnership

attributable to its Italian permanent establishment. It will not subject to individual income tax the

partners’ shares of that partnership income. And under this Article, Italy agrees to avoid double

taxation of the share of such partnership income of U.S. citizens who are residents of Italy by

allowing them to credit against their liability for Italian income tax their pro rata portion of the

corporation income tax imposed in that year on the income of the Italian office. If the corporation

tax credit exceeds the applicable individual income tax, the excess is refundable. A U.S.

partnership for this purpose is a U.S. national, defined (in Article 3 (General Definitions) of the

Convention) as a partnership deriving its status as such under the laws in force in the United

States.

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
- 53 -

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, Etc.), 19

(Government Service), 20 (Professors and Teachers), and 21 (Students and Trainees) 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, Etc.)

and is not taxable in the State of source under the provisions of that article.

 The paragraph, as does paragraph 1 of Article 15 of the OECD Model, refers to "salaries,

wages and other similar remuneration," whereas the U.S. Model applies to "salaries, wages and

other remuneration." It is understood that, notwithstanding the word "similar," Article 15 applies

to any form of compensation for employment, including payments in kind. This position on inkind payments was confirmed by the addition of paragraph 2.1 to the Commentaries to Article 15

of the OECD Model in 1997.

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 State.

Paragraph 2

Paragraph 2 sets forth an exception to the general rule that employment income may be

taxed in the State where the employment 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 the fiscal year concerned; (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 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. 

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
- 54 -

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 payer for compensation paid and at the same time to exempt the

employee on the amount received. Accordingly, if a foreign person pays the salary of an

employee who is employed in the host State, but a host State corporation or permanent

establishment reimburses the payer with a payment that can be identified as a reimbursement,

neither condition (b) nor (c), as the case may be, will be considered to have been fulfilled. 

The reference to remuneration "borne by" a permanent establishment or fixed base is

understood to encompass all expenses that economically are incurred and not merely expenses

that are currently deductible for tax purposes. Accordingly, the expenses referred to include

expenses that are capitalizable as well as those that are currently deductible. Further, salaries paid

by residents that are exempt from income taxation may be considered to be borne by a permanent

establishment or fixed base notwithstanding the fact that the expenses will be neither deductible

nor capitalizable since the payer is exempt from tax. 

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. Under this paragraph, the employment income of such person may be taxed in the State of

residence of the enterprise operating the ship or aircraft. This is not an exclusive taxing right. 

The State of residence of the employee may also tax the remuneration. This provision is based on

the OECD Model. U.S. internal law generally does not impose tax on non-U.S. source income of

a person who is neither a U.S. citizen nor a U.S. resident, even if that person is an employee of a

U.S. resident enterprise. Thus, the United States may not tax the salary of a resident of Italy who

is employed by a U.S. carrier, except as provided in paragraph 2.

Relation to other Articles 

If a U.S. citizen who is resident in Italy performs services as an employee in the United

States and meets the conditions of paragraph 2 for source country exemption, he nevertheless is
- 55 -

taxable in the United States by virtue of the saving clause of paragraph 2 of Article 1 (Personal

Scope), subject to the special foreign tax credit rule of paragraph 4 of Article 23 (Relief from

Double Taxation).

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 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.

Although the language of the Article is identical to that of Article 16 of the OECD Model,

paragraph 14 of Article 1 of the Protocol provides that payments described in Article 16 may be

taxed in the State of residence of the paying Company only to the extent that the payments are

attributable to services performed in that State. Thus, the treatment of directors’ fees is the same

as under the U.S. Model.

This Article is subject to the saving clause of paragraph 2 of Article 1 (Personal Scope). 

Thus, if a U.S. citizen who is a resident of Italy is a director of a U.S. corporation, the United

States may tax his full remuneration regardless of where he performs his services.

ARTICLE 17 (ARTISTES AND ATHLETES)

This Article deals with the taxation in a Contracting State of artistes (i.e., performing

artists and entertainers) and athletes resident in the other Contracting State from the performance

of their services as such. The Article applies both to the income of an entertainer or athlete who

performs services on his own behalf and one who performs services on behalf of another person,

either as an employee of that person, or pursuant to any other arrangement. The rules of this

Article take precedence, in some circumstances, over those of Articles 14 (Independent Personal

Services) and 15 (Dependent Personal Services). 

This Article applies only with respect to the income of performing artists and athletes. 

Others involved in a performance or athletic event, such as producers, directors, technicians,

managers, coaches, etc., remain subject to the provisions of Articles 14 and 15. In addition,

except as provided in paragraph 2, income earned by juridical persons is not covered by Article

17. Although this Article, like the prior Convention but unlike the U.S. Model and OECD Model,

uses the term “athlete” instead of “sportsman,” the terms are understood to have the same

meaning.
- 56 -

Paragraph 1

Paragraph 1 describes the circumstances in which a Contracting State may tax the

performance income of an entertainer or athlete who is a resident of the other Contracting State. 

Under the paragraph, income derived by an individual resident of a Contracting State from

activities as an entertainer or athlete exercised in the other Contracting State may be taxed in that

other State under either of two circumstances.

Subparagraph 1(a), consistent with the U.S. Model, provides that the State of

performance may tax the income if the amount of the gross receipts derived by the performer

exceeds $20,000 (or its equivalent in the currency of Italy) 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 athletes with no dollar or time threshold. This Convention

provides the dollar threshold test to distinguish between two groups of entertainers and athletes --

those who are paid relatively large sums of money for very short periods of service, and who

would, therefore, normally be exempt from host country tax under the standard personal services

income rules, and those who earn relatively modest amounts and are, therefore, not easily

distinguishable from those who earn other types of personal service income. The United States

has entered a reservation to the OECD Model on this point.

Subparagraph 1(b), like the prior Convention but unlike the U.S. Model, also allows the

State of performance to tax the income if the entertainer or athlete is present in that State for a

period or periods aggregating more than 90 days in the fiscal year concerned, even if the $20,000

threshold is not satisfied.

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 or he is present

in the host State for more than 90 years during the fiscal year, 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 is present in the host country for no more than 90

days during the fiscal year, 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 and is present for only 45 days during the
- 57 -

fiscal 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. 

Since it frequently is not possible to know until year-end whether the income an

entertainer or athlete derived from performances in a Contracting State will exceed $20,000 and

whether he will have been present in the state for more than 90 days during the year, 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 tests have 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 or athlete, 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 country

tax under paragraph 3 of 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 (Business Profits), 14 (Independent Personal Services) or 15 (Dependent Personal

Services).

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 actor-director), but his role in one of the two capacities is negligible, the predominant character

of the individual's activities should control the characterization of those activities. In other cases

there should be an apportionment between the performance-related compensation and other

compensation.

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
- 58 -

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

frequently perform in the United States as employees of, or under contract with, a company or

other person. 

The relationship may truly be one of employee and employer, with no abuse of the tax

system either intended or realized. On the other hand, the "employer" may, for example, be a

company established and owned by the performer, which is merely acting as the nominal income

recipient in respect of the remuneration for the performance (a “star company”). The performer

may act as an "employee," receive a modest salary, and arrange to receive the remainder of the

income from his performance in another form or at a later time. In such case, absent the

provisions of paragraph 2, the income arguably could escape host-country tax because the

company earns business profits but has no permanent establishment in that country. The

performer may largely or entirely escape host-country tax by receiving only a small salary 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),

independent personal services (Article 14), or dependent personal services (Article 15). Thus,

even if the "employer" has no permanent establishment or fixed base in the host country, its

income may be subject to tax there under the provisions of paragraph 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
- 59 -

deferred remuneration, bonuses, fees, dividends, partnership income or other income or

distributions. 

Paragraph 2 does not apply if the artiste or sportsmen establishes that neither the

performer nor any persons related to the performer participate directly or indirectly in the receipts

or profits of the person providing the services of the performer. Assume, for example, that a

circus owned by a U.S. corporation performs in Italy, and promoters of the performance in Italy

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 (Personal Scope) the Convention only applies to persons who

are residents of one of the Contracting States, if the star company is not a resident of one of the

Contracting States then taxation of the income is not affected by Article 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. 

Relation to Other Articles

This Article is subject to the provisions of the saving clause of paragraph 2 of Article 1

(Personal Scope). Thus, if an entertainer or an athlete who is resident in Italy is a citizen of the

United States, the United States may tax all of his income from performances in the United States

without regard to the provisions of this Article, subject, however, to the special foreign tax credit

provisions of paragraph 4 of Article 23 (Relief from Double Taxation). In addition, benefits of

this Article are subject to the provisions of Article 2 of the Protocol, regarding limitation on

benefits. 

