Technical Explanation - U.S-U.K. Income Tax Convention of 24 July 2001

DEPARTMENT OF THE TREASURY

TECHNICAL EXPLANATION OF THE CONVENTION BETWEEN

THE GOVERNMENT OF THE UNITED STATES OF AMERICA AND

THE GOVERNMENT OF THE UNITED KINGDOM OF

GREAT BRITAIN AND NORTHERN IRELAND

FOR THE AVOIDANCE OF DOUBLE TAXATION AND THE PREVENTION OF FISCAL

EVASION WITH RESPECT TO TAXES ON INCOME AND ON CAPITAL GAINS

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

United Kingdom of Great Britain and Northern Ireland, signed on July 24, 2001 (the

“Convention”), as amended by the Protocol between the United States and the United Kingdom

of Great Britain and Northern Ireland, signed on July 22, 2002 (the "Protocol"). References are

made to the Convention between the Government of the United States of America and the

Government of the United Kingdom of Great Britain and Northern Ireland for the Avoidance of

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

Capital Gains, signed on December 31, 1975, as amended by Protocols signed on August 26,

1976, March 31, 1977, and March 15, 1979 (the “prior Convention”). The Convention replaces

the prior Convention.

In connection with the negotiation of the Convention, the delegations of the United States

and the United Kingdom developed and agreed upon an exchange of diplomatic notes (the

"notes"). The notes constitute an agreement between the two governments that shall enter into

force at the same time as the entry into force of the Convention. These understandings and

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

the Contracting States in interpreting the Convention. The notes are discussed below in

connection with relevant provisions of the Convention.

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

and the Treasury Department’s Model Income Tax Convention, published on September 20,

1996 (the “U.S. Model”). Negotiations also took into account the Model Tax Convention on

Income and on Capital, published by the Organization for Economic Cooperation and

Development, as updated in April 2000 (the “OECD Model”), and recent tax treaties concluded

by both countries.

The notes provide that the United States and the United Kingdom will consult together at

regular intervals regarding the terms, operation and application of the Convention to ensure that

it continues to serve the purposes of avoiding double taxation and preventing fiscal evasion. The

first such consultation will take place no later than December 31st of the fifth year following the

date on which the Convention enters into force in accordance with the provisions of Article 29

(Entry into Force). Further consultations shall take place thereafter at intervals of no more than

five years. The notes also provide that the United States and the United Kingdom will conclude

further protocols to amend the Convention, if appropriate.

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

behind particular Convention provisions, as well as understandings reached with respect to the

application and interpretation of the Convention. References in the Technical Explanation to

“he” or “his” should be read to mean “he or she” or “his or her.”

Article 1 (General Scope)

Paragraph 1

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

States or the United Kingdom, except where the terms of the Convention provide otherwise.

Under Article 4 (Residence), a person is generally treated as a resident of a Contracting State if

that person is, under the laws of that State, liable to tax therein by reason of his domicile,

residence or other similar criteria. However, if a person is considered a resident of both

Contracting States, Article 4 provides rules for determining a single State of residence (or no

State of residence). This determination governs for all purposes of the Convention.

Certain provisions are applicable to persons who may not be residents of either

Contracting State. For example, Article 19 (Government Service) may apply to an employee of a

Contracting State who is resident in neither State. Under Article 27 (Exchange of Information

and Administrative Assistance), information may be exchanged with respect to residents of third

states.

Paragraph 2

Paragraph 2 states the generally accepted relationship both between the Convention and

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

(i.e., that no provision in the Convention may restrict any benefit accorded by the tax laws of the

Contracting States, or by any other agreement between the Contracting States). The relationship

between the non-discrimination provisions of the Convention and other agreements is addressed

not in paragraph 2 but in paragraph 3.

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

Revenue Code (the “Code”) in computing the U.S. taxable income of a resident of the United

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

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

resident of a Contracting State beyond the burden determined under domestic law. Thus, a right

to tax given by the Convention cannot be exercised unless that right also exists under internal

law.

It follows that, under the principle of paragraph 2, a taxpayer’s U.S. tax liability need not

be determined under the Convention if the Code would produce a more favorable result. A

taxpayer may not, however, choose among the provisions of the Code and the Convention in an

inconsistent manner in order to minimize tax. For example, assume that a resident of the United

Kingdom has three separate businesses in the United States. One is a profitable permanent

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

the Code but that do not meet the permanent establishment threshold tests of the Convention.