ARTICLE 18 (PENSIONS, ETC.)

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

derived by a resident of a Contracting State in consideration of past employment are taxable only

in the State of residence of the beneficiary. The phrase “pensions and other similar remuneration”
- 60 -

is intended to encompass payments made by private retirement plans and arrangements in

consideration of past employment. In general, the phrase is intended to include both periodic and

lump-sum distributions. However, paragraph 3 provides special rules with respect to certain

lump-sum distributions.

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,

individual retirement annuities, section 408(p) accounts, and Roth IRAs under section 408A),

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 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.
- 61 -

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.

Paragraph 1 does not include the sentence from the U.S. Model providing that the

exclusive residence-based taxation is limited to taxation of amounts that were not previously

included in taxable income in the other Contracting State. It is anticipated that any issues of

potential double-taxation that arise due to the previous inclusion of a portion of the distribution in

taxable income of the individual in the other Contracting State may be addressed by the

competent authorities pursuant to the mutual agreement procedure of Article 25 (Mutual

Agreement Procedure). However, it is understood that, in the case of a U.S. resident receiving a

pension distribution from an Italian pension plan, the United States may tax the entire distribution

pursuant to paragraph 1 regardless of the fact that Italy may have previously imposed a tax on the

Italian pension plan with respect to earnings and accretions. 

Paragraph 2

The treatment of social security benefits is dealt with in paragraph 2. As in the prior

Convention, but unlike the U.S. Model, this paragraph provides that 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 will be taxable only in the other Contracting State. This paragraph

applies to social security beneficiaries whether they have contributed to the system as private

sector or Government employees. The phrase "similar legislation" is intended to refer to United

States tier 1 Railroad Retirement benefits.

Paragraph 3

Paragraph 3 provides that, notwithstanding the exclusive residence country taxation of

paragraph 1, if a resident of a Contracting State becomes a resident of the other Contracting

State, lump-sum payments or severance payments (indemnities) received after such change of

residence that are paid with respect to employment exercised in the first-mentioned State while a

resident thereof, shall be taxable only in the first-mentioned State. The term “severance payments

(indemnities)” includes any payment made in consequence of the termination of any office or

employment of a person.

This paragraph is intended to prevent potential abuses of paragraph 1. For example,

Italian law requires Italian employers to make certain lump-sum retirement payments to

employees upon their retirement. Absent paragraph 3, an employee resident in Italy who

anticipates receiving such a payment might establish residence in the United States in order to

obtain more favorable U.S. tax treatment under paragraph 1. Similarly, paragraph 3 prevents a
- 62 -

U.S. resident who anticipates receiving a lump-sum distribution from a U.S. pension plan with

respect to employment in the United States from establishing residence in Italy in order to obtain

more favorable Italian tax treatment under paragraph 1.

Paragraph 4

Under paragraph 4, 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 life or 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 14

(Independent Personal Services) or Article 15 (Dependent Personal Services).

Paragraph 5

Paragraph 4 provides rules for the taxation of alimony and child support payments made

by a resident of one Contracting State to a resident of the other State and defines the terms

“alimony” and “child support”. The general rule is that such payments are taxable only in the

country of residence of the recipient. However, if the payer is not entitled to a deduction in his

country of residence, the amount will not be taxable to the recipient in either State. Thus, for

example, since under present law alimony is deductible by the payer in each country, it is taxable

to the recipient only in his country of residence, and since child support is not deductible by the

payer in either country, it will not be taxable to the recipient in either country. The United States

does not tax child support payments to the recipient; in the absence of the Convention, Italy

would generally do so.

The reference to “entitled to” a deduction means permitted to claim a deduction under

statutory rules. For example, a U.S. taxpayer who did not claim a deduction for alimony because

he claimed the zero bracket amount or because he had a loss from other activities is nevertheless

“entitled to” such a deduction if it is allowed by the Code.

Paragraph 6

Paragraph 6 deals with cross-border pension contributions in order to remove barriers to

the flow of personal services between the Contracting States that could otherwise result from a

failure of the two Contracting States' laws regarding the deductibility of pension contributions to

mesh properly. Many countries allow deductions or exclusions to their residents for

contributions, made by them or on their behalf, to resident pension plans, but do not allow

deductions or exclusions for payments made to plans resident in another country, even if the

structure and legal requirements of such plans in the two countries are similar.
- 63 -

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.

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 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, individual retirement annuities, section 408(p) accounts,

and Roth IRAs under section 408A), section 403(a) qualified annuity plans, and section 403(b)

plans. Paragraph 15 of Article 1 of the Protocol provides that, in the case of Italy, the pension

plans eligible for the benefits of paragraph 6 include a “fondi pensione”.

Finally, the benefits under this paragraph are limited to the benefits that the host country

accords under its law, to the 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. 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 calculated

as if the individual were the only employee covered by the plan.

Relationship to other Articles

Paragraphs 1, 2, 3 and 4 of Article 18 are subject to the saving clause of paragraph 4 of

Article 1 (Personal Scope). Thus, a U.S. citizen who is resident in Italy, and receives either a

pension, social security, annuity or alimony payment from the United States, may be subject to
- 64 -

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. However, as explained with respect to

Article 2 above, and as in the prior Convention, paragraph 2 of Article 1 of the Protocol provides

that the saving clause does not override the exclusive residence country taxation provided in

paragraph 2 of Article 18 of the Convention for individuals who are citizens of the residence State

even if they are citizens of both States. Thus, if the United States makes a social security payment

to a resident of Italy who is a citizen of both the United States and Italy, only Italy can tax that

payment. 

Paragraphs 5 and 6 are excepted from the saving clause by virtue of paragraph 3(a) of

Article 1. Thus, the United States will allow U.S. citizens and residents the benefits of paragraphs

5 and 6.

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). Unlike the OECD Model, the

paragraph applies both to government employees and to independent contractors engaged by

governments to perform services for them.

Subparagraph (a) provides that remuneration paid by 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, 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

(i) a national of that State who is not also a national of the other State, or (ii) a person who did

not become resident of that State solely for purposes of rendering the services.

For example, assume that the U.S. Embassy in Rome hires a local resident who did not

become a resident of Italy solely for purposes of rendering services to the Embassy. If that

individual is an Italian national and not a U.S. citizen, the salary paid to him will be taxable only

by Italy. However, if the individual is not an Italian national, or is both an Italian national and a

U.S. citizen, the salary will be taxable only by the United States. In the converse situation, the

rule differs because of the unilateral effect of the saving clause of paragraph 2 of Article 1

(Personal Scope). For example, assume that the Italian Embassy in Washington hires a local

resident who did not become a resident of the United States solely for purposes of rendering

services to the Embassy. If the individual is not a U.S. citizen, or is both a U.S. citizen and an

Italian national, subparagraph (a) provides that the salary will be taxable only by Italy. 

Notwithstanding this provision, the United States may also tax the salary of the individual by

reason of the saving clause of paragraph 2 of Article 1 (Personal Scope). In order to relieve

double taxation, paragraph 5 of Article 23 (Relief from Double Taxation) provides that, in the
- 65 -

case of a person who is a dual national of the United States and Italy, the income for services

rendered to the Italian government will be treated as Italian source income for purposes of the

U.S. foreign tax credit. Thus, the United States may tax the income but must allow a credit for

the Italian income tax, if any, in accordance with the provisions of Article 23.

As in the prior Convention, if the spouse or dependent child of an individual who under

this paragraph is taxable only in the paying State should also perform governmental functions in

the other State, the remuneration for those functions is taxable only in the paying State, provided

that the spouse or child is not a national of the other State. This rule is intended to benefit, for

example, the spouse of a U.S. Embassy official in Rome who accepts employment at the U.S.

Embassy after having already become a resident of Italy by moving there with his spouse.

Paragraph 16 of Article 1 of the Protocol provides that the competent authorities may, by

mutual agreement, apply the provisions of paragraphs 1 and 2 of Article 19 to employees of

organizations that perform functions of a governmental nature. For example, it is anticipated that

these provisions will apply, in the case of the United States, to employees of the Federal Reserve

Banks, the Export-Import Bank, and the Overseas Private Investment Corporation and, in the

case of Italy, to employees of the Central Bank, the Foreign Trade Institute, and the Official

Insurance Institute for Export Credits.

The phrase "functions of a governmental nature" is not defined. In general it is

understood to encompass functions traditionally carried on by a government. Generally, 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.

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. 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 security benefits,

however, those payments are covered by paragraph 2 of Article 18 (Pensions, Etc.). 

Paragraph 3

Paragraph 3 provides that if the services are performed in connection with a business

carried on by the State or individual subdivision or local authority, then paragraphs 1 and 2 do not

apply. In such cases, the ordinary rules apply: Article 15 for wages and salaries, Article 16 for
- 66 -

directors fees and other similar payments, Article 17 for artistes and athletes, and Article 18 for

pensions.

Relation to other Articles

Under paragraph 3(b) of Article 1 (Personal Scope), the saving clause (paragraph 2 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

Italy who in the course of performing functions of a governmental nature becomes a resident of

the United States (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 Italy in respect of

services rendered to that Government is taxable on that pension only in Italy unless the individual

is a U.S. citizen or acquires a U.S. green card.

ARTICLE 20 (PROFESSORS AND TEACHERS)

This Article provides rules for host-country taxation of visiting professors and teachers. 

Although the U.S. Model does not contain such a provision, a similar provision was included in

the prior Convention.

Paragraph 1

Paragraph 1 provides an exemption from tax in one Contracting State for an individual

who visits that State (the "host State") for a period that is not expected to exceed two years for

the purpose of teaching or engaging in research at a university, college, school or other

recognized educational institution in that State, or at a medical facility primarily funded from

governmental sources. This rule applies only if the individual is a resident of the other

Contracting State immediately before his visit begins. The exemption applies to any remuneration

for such teaching or research. The exemption from tax applies for a period not exceeding two

years from the date he first visits the host State for the purpose of teaching or engaging in

research at the qualifying educational institution or medical facility there.

Paragraph 17 of Article 1 of the Protocol clarifies that the term “recognized educational

institution” in the case of the United States means an accredited educational institution (i.e., an

institution accredited by an authority that generally is responsible for accreditation of institutions

in the particular field of study).

Paragraph 2

Paragraph 2 provides that the Article shall apply to income from research only if such

research is undertaken by the individual in the public interest and not primarily for the benefit of

some other private person or persons. 
- 67 -

Relation to Other Articles

Under paragraph 3(b) of Article 1 (General Scope), the saving clause (paragraph 2 of

Article 1) does not apply to the benefits conferred by one of the States under this Article 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 

Italy who visits the United States for two academic years as a professor and becomes a U.S.

resident according to the Code, other than by virtue of acquiring a green card, would continue to

be exempt from U.S. tax in accordance with this Article so long as he is not a U.S. citizen and

does not acquire immigrant status in the United States.

ARTICLE 21 (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 exclusively for the 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. 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 a recognized 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. 

Paragraph 17 of Article 1 of the Protocol clarifies that the term “recognized educational

institution” in the case of the United States means an accredited educational institution (i.e., an

institution 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 payer is located outside the host State. Thus, if an employer from one of the Contracting

States sends an employee to the other Contracting State for training, the payments the trainee
- 68 -

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 will prevail in

determining the identity of the payer. 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-hostcountry source, such as, for example, a foreign bank account, should not be treated as arising

outside the United States for this purpose. Moreover, if a U.S. person reimbursed a foreign

person for payments by the foreign person to the visitor, the payments by the foreign person

would not be treated as arising outside the United States for purposes of the Article.

Relation to Other Articles

The saving clause of paragraph 2 of Article 1 (Personal Scope) does not apply to this

Article with respect to an individual who is neither a citizen of the host State nor has been

admitted for permanent residence there. The saving clause, however, does apply with respect to

citizens and permanent residents of the host State. Thus, a U.S. citizen who is a resident of Italy

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.

ARTICLE 22 (OTHER INCOME)

Article 22 generally assigns taxing jurisdiction over income not dealt with in the other

articles (Articles 6 through 21) of the Convention 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 22 include income from gambling,

punitive (but not compensatory) damages, covenants not to compete, and income from certain

financial instruments to the extent derived by persons not engaged in the trade or business of

dealing in such instruments (unless the transaction giving rise to the income is related to a trade or

business, in which case it is dealt with under Article 7 (Business Profits)). The article also applies

to items of income that are not dealt with in the other articles because of their source or some

other characteristic. For example, Article 11 (Interest) addresses only the taxation of interest

arising in a Contracting State. Interest arising in a third State that is not attributable to a

permanent establishment, therefore, is subject to Article 22. 

Distributions from partnerships and distributions from trusts are not generally dealt with

under Article 22 because partnership and trust distributions generally do not constitute income. 
- 69 -

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 22 is contained in paragraph 1. Items of income of a resident

of a Contracting State not dealt with in other articles 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.

Although this paragraph, like the OECD Model, refers to “items of income of a resident of

a Contracting State” rather than, like the U.S. Model, "items of income beneficially owned by a

resident of a Contracting State," this is not a substantive difference. It is understood 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. 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, when the right or property giving rise to the income is effectively

connected with a permanent establishment or fixed base maintained in a Contracting State by a

resident of the other Contracting State. In such case the State in which the permanent

establishment or fixed base exists will retain the right to impose tax on such income. Paragraph

10 of Article 1 of the Protocol clarifies that the provisions of Articles 7 (Business Profits) or 14

(Independent Personal Services), as the case may be, apply to such income. Therefore, income

arising outside the United States that is attributable to a permanent establishment maintained in

the United States by a resident of Italy 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 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 establish-
- 70 -

ment or fixed base in a Contracting State, that State may not tax the income if neither the situs of

the property nor the residence of the owner is in that State. 

Paragraph 3

Paragraph 3 provides that the benefits of this Article will be denied in cases in which the

main purpose, or one of the main purposes, for the creation or assignment of the rights in respect

of which the income is paid is to take advantage of this Article. This provision is analogous to

paragraph 10 of Article 10 (Dividends), discussed above

Relation to Other Articles

This Article is subject to the saving clause of paragraph 2 of Article 1 (Personal Scope). 

Thus, the United States may tax the income of a resident of Italy 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 2 of the Protocol, regarding limitation on benefits. Thus, if a resident of

Italy earns income that falls within the scope of paragraph 1 of Article 22, 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 22 only if the resident satisfies one of the tests of Article 2 of the Protocol

for entitlement to benefits. 

ARTICLE 23 (RELIEF FROM DOUBLE TAXATION)

Paragraph 1

Paragraph 1 provides that each Contracting State will undertake to relieve double taxation

in the manner set forth in this Article. 

Paragraph 2

The United States agrees, in subparagraph 2(a), to allow to its citizens and residents a

credit against U.S. tax for the appropriate amount of income tax paid to Italy. 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. 

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.,
- 71 -

Code section 986). Similarly, U.S. law applies to determine carryover periods for excess credits

and other inter-year adjustments. When the alternative minimum tax is due, the alternative

minimum tax foreign tax credit generally is limited in accordance with U.S. law to 90 percent of

alternative minimum tax liability. 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)).

Subparagraph 2(a) also provides for a deemed-paid credit, consistent with section 902 of

the Code, to a U.S. corporation in respect of dividends received from a corporation resident in

Italy of which the U.S. corporation owns at least 10 percent of the voting stock. This credit is for

the income tax paid by the corporation of Italy on the profits out of which the dividends are

considered paid.

Subparagraph 2(b) provides, in general, that Italy’s covered taxes are income taxes for

U.S. purposes. This provision is based on the Treasury Department’s review of Italy’s laws. 

However, in the case of the regional tax on productive activities (l’imposta regionale sulle attività

produttive) (“IRAP”), referred to in paragraph 2(b)(iii) of Article 2 (Taxes Covered), only that

portion specified in subparagraph 2(c) is considered to be an income tax for purposes of Article

23.

Under the prior Convention, Italy’s local income tax (l’imposta locale sul redditi)

(“ILOR”) was a covered tax and was considered an income tax for purposes of the U.S. tax credit

under Article 23. However, effective January 1, 1998, Italy repealed ILOR (as well as certain

other taxes, including a local social security tax) and enacted IRAP, which applies to Italian

residents as well as non-residents of Italy with a permanent establishment in Italy. Unlike ILOR,

IRAP is calculated without a deduction for labor costs and, for certain taxpayers, without a

deduction for interest costs. For example, the IRAP tax base for a manufacturing company

generally equals gross revenue from sales in Italy, with certain deductions including cost of goods

sold, rent and depreciation (but with no deduction for interest or labor expenses). The IRAP tax

base for a bank or other financial institution generally equals interest and other income received,

with certain deductions including interest paid, rent and depreciation (but with no deduction for

labor expenses). The initial IRAP tax rate generally is 4.25 percent (5.4 percent for banks and

other financial institutions).