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

establishment is taxable in the United States, and both the profit and loss of the other two

businesses are ignored. Under the Code, all three would be subject to tax, but the loss would

offset the profits of the two profitable ventures. The taxpayer may not invoke the Convention to

exclude the profit of the profitable trade or business and invoke the Code to claim the loss of the

losing trade or business against the profit of the permanent establishment. See Rev. Rul. 84-17,

1984-1 C.B. 308. If, however, the taxpayer invokes the Code for the taxation of all three

ventures, the taxpayer would not be precluded from invoking the Convention, for example, with

respect to any dividend income the taxpayer may receive from the United States that is not

effectively connected with any of the taxpayer’s business activities in the United States.

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

other agreement between the United States and the United Kingdom. For example, if certain

benefits are provided for military personnel or military contractors under a Status of Forces

Agreement between the United States and the United Kingdom, those benefits will be available

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

the Convention.

Paragraph 3

Paragraph 3 specifically relates to non-discrimination obligations of the Contracting

States under other agreements. The provisions of paragraph 3 are an exception to the rule

provided in subparagraph (b) of paragraph 2 of this article under which the Convention shall not

restrict in any manner any benefit now or hereafter accorded by any other agreement between the

Contracting States.

Clause (i) of subparagraph (a) of paragraph 3 provides that, notwithstanding any other

agreement to which the Contracting States may be parties, a dispute concerning the interpretation

or application of the Convention, including a dispute concerning whether a taxation measure is

within the scope of the Convention, shall be considered only by the competent authorities of the

Contracting States, and the procedures under Article 26 (Mutual Agreement Procedure) of the

Convention exclusively shall apply to the dispute. Thus, dispute-resolution procedures that may

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

not apply in determining the scope of the Convention.

Clause (ii) of subparagraph (a) of paragraph 3 provides that the dispute resolution

procedures set forth in Article II and Article XVII of the General Agreement on Trade in

Services shall not apply to any taxation measure unless the competent authorities agree that such

measure is not within the scope of the non-discrimination provisions of Article 25 (Non-

Discrimination) of the Convention. Accordingly, no national treatment or most-favored-nation

("MFN") obligations undertaken by the Contracting States pursuant to the GATS shall apply to a

taxation measure, unless the competent authorities otherwise agree.

The Convention does not include an additional limitation on the application of other

agreements that is included in the U.S. Model. The U.S. Model provision states that national-

treatment or MFN obligations undertaken by the Contracting States under agreements other than

the Convention (with the exception of the General Agreement on Tariffs and Trade, as applicable

to trade in goods) may not apply to a taxation measure, unless the competent authorities

otherwise agree. Instead of limiting the effect of other agreements, the Contracting States

analyzed existing agreements that might provide such rights. As reflected in the notes, the

Contracting States believe that the only agreements in force as between the two Contracting

States that may impose such national treatment or MFN obligations are: the General Agreement

on Trade in Services; the General Agreement on Tariffs and Trade; the Convention to Regulate

the Commerce between the Territories of the United States and of his Britannick Majesty, signed

in London on July 3, 1815; and the Treaty of Amity, Commerce, and Navigation, between his

Britannic Majesty and the United States of America, signed at London, November 19, 1794. The

interaction between the Convention and the General Agreement on Trade in Services is

discussed above. The specific language of the other three agreements makes it unlikely that they

would ever apply with respect to an income tax provision. However, if there were overlap

between Article 25 (Non-Discrimination) and any of these agreements, benefits would be

available under both agreements. In the event of such overlap, to the extent benefits are available

under one of the above three agreements, and such benefits are not available under Article 25 of

the Convention, a resident of a Contracting State is entitled to the benefits provided under the

overlapping agreement. Conversely, if benefits available under the Convention are not available

under the overlapping agreement, a resident of a Contracting State is entitled to the benefits

provided by Article 25.

The notes clarify that if it is determined that some other agreement in force at the time of

the signing of the Convention includes such obligations with respect to taxation measures, the

Contracting States will consult with a view to ensuring the proper interaction of the Convention

and such other agreement. Such consultation may result in an amendment to the Convention if

necessary. Unless and until such an amendment is made, any other such agreement would apply

concurrently with the Convention.

Subparagraph (b) of paragraph 3 defines a “measure” broadly. It would include, for

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

governmental action or guidance.

Paragraph 4

Paragraph 4 contains the traditional saving clause found in U.S. tax treaties. The

Contracting States reserve their rights, except as provided in paragraph 5, to tax their residents

and citizens as provided in their internal laws, notwithstanding any provisions of the Convention

to the contrary. For example, if a resident of the United Kingdom performs professional services

in the United States and the income from the services is not attributable to a permanent

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

United States from taxing the income. If, however, the resident of the United Kingdom is also a

citizen of the United States, the saving clause permits the United States to include the

remuneration in the worldwide income of the citizen and subject it to tax under the normal Code

rules (i.e., without regard to Code section 894(a)). However, subparagraph 5(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 the United Kingdom. See paragraph 6 of Article 24 (Relief

from Double Taxation).