The portion of IRAP specified in subparagraph 2(c) is intended, in general, to approximate

that portion of IRAP that is imposed on the business profits of a taxpayer, and which therefore

represents a tax on net income. The portion of IRAP that is considered to be an income tax

pursuant to subparagraph 2(c) is calculated as follows:

portion considered an applicable total amount paid

income tax under = ratio X of IRAP paid or

subparagraph 2(c) accrued
- 72 -

The “applicable ratio” is calculated as follows:

applicable adjusted total tax base upon

ratio = base ÷ which IRAP is

actually imposed

The “adjusted base” equals the greater of:

(a) Zero (0), or

(b) The total tax base upon which IRAP is actually imposed, less the total

amount of labor and interest expense not otherwise taken into account in

determining the total tax base upon which IRAP is actually imposed

In general terms, the amount of IRAP paid or accrued that is considered an income tax

under this formula is determined by multiplying the amount of IRAP paid or accrued to Italy by a

fraction, the numerator of which represents an amount approximating the taxpayer’s business

profits (including deductions for interest and labor expense) that were subject to IRAP, and the

denominator of which equals the actual tax base upon which Italy imposed IRAP. In the case of a

non-financial institution, the interest expense deduction in the numerator refers to gross interest

expense (rather than net interest expense)

The following examples illustrate these calculations:

Example 1. M is a manufacturing company resident in the United States, with a

permanent establishment in Italy. M has the following items of income and expense attributable to

the permanent establishment in Italy:

Gross Revenue subject to IRAP $100,000

Rent/Depreciation Expense 40,000

Labor Expense 20,000

Interest Expense 10,000

The tax base upon which IRAP is imposed equals $60,000 ($100,000, less $40,000

rent/depreciation expense). No deduction is allowed under Italian law for the labor and interest

expenses in calculating IRAP. Accordingly, M pays IRAP equal to $2,550 (4.25 percent rate,

multiplied by $60,000).

For purposes of determining the portion of this tax that is considered an income tax under

subparagraph 2(c), the “adjusted base” equals $30,000 ($60,000 base upon which IRAP is

actually imposed, less $20,000 labor expense and $10,000 interest expense that were not

otherwise taken into account in determining the actual IRAP tax base). The “applicable ratio”

equals 1⁄2 ($30,000 adjusted base, divided by $60,000 actual IRAP tax base). Accordingly, the
- 73 -

portion of IRAP that is considered an income tax under subparagraph 2(c) equals $1,275 (1⁄2

applicable ratio, multiplied by $2,550 total amount of IRAP paid).

Example 2. B is a bank resident in the United States, which conducts banking activities

through a permanent establishment in Italy. B has the following items of income and expense

attributable to the permanent establishment in Italy:

Gross Revenue subject to IRAP $100,000

Rent/Depreciation Expense 20,000

Labor Expense 15,000

Interest Expense 60,000

The tax base upon which IRAP is imposed equals $20,000 ($100,000, less $20,000

rent/depreciation expense and $60,000 interest expense). No deduction is allowed under Italian

law for the labor expense in calculating IRAP. Accordingly, B pays IRAP equal to $1,080 (5.4

percent rate, multiplied by $20,000).

For purposes of determining the portion of this tax that is considered an income tax for

purposes of subparagraph 2(c), the “adjusted base” equals $5,000 (the $20,000 base upon which

IRAP is actually imposed, less the $15,000 labor expense that was not otherwise taken into

account in determining the actual IRAP tax base). The “applicable ratio” equals 1⁄4 ($5,000

adjusted base, divided by $20,000 actual IRAP tax base). Accordingly, the portion of IRAP that

is considered an income tax for purposes of subparagraph 2(c) is $270 (1⁄4 applicable ratio,

multiplied by $1,080 total amount of IRAP paid).

Paragraph 3

In paragraph 3, Italy agrees to allow its residents a credit against Italian tax for U.S. taxes

on income. With respect to items of income that the United States may tax under the Convention

(other than solely by reason of the saving clause applied to U.S. citizens), Italy may include such

items of income in the tax base of its residents except as otherwise provided by the Convention. 

In such a case, the U.S. taxes that are covered taxes under paragraphs 2(a) and 3 of Article 2

(Taxes Covered) will be allowed as a credit against the Italian tax liability in an amount not to

exceeding the proportion of Italian tax that such items of income that are taxable by the United

States bear to the total income of the taxpayer.

Italy will not give a foreign tax credit in cases where the taxpayer has elected under Italian

law to pay a final withholding tax on an item of income, e.g., dividends, thereby excluding that

income from the tax base subject to the ordinary rates of tax.

Italy does not grant an indirect credit comparable to the credit authorized by section 902

of the Code. However, under Article 2359 of Italy’s tax law, a portion of the dividends received
- 74 -

by an Italian corporation from a foreign subsidiary (defined in terms of 10 percent ownership or a

“controlling interest”) are excluded from the tax base.

Paragraph 4

Paragraph 4 provides special rules for the tax treatment in both States of certain types of

income derived from U.S. sources by U.S. citizens who are resident in Italy. 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 Italy 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 Italy who is not a U.S. citizen. 

Subparagraph (a) of paragraph 4 provides special credit rules for Italy 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 Italy who are not U.S. citizens. 

The tax credit of Italy allowed by paragraph 4(a) under these circumstances, to the extent consistent with the law of Italy, need not exceed the U.S. tax that may be imposed under the provisions

of the Convention on a resident of Italy that is not a U.S. citizen. Thus, if a U.S. citizen resident

in Italy receives U.S. source portfolio dividends, the foreign tax credit granted by Italy 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 royalties arising from the use of, or right to use, a copyright

of literary, artistic or scientific work described in paragraph 3 of Article 12 (Royalties), Italy

would allow no foreign tax credit, because its residents are exempt from U.S. tax on this class of

income under Article 12.

Paragraph 4(b) eliminates the potential for double taxation that can arise because

subparagraph4(a) provides that Italy need not provide full relief for the U.S. tax imposed on its

citizens resident in Italy. The subparagraph provides that the United States will credit the income

tax paid or accrued to Italy, after the application of subparagraph 4(a). It further provides that in

allowing the credit, the United States will not reduce its tax below the amount that is taken into

account in Italy in applying subparagraph 4(a). Since the income described in paragraph 4 is U.S.

source income, special rules are required to resource some of the income to Italy in order for the

United States to be able to credit the Italy’s tax. This resourcing is provided for in subparagraph

4(c), which deems the items of income referred to in subparagraph 4(a) to be from foreign sources

to the extent necessary to avoid double taxation under paragraph 4(b). The rules of paragraph

4(c) apply only for purposes of determining U.S. foreign tax credits with respect to taxes

considered to be income taxes pursuant to subparagraph 2(b) of Article 23 (Relief from Double

Taxation).

The following two examples illustrate the application of paragraph 4 in the case of a U.S.

source portfolio dividend received by a U.S. citizen resident in Italy. In both examples, the U.S.

rate of tax on residents of Italy under paragraph 2(b) of Article 10 (Dividends) of the Convention
- 75 -

is 15 percent. In both examples the U.S. income tax rate on the U.S. citizen is 36 percent. In

example I, the Italian income tax rate on its resident (the U.S. citizen) is 25 percent (below the

U.S. rate), and in example II, the Italian income tax rate on its resident is 40 percent (above the

U.S. rate). 

Example I Example II

Paragraph 4(a)

U.S. dividend declared $100.00 $100.00

Notional U.S. withholding tax per Article 10(2)(b) 15.00 15.00

Italian taxable income 100.00 100.00

Italian tax before credit 25.00 40.00

Italian foreign tax credit 15.00 15.00

Net post-credit Italian tax 10.00 25.00

Example I Example II

Paragraphs 4(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 Italy 27.77 58.33

U.S. tax on resourced income 10.00 21.00

U.S. credit for Italian 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 subparagraph 4(a), Italy credits a 15 percent U.S.

tax against its residence tax on the U.S. citizen. In example I the net Italian tax after foreign tax

credit is $10.00; in the second example it is $25.00. In the application of subparagraphs 4(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

Italian 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 Italian tax, an appropriate

amount of the income must be resourced. The amount that must be resourced depends on the

amount of Italian tax for which the U.S. citizen is claiming a U.S. foreign tax credit. In example I,

Italian 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 Italian 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,

Italian tax was $25 but, because the amount available for credit is reduced under subparagraph

4(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
- 76 -

for $21 of Italian tax, or $58.33 ($21 divided by .36). Thus, even though Italian tax was $25.00

and the U.S. tax available for credit was $21.00, there is no excess credit available for carryover.

Paragraph 5

Paragraph 5 provides a resourcing rule for purposes of the U.S. foreign tax credit in

situations where an individual who is a dual national of both the United States and Italy is taxable

by Italy pursuant to subparagraph 1(a) of Article 19 (Government Service) and by the United

States pursuant to the saving clause of paragraph 2 of Article 1 (Personal Scope). This provision

is explained in more detail above in the discussion of Article 19.

Relation to other articles

By virtue of the exceptions in subparagraph 3(a) of Article 1 this Article is not subject to

the saving clause of paragraph 4 of Article 1 (Personal 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 (such as the re-sourcing provided by subparagraph

4(c) and paragraph 5).

ARTICLE 24 (NON-DISCRIMINATION)

 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
- 77 -

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 other or more

burdensome than the taxes and connected requirements imposed upon a national of that other

State in the same circumstances. As noted above, whether or not the two persons are both

taxable on worldwide income is a significant circumstance for this purpose. The 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, the U.S. Model expands the phrase to refer, not to

residence, but to taxation on worldwide income. The Convention contains an explicit sentence

providing that, for purposes of U.S. taxation, U.S. citizens who are subject to tax on a worldwide

basis are not in the same circumstances as Italian nationals who are not residents of the United

States. Despite these different formulations, the underlying concept is essentially the same in the

two Models and the Convention.

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 Italy as a national of Italy

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). The term national includes both individuals and juridical persons.

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 Italy 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

Italy who are not United States residents. Thus, for example, Article 24 would not entitle a

national of Italy resident in a third country to taxation at graduated rates of U.S. source dividends

or other investment income that applies to a U.S. citizen resident in the same third country. 

Paragraph 2
- 78 -

Paragraph 2 of the Article provides that a Contracting State may not tax a permanent

establishment of an enterprise of the other Contracting State less favorably than an enterprise of

that first-mentioned State that is carrying on the same activities. 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 Italy 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 Italy 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 Italy is subject to U.S. tax

only on income that is attributable to the permanent establishment, while a U.S. corporation

engaged in the same activities is taxable on its worldwide income is not, in itself, a sufficient

difference to deny national treatment to the permanent establishment. There are cases, however,

where the two enterprises would not be similarly situated and differences in treatment may be

warranted. For instance, it would not be a violation of the 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 Convention, this obligation applies with respect to a share

of the partnership income of a partner resident in Italy, and attributable to a U.S. permanent establishment. There is no similar obligation with respect to the distributive shares of U.S. resident

partners. It is understood, however, that this distinction is not a form of discrimination within the

meaning of paragraph 2 of the Article. No distinction is made between U.S. and non-U.S.

partnerships, since the law requires that partnerships of both U.S. and non-U.S. domicile withhold

tax in respect of the partnership shares of non-U.S. partners. Furthermore, in distinguishing

between U.S. and non-U.S. partners, the requirement to withhold on the non-U.S. but not the

U.S. partner's share is not discriminatory taxation, but, like other withholding on nonresident

aliens, is merely a reasonable method for the collection of tax from persons who are not

continually present in the United States, and as to whom it otherwise may be difficult for the

United States to enforce its tax jurisdiction. If tax has been over-withheld, the partner can, as in

other cases of over- withholding, file for a refund. (The relationship between paragraph 2 and the
- 79 -

imposition of the branch tax is dealt with below in the discussion of paragraph 18 of Article 1 of

the Protocol.)

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 7 of Article 11 (Interest) or paragraph 7 of Article 12 (Royalties) apply,

because in these situations, the related parties have entered into transactions on an arm’s length

basis. 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.

The Convention does not include an explicit statement, as is found in the U.S. Model and

the OECD Model, that any debts of a resident of a Contract State to a resident of the other

Contracting State shall, for the purpose of determining the taxable capital of the first-mentioned

resident, be deductible under the same conditions as if they have been contracted to a resident of

the first-mentioned State. However, it is understood that this principle is incorporated in the

general principles of Article 24 and, therefore, is applicable.

Paragraph 4

Paragraph 4 requires that a Contracting State not impose other or more burdensome

taxation or connected requirements on an enterprise of that State that is wholly or partly owned

or controlled, directly or indirectly, by one or more residents of the other Contracting State, than

the taxation or connected requirements that it imposes on other similar enterprises of that

first-mentioned Contracting State. For this purpose it is understood that “similar” refers to similar

activities or ownership of the enterprise.

This rule, like all nondiscrimination provisions, does not prohibit differing treatment of

entities that are in differing circumstances. Rather, a protected enterprise is only required to be

treated in the same manner as other enterprises that, from the point of view of the application of

the tax law, are in substantially similar circumstances both in law and in fact. The taxation of a

distributing corporation under section 367(e) on an applicable distribution to foreign shareholders

does not violate paragraph 4 of the Article because a foreign-owned corporation is not similar to a
- 80 -

domestically-owned corporation that is accorded nonrecognition treatment under sections 337

and 355. 

For the reasons given above in connection with the discussion of paragraph 2 of the

Article, it is also understood that the provision in section 1446 of the Code for withholding of tax

on non-U.S. partners does not violate paragraph 4 of the Article. 

It is further understood that the ineligibility of a U.S. corporation with nonresident alien

shareholders to make an election to be an "S" corporation does not violate paragraph 4 of the

Article. If a corporation elects to be an S corporation (requiring 75 or fewer shareholders), it is

generally not subject to income tax and the shareholders take into account their pro rata shares of

the corporation's items of income, loss, deduction or credit. (The purpose of the provision is to

allow an individual or small group of individuals to conduct business in corporate form while

paying taxes at individual rates as if the business were conducted directly.) A nonresident alien

does not pay U.S. tax on a net basis, and, thus, does not generally take into account items of loss,

deduction or credit. Thus, the S corporation provisions do not exclude corporations with

nonresident alien shareholders because such shareholders are foreign, but only because they are

not net-basis taxpayers. Similarly, the provisions exclude corporations with other types of

shareholders where the purpose of the provisions cannot be fulfilled or their mechanics

implemented. For example, corporations with corporate shareholders are excluded because the

purpose of the provisions to permit individuals to conduct a business in corporate form at

individual tax rates would not be furthered by their inclusion.

Paragraph 5

As noted above, notwithstanding the specification in Article 2 (Taxes Covered) of taxes

covered by the Convention 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.

Paragraph 18 of Article 1 of the Protocol

Paragraph 18 of Article 1 of the Protocol, which corresponds to paragraph 5 of Article 24

of the U.S. Model, confirms that no provision of the Article 24 will prevent either Contracting

State from imposing the branch tax described in paragraph 6 of Article 10 (Dividends) or the

branch level interest tax described in paragraph 8 of Article 11 (Interest). Since imposition of

these taxes under the Convention is specifically sanctioned under Articles 10 and 11, its

imposition could not be precluded by Article 24, even without paragraph 18 of Article 1 of the

Protocol. Under the generally accepted rule of construction that the specific takes precedence

over the more general, the specific branch tax provisions of Articles 10 and 11 would take

precedence over the more general national treatment provision of Article 24.
- 81 -

Relation to Other Articles

The saving clause of paragraph 2 of Article 1 (Personal Scope) does not apply to this

Article, by virtue of the exceptions in paragraph 3(a) of Article 1. Thus, for example, a U.S.

citizen who is a resident of Italy 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 2 of the Protocol, regarding 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 2 of

the Protocol.

ARTICLE 25 (MUTUAL AGREEMENT PROCEDURE)

This Article provides the mechanism for taxpayers to bring to the attention of the

Contracting States’ 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 Article also

provides for the possibility of the use of arbitration to resolve disputes that cannot be settled by

the competent authorities. The competent authorities of the two Contracting States are identified

in paragraph 1(e) of Article 3 (General Definitions).

Because Article 25 makes a number of changes to the corresponding provision of the prior

Convention, paragraph 2 of Article 7 of the Protocol provides that, within three years after the

entry into force of the Convention, the competent authorities shall consult with respect to the

implementation of Article 25 and, taking into account experience with respect thereto, determine

whether any modifications to Article 25 would be appropriate.