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

Thus, an individual who is a U.S. resident under the Internal Revenue Code but who is deemed

to be a resident of the United Kingdom under the tie-breaker rules of Article 4 would be subject

to U.S. tax only to the extent permitted by the Convention. For example, if an individual who is

not a U.S. citizen is a resident of the United States under the Code, and is also a resident of the

United Kingdom under its law, and that individual has a permanent home available to him in the

United Kingdom and not in the United States, he would be treated as a resident of the United

Kingdom under Article 4 and for purposes of the saving clause. The United States would not be

permitted to apply its statutory rules to that person if they are inconsistent with the treaty.

However, the person would be treated as a U.S. resident for U.S. tax purposes other than

determining the individual's U.S. tax liability. For example, in determining under Code section

957 whether a foreign corporation is a controlled foreign corporation, shares in that corporation

held by the individual would be considered to be held by a U.S. resident. As a result, other U.S.

citizens or residents might be deemed to be United States shareholders of a controlled foreign

corporation subject to current inclusion of Subpart F income recognized by the corporation. See

Treas. Reg. section 301.7701(b)-7(a)(3). The application of the saving clause to former citizens

and long-term residents is addressed not in paragraph 4 but in paragraph 6.

Paragraph 5

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

benefits do not exist under internal law. Paragraph 5 sets forth certain exceptions to the saving

clause that preserve these benefits for citizens and residents of the Contracting States.

Subparagraph (a) lists certain provisions of the Convention that are applicable to all

citizens and residents of a Contracting State, despite the general saving clause rule of

paragraph 4:

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

adjustment with respect to income tax due on profits reallocated under Article 9.

(2) Subparagraph 1(b) and paragraphs 3 and 5 of Article 17 (Pensions, Social Security,

Annuities, Alimony, and Child Support) provide exemptions from source or residence

State taxation for certain pension distributions, social security payments and child

support.

(3) Paragraph 1 of Article 18 (Pension Scheme) provides an exemption for certain

investment income of pension schemes located in the other State, while paragraph 5

provides benefits for certain contributions by or on behalf of a U.S. citizen to certain

pension schemes established in the United Kingdom.

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

and residents of one Contracting State for income taxes paid to the other, even if such a

credit may not be available under the Code.

(5) Article 25 (Non-Discrimination) requires one Contracting State to grant national

treatment to nationals of the other Contracting State in certain circumstances. Excepting

this Article from the saving clause requires, for example, that the United States give such

benefits to a national of the United Kingdom even if that person is a citizen of the United

States.

(6) Article 26 (Mutual Agreement Procedure) may confer benefits on residents or

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

for refunds and the competent authorities are permitted to use a definition of a term that

differs from the internal law definition. As with the foreign tax credit, these benefits are

intended to be granted by a Contracting State to its citizens and residents.

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

clause. The benefits referred to are all intended to be granted to temporary residents of a

Contracting State (for example, in the case of the United States, holders of non-immigrant visas),

but not to citizens or to persons who have acquired permanent residence in that State. If

beneficiaries of these provisions travel from one of the Contracting States to the other, and

remain in the other long enough to become residents under its internal law, but do not acquire

permanent residence status (i.e., in the U.S. context, they do not become "green card" holders)

and are not citizens of that State, the host State will continue to grant these benefits even if they

conflict with statutory rules. The benefits preserved by this paragraph are: the host country

exemptions for the following items: government service salaries and pensions under Article 19

(Government Service); certain income of visiting students, trainees, teachers, professors, and

researchers under Articles 20 (Students) and 20A (Teachers); the income of diplomatic agents

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

beneficial tax treatment of pension fund contributions under paragraph 2 of Article 18 (Pension

Schemes).

Paragraph 6

Under paragraph 6, each Contracting State reserves for a period of ten years its right to

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

had as one of its principal purposes the avoidance of tax. Thus, the saving clause in paragraph 4

applies to such persons for a period of ten years. Paragraph 6 further provides that the saving

clause of paragraph 4 will not apply in the case of a former citizen or long-term resident of a

Contracting State who gave up that status before February 6, 1995. This date is consistent with

the February 5, 1995 effective date of the amendments to section 877 made by the Health

Insurance Accountability and Portability Act of 1996, § 511, Pub. L. No. 104-191, 110 Stat.

1936, 2093 (1996).

In the case of the United States, section