Paragraph 1

This paragraph, like the OECD Model, 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 his State

of residence or, if his case comes under paragraph 1 of Article 24 (Non-Discrimination), to the

competent authority of the State of which he is a national. 

Although the typical cases brought under this paragraph will involve economic double

taxation arising from transfer pricing adjustments, the scope of this paragraph is not limited to

such cases. For example, if 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
- 82 -

establishment, or that no permanent establishment exists, the resident may bring a complaint under

paragraph 1 to the competent authority of his State of residence.

 

It is not necessary for a person bringing a complaint first to have exhausted the remedies

provided under the national laws of the Contracting States before presenting a case to the

competent authorities. The case must be presented within three years of the first notification of

the action resulting in taxation not in accordance with the Convention. (See Article 5 of the

Protocol, discussed below, for time limits regarding claims for refund of taxes withheld at source) 

Although the U.S. Model would avoid any time limits for presenting a case for competent

authority action, Italy advocated a three-year limit, which is consistent with the OECD Model. 

The phrase “first notification of the action resulting in taxation not in accordance with the

provisions of the Convention” should be interpreted in the way most favorable to the taxpayer. 

See paragraph 18 of the OECD Commentaries to Article 25. With respect tog Italy’s existing

practice for implementing these benefits See Article 5 of the Protocol, discussed below

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. 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 Italy. See, Rev. Proc. 96-13, 1996-3

I.R.B. 31, section 7.05. Because, as specified in paragraph 2 of Article 1 (Personal 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. This paragraph follows the OECD

Model treaty. The U.S. Model contains a non-exhaustive list of examples of the kinds of matters

about which the competent authorities may reach agreement. This list is not in the Convention

because the negotiators viewed it as unnecessary. The negotiators agreed that the list would not

grant any authority that is not implicitly present as a result of the introductory sentence of

paragraph 3. Thus, under this paragraph, the competent authorities may agree to settle a variety

of conflicting applications of the Convention. 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 or between related persons. These
- 83 -

allocations are to be made in accordance with the arm's length principle underlying Article 7

(Business Profits) and Article 9 (Associated Enterprises). Agreements reached under these

subparagraphs may include agreement on a methodology for determining an appropriate transfer

price, common treatment of a taxpayer's cost sharing arrangement, or upon an acceptable range of

results under that methodology. They may also agree to apply this methodology and range of

results prospectively to future transactions and time periods pursuant to advance pricing

agreements.

The competent authorities also may agree to characterize particular items of income in the

same way, to characterize entities in a particular way, to apply the same source rules to particular

items of income, and to adopt a common meaning of a term. 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. The competent authorities may seek agreement on a uniform set of

standards for the use of exchange rates, or agree on consistent timing of gain recognition with

respect to a transaction to the extent necessary to avoid double taxation. Agreements reached by

the competent authorities under paragraph 3 need not conform to the internal law provisions of

either Contracting State.

Paragraph 3 explicitly 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 Italy. Since no resident of a Contracting State is involved in the case, the

Convention does not apply, but the competent authorities nevertheless may use the authority of

the Convention to prevent the double taxation.

Paragraph 19 of Article 1 of the Protocol makes clear that the competent authorities can

agree that the conditions for application of the anti-abuse provisions in paragraph 10 of Article 10

(Dividends), paragraph 9 of Article 11 (Interest), paragraph 8 of Article 12 (Royalties), or

paragraph 3 of Article 22 (Other Income), have been met. As with all other matters, the

competent authorities’ agreement does not have to relate to a particular case. Thus, if the

competent authorities become aware of a type of transaction entered into by several taxpayers,

they could reach an agreement that all such transactions are entered into with a main purpose of

taking advantage of a relevant Article. In that case, treaty benefits would be denied to all

taxpayers who had entered into such transactions. It is anticipated that the public would be

notified of such generic agreements through the issuance of press releases. It is anticipated that

the standard of judicial review regarding such an agreement would be the same as for a

determination with respect to a particular taxpayer.
- 84 -

Paragraph 4

Paragraph 4 provides that the competent authorities may communicate with each other

directly 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 the competent authorities or their representatives.

Paragraph 5

Paragraph 5 contains an arbitration procedure found in several recent U.S. tax treaties,

although the arbitration procedures currently are operative only under the treaty with Federal

Republic of Germany. Paragraph 5 provides that where the competent authorities have been

unable to resolve a disagreement regarding the application or interpretation of the Convention, the

disagreement may, by mutual consent of the competent authorities and the affected taxpayers, be

submitted for arbitration. Nothing in the provision requires that any case be submitted for

arbitration. If a case is submitted to an arbitration board, however, the board's decision in that

case will be binding on both Contracting States and the taxpayer(s) with respect to that case. 

When a case is referred to an arbitration board, confidential information necessary for

carrying out the arbitration procedure may be released by the States to the board. The members

of the board, and any staff, however, are subject to the disclosure rules of Article 26. 

The arbitration procedures will not come into effect until the Contracting States have

agreed through an exchange of diplomatic notes. Pursuant to paragraph 2 of Article 7 of the

Protocol, within three years after entry into force of the Convention the competent authorities will

consult to determine whether it appropriate to exchange diplomatic notes implementing the

arbitration procedure, taking into account the operation of Article 25 and the experience with

respect to arbitration of international tax disputes .

The Memorandum of Understanding elaborates on the circumstances under which an

exchange of diplomatic notes implementing the arbitration procedure will take place. It notes the

understanding that the two States will exchange diplomatic notes implementing the arbitration

procedure at such time as either the provision under the U.S.-Germany income tax treaty, or the

similar provision in the European Communities agreement signed on 23 July, 1990, has proven to

be satisfactory to competent authorities of both the United States and Italy. The arbitration

procedures themselves also will be established through an exchange of notes. 

The Memorandum of Understanding also sets forth the procedures that will apply to

arbitration proceedings if the arbitration provision is implemented pursuant to an exchange of

notes. The competent authorities may agree to modify or supplement the arbitration procedures

set forth in the Memorandum of Understanding. However, they shall continue to be bound by the

general principles established therein.
- 85 -

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. Even though the prior Convention was in effect

during the years in which the transaction at issue occurred, the mutual agreement procedures of

the Convention would apply.

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 2 of Article 1 (Personal

Scope) by virtue of the exceptions in paragraph 3(a) of that Article. Thus, rules, definitions,

procedures, etc. that are agreed upon by the competent authorities under this Article may be

applied by the United States with respect to its citizens and residents even if they differ from the

comparable Code provisions. Similarly, as indicated above, U.S. law may be overridden to

provide refunds of tax to a U.S. citizen or resident under this Article. A person may seek relief

under Article 25 regardless of whether he is generally entitled to benefits under Article 2 of the

Protocol, regarding 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. 
- 86 -

ARTICLE 26 (EXCHANGE OF INFORMATION)

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 necessary for carrying

out the provisions of the Convention or the domestic laws of the United States or of Italy

concerning the taxes covered by the Convention. The reference to information that is “necessary”

is consistent with the OECD Model, and while the U.S. Model refers to information that is

“relevant”, the terms consistently have been interpreted as being equivalent, and as not requiring a

requesting State to demonstrate that it would be unable to enforce its tax laws unless it obtained a

particular item of information. Therefore, it should not be interpreted that “necessary” creates a

higher threshold than “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

20 of Article 1 of the Protocol, 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 Italy 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 thirdcountry company (since there is no relevant treaty in force), the Contracting States may exchange

information regarding the prices that their residents paid in their transactions with the thirdcountry resident.

Paragraph 1 states that information exchange is not restricted by Article 1 (Personal

Scope). Accordingly, information may be requested and provided under this Article with respect

to persons who are not residents of either Contracting State. For example, if a third-country

resident has a permanent establishment in Italy 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 Italy, 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 Italy with respect to that person's

account.
- 87 -

Paragraph 1 also provides assurances that any information exchanged will be treated as

secret, subject to the same disclosure constraints as information obtained under the laws of the

requesting State. Information received may be disclosed only to persons, including courts and

administrative bodies, involved with the assessment or collection of, enforcement or prosecution

in respect of, or the determination of appeals in relation to, the taxes to which the information

relates. Paragraph 20 of Article 1 of the Protocol provides that information may also be disclosed

to persons or authorities involved in the oversight of such activities. The information must be

used by these persons in connection with these designated functions. Persons in the United States

involved with the oversight 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 which would be contrary to public policy. Thus, a requesting State

may be denied information from the other State if the information would be obtained pursuant to

procedures or measures that are broader than those available in the requesting State. 

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.

The Convention does not contain a paragraph corresponding to paragraph 3 of the Model,

which sets forth certain exceptions from the dispensations described in paragraph 2. One such

exception contained in the U.S. Model 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 Mode,

like the Convention, 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.
- 88 -

(See paragraph 16 of the OECD Commentary to Article 26.) Thus, it is implicit in the

Convention.

The Convention also does not contain the first sentence of paragraph 3 of the Model,

which 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. The United States

has received assurances from the Italian Ministry of Finance concerning Italy’s ability to exchange

third-party information obtained from banks and other financial institutions. Given these

assurances, and the longstanding relationship with Italy regarding exchange of information under

the prior Convention , the Treasury Department believes that the omission of the sentence will not

affect the United States’ ability to obtain this third-party information from Italy.

Article 6 of the Protocol

Article 6 of the Protocol, which is similar to paragraph 4 of Article 26 of the U.S. Model,

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

Article 6 of the Protocol, a Contracting State may collect on behalf of the other State 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 Italy, the withholding agent under

current rules may 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 third-country resident, Article 6 of the

Protocol would permit Italy to withhold and remit to the United States the additional tax that

should have been collected by the U.S. withholding agent.

Unlike the corresponding provision of the Model, this paragraph merely permits, rather

than requires, each Contracting State to endeavor to assist in the collection described therein. 

This provision 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 20 of Article 1 of the Protocol

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.

Treaty effective dates and termination in relation to competent authority dispute resolution
- 89 -

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. Even though a prior treaty

may have been in effect during the years in which the transaction at issue occurred, the exchange

of information provisions of the current treaty apply. 

ARTICLE 27 (DIPLOMATIC AGENTS AND CONSULAR OFFICIALS)

This Article confirms that any fiscal privileges to which diplomatic or consular officials are

entitled under general provisions of international law or under special agreements will apply

notwithstanding any provisions to the contrary in the Convention. The agreements referred to

include any bilateral agreements, such as consular conventions, that affect the taxation of

diplomats and consular officials and any multilateral agreements dealing with these issues, such as

the Vienna Convention on Diplomatic Relations and the Vienna Convention on Consular

Relations. The U.S. generally adheres to the latter because its terms are consistent with

customary international law.

The Article does not independently provide any benefits to diplomatic agents and consular

officers. Article 19 (Government Service) does so, as do Code section 893 and a number of

bilateral and multilateral agreements. In the event that there is a conflict between the 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 3(b) of Article 1, the saving clause of paragraph 2 of Article 1

(Personal Scope) does not apply to override any benefits of this Article available to an individual

who is neither a citizen of the United States nor has immigrant status in the United States. 

ARTICLE 28 (ENTRY INTO FORCE)

This Article contains the rules for bringing the Convention into force and giving effect to

its provisions. 
- 90 -

Paragraph 1

Paragraph 1 provides for the ratification of the Convention by both Contracting States

according to their constitutional and statutory requirements. Instruments of ratification will be

exchanged as soon as possible after both States’ 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 Senate’s advice and consent to ratification, the treaty

is returned to the President for his signature on the ratification document. The President's

signature on the document completes the process in the United States. 

Paragraph 2

Paragraph 2 provides that the Convention will enter into force upon the exchange of

instruments of ratification. The date on which a treaty enters into force is not necessarily the date

on which its provisions take effect. Paragraph 2, therefore, also contains rules that determine

when the provisions of the treaty will have effect. Under paragraph 2(a), the Convention will

have effect with respect to taxes withheld at source (principally dividends, interest and royalties)

for amounts paid or credited on or after the first day of the second month following the date on

which the Convention enters into force. For example, if instruments of ratification are exchanged

on April 25 of a given year, the withholding rates specified in paragraph 2 of Article 10 (Dividends) would be applicable to any dividends paid or credited on or after June 1 of that year. This

rule allows the benefits of the withholding reductions to be put into effect as soon as possible,

without waiting until the 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. If for

some reason a withholding agent withholds at a higher rate than that provided by the Convention

(perhaps because it was not able to re-program its computers before the payment is made), a

beneficial owner of the income that is a resident of Italy may make a claim for refund pursuant to

section 1464 of the Code.

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. 
- 91 -

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.

Paragraph 3

As in many recent U.S. treaties, Paragraph 3 provides a "grace period" in the form of a

general exception to the effective date rules of paragraph 2. Under this paragraph, if the prior

Convention would have afforded greater relief from tax to a person entitled to its benefits than

would be the case under this Convention, that person may elect to remain subject to all of the

provisions of the prior Convention for a twelve-month period from the date on which this

Convention would have had effect under the provisions of paragraph 2 of this Article. During the

period in which the election is in effect, the provisions of the prior Convention will continue to

apply only insofar as they applied prior to the entry into force of the Convention.

If the grace period is elected, all of the provisions of the prior Convention must be applied

for that additional year. The taxpayer may not apply certain, more favorable, provisions of the

prior Convention and, at the same time, apply other, more favorable, provisions of the

Convention. The taxpayer must choose one regime or the other.

Paragraph 4

Paragraph 4 provides a rule to coordinate the termination of the prior Convention with the

effective dates of this Convention. The prior Convention will cease to have effect when the

provisions of this Convention take effect in accordance with paragraphs 2 and 3 of the Article. 

Thus, for a person not taking advantage of the election in paragraph 3, the prior Convention will

cease to have effect at the time, on or after January 1 of the year following entry into force of the

Convention, when the provisions of the new Convention first have effect. For persons electing

the additional year of coverage of the prior Convention, the prior Convention will remain in effect

for one additional year beyond the date specified in the preceding sentence. The prior Convention

will terminate on the last date on which it has effect in accordance with the provisions of Article

28.

ARTICLE 29 (TERMINATION)

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 5 years from the date on 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 as of January 1 next following the date that is 6 months after the

date of delivery of notice of termination. For other taxes, the Convention will cease to have effect

as of taxable periods beginning on or after the date that is 6 months after the date of delivery of

notice of termination.
- 92 -

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 on or 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 on or 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 5-year waiting period or 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. 
- 93 -

PROTOCOL

A Protocol, signed on the same occasion and forming an integral part of the Convention,

amplifies the provisions of the Convention. Because it is an integral part of the Convention, its

entry into force and termination are governed, respectively, by Article 28 (Entry into Force) and

Article 29 (Termination) of the Convention.

Article 1

Article 1 of the Protocol contains twenty paragraphs which modify or elaborate on certain

provisions of Articles 1, 2, 3, 4, 5, 8, 9, 10, 11, 12, 13, 16, 18, 19, 20, 21, 22, 24, 25, and 26 of

the Convention. Those paragraphs are discussed above in connection with the relevant article of

the Convention. 

Article 2

Article 2 of the Protocol contains a limitation on benefits provision. This provision is

substantially similar to Article 22 (Limitation on Benefits) of the U.S. Model.

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 substanceover-form principles, to a nominee in one State deriving income from the other on behalf of a

third-country resident. In addition, although the text of the OECD Model does not contain

express anti-abuse provisions, the 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. 
- 94 -

Of course, the fundamental problem presented by this approach is that it is based on the

taxpayer's motives in establishing an entity in a particular country, which a tax administrator is

normally ill-equipped to identify. In order to avoid the necessity of making this subjective

determination, Article 2 of the Protocol 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 connection is sufficient to

justify the conclusion that obtaining the benefits of the treaty is not a principal purpose of

establishing or maintaining residence in that other State.

For instance, the assumption underlying the active trade or business test under paragraph 3

is that a third country resident that establishes a "substantial" operation in Italy 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 Italy, 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 Italy. It is considered unlikely that the investor would incur the

expense of establishing a substantial trade or business in Italy simply to obtain the benefits of the

Convention. A similar rationale underlies other tests in Article 2 of the Protocol. 

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 2 of the Protocol 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 2 of the Protocol, 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 2 of the Protocol and the anti-abuse provisions of domestic law complement each

other, as Article 2 of the Protocol effectively determines whether an entity has a sufficient nexus

to the Contracting State to be treated as a resident for treaty purposes, while domestic anti-abuse

provisions (e.g., business purpose, substance-over-form, step transaction or conduit principles)

determine whether a particular transaction should be recast in accordance with its substance.

Thus, internal law principles of the source State may be applied to identify the beneficial owner of

an item of income, and Article 2 of the Protocol 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. 

Even if a resident of a Contracting State is entitled to the benefits of the Convention

pursuant to Article 2 of the Protocol, other provisions of the Convention may preclude that

person from obtaining benefits with respect to specific transactions. In particular, paragraph 10 of

Article 10 (Dividends), paragraph 9 of Article 11 (Interest), paragraph 8 of Article 12 (Royalties),

or paragraph 3 of Article 22 (Other Income) may deny the benefits of the respective articles in the
- 95 -

event of abusive transactions where the main purpose, or one of the main purposes, of the

transaction was to take advantage of the relevant article. 

Structure of the Article

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 source-based 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 Officials). Article 2 of

the Protocol accordingly does not limit the availability of the benefits of these provisions. 

Paragraph 2

Paragraph 2 has six subparagraphs, each of which describes a category of residents that

are entitled to all benefits of the Convention. 

Individuals -- Subparagraph 2(a)

Subparagraph (a) provides that individual residents of a Contracting State will be entitled

to all treaty benefits. If such an individual receives income as a nominee on behalf of a third

country resident, benefits may be denied under the respective articles of the Convention by the

requirement that the beneficial owner of the income be a resident of a Contracting State. 
- 96 -

Qualified Governmental Entities -- Subparagraph 2(b)

Subparagraph (b) provides that qualified governmental entities, as defined in subparagraph

3(i) of Article 3 (Definitions) of the Convention, 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 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: 
- 97 -

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. Authorized but unissued shares are not considered for

purposes of this test.

As described more fully below, 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 Italy. 

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 five or fewer companies that are described in

subparagraph 2(c)(i). 

This test differs from that under subparagraph 2(c)(i) in that 50 percent of each class of

the company's shares, not merely the class or classes accounting for more than 50 percent of the

company's votes and value, must be held by publicly-traded companies described in subparagraph

2(c)(i). Thus, the test under subparagraph 2(c)(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

5(a)(i) of Article 1 of the Protocol 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. Like the U.S. Model, this provision does not limit the uses to which the charity may

put its funds. Thus, for example, an Italian charity would qualify even if all of its funds were used

to provide humanitarian relief to refugees in a third country.
- 98 -

Pension Funds -- Subparagraph 2(e)

Subparagraph 2(e) provides that organizations described in subparagraph 5(a)(ii) of

Article 1 of the Protocol 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). 

The ownership prong of the test, under clause (i), requires that 50 percent or more of each

class of beneficial interests in the person (in the case of a corporation, 50 percent or more of each

class of its shares) be owned on at least half the days of the person's taxable year by persons who

are themselves entitled to benefits under the other tests of paragraph 2 (i.e., subparagraphs (a),

(b), (c), (d), or (e)). The ownership may be indirect through other persons themselves entitled to

benefits under paragraph 2.

Trusts may be entitled to benefits under this provision if they are treated as residents under

Article 4 (Resident) of the Convention 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
- 99 -

the income derived from the source State is in fact subject to the tax regime of either 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).

The term "gross income" is not defined in the Convention. Thus, in accordance with

paragraph 2 of Article 3 (General Definitions) of the Convention, 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, if there is common

ownership of the activities in both States, 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)

The term "trade or business" is not defined in the Convention. Pursuant to paragraph 2 of

Article 3 (General Definitions) of the Convention, when determining whether a resident of the

other State is entitled to the benefits of the Convention under paragraph 3 with respect to income
- 100 -

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 will be considered to be a trade or business

only when part of banking, insurance or securities activities conducted by a bank, insurance

company, or registered securities dealer. 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 bank, insurance company or registered securities dealer

but not as part of the company's banking, insurance or dealer business.

Because a headquarters operation is in the business of managing investments, a company

that functions solely as a headquarters company will not be considered to be engaged in an active

trade or business for purposes of paragraph 3. 

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 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
- 101 -

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 Italy. FCo distributes USCo products in Italy. 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 Italy. FSub

operates a chain of hotels in Italy that are located near airports served by Americair flights. 

Americair frequently sells tour packages that include air travel to Italy 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 Italy 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 Italy. 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

Italy: ForFlower, ForLawn, and ForFish. ForFlower distributes USFlower flowers under the

USFlower trademark in Italy. ForLawn markets a line of lawn care products in Italy 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 Italy. For purposes of paragraph 3, the business of ForFlower
- 102 -

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 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 2002, the preceding year is 2001. If one of the ratios

for 2001 is not greater than 7.5 percent, the average ratio for 1999, 2000, and 2001 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).
- 103 -

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 Italy 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 Italy would be taken into account. 

Consequently, if neither the recipient nor a person related to the recipient has an

ownership interest in the person from whom the income is derived, the substantiality test always

will be satisfied (the denominator in the computation of each ratio will be zero and the numerator

will be a positive number). Of course, the other two prongs of the test under paragraph 3 would

have to be satisfied in order for the recipient of the item of income to receive treaty benefits with

respect to that income. For example, assume that a resident of a Contracting State is in the

business of banking in that State. The bank loans money to unrelated residents of the United

States. The bank would satisfy the substantiality requirement of this subparagraph with respect to

interest paid on the loans because it has no ownership interest in the payers. 

Paragraph 4

Paragraph 4 provides that a resident of one of the States that is not otherwise entitled to

the benefits of the Convention may be granted benefits under the Convention if the competent

authority of the State from which benefits are claimed so determines. This discretionary provision

is included in recognition of the fact that, with the increasing scope and diversity of international

economic relations, there may be cases where significant participation by third country residents in

an enterprise of a Contracting State is warranted by sound business practice or long-standing

business structures and does not necessarily indicate a motive of attempting to derive unintended

Convention benefits.

The competent authority of a State will base a determination under this paragraph on

whether the establishment, acquisition, or maintenance of the person seeking benefits under the

Convention, or the conduct of such person's operations, has or had as one of its principal

purposes the obtaining of benefits under the Convention. Thus, persons that establish operations

in one of the States with the principal purpose of obtaining the benefits of the Convention

ordinarily will not be granted relief under paragraph 4. 

The competent authority may determine to grant all benefits of the Convention, or it may

determine to grant only certain benefits. For instance, it may determine to grant benefits only with

respect to a particular item of income in a manner similar to paragraph 3. Further, the competent

authority may set time limits on the duration of any relief granted.
- 104 -

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 2 of the Protocol.

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) any stock exchange constituted and

organized according to Italian laws. In addition, subparagraph 5(c) allows the competent

authorities to agree as to other stock exchanges that constitute “recognized stock exchanges.” 

Article 3

This provision is discussed above in connection with Article 1 (Personal Scope) of the

Convention.

Article 4

This provision is discussed above in connection with Article 14 (Independent Personal

Services) of the Convention.

Article 5

Article 5 of the Protocol is the same as the corresponding provision in the protocol to the

prior Convention. It confirms Italy’s practice of granting reduced rates of tax in a treaty by

initially withholding tax at the statutory rate and providing refunds of the excess over the treaty

rate on the basis of an official certification that the claimant is a resident of the treaty country

entitled to such benefits. The claim for refund must be made within the time limit fixed by the law

of the State that is obliged to make the refund. This article simply confirms Italy’s existing

practice. It does not prevent either Contracting State from changing its method of implementing

Convention benefits.
- 105 -

Article 6

This provision is discussed above in connection with Article 26 (Exchange of Information)

of the Convention.

Article 7

Paragraph 1 of Article 7 of the Protocol is intended to deal with changes in law of either

of the Contracting States that have the effect of changing the application of the Convention in a

significant manner or that alter the relationship between the Contracting States. Paragraph 1

provides, first, that, in response to a change in the law of either State, the appropriate authority of

either State may request consultations with its counterpart in the other State to determine whether

a change in the Convention is appropriate. The "appropriate authorities" may be the Contracting

States themselves, communicating through diplomatic channels, or they may be the competent

authorities under the Convention, communicating directly. The request for consultations may

come either from the authority of the Contracting State making the change in law, or it may come

from the authority of the other State. If the authorities determine, on the basis of the

consultations, that a change in domestic legislation has significantly altered the balance of benefits

provided by the Convention, they will consult with a view to amending the Convention to restore

an appropriate balance. Any such amendment would, of course, require a protocol or new treaty

which, in the case of the United States, would be subject to Senate advice and consent to

ratification.

Paragraph 2 of Article 7 of the Protocol, which relates to consultations between the

competent authorities within three years of entry into force of the Convention, is discussed above

in connection with Article 25 (Mutual Agreement Procedure) of the Convention.

Article 8

This provision is discussed above in connection with Article 8 (Shipping and Air

Transport) of the Convention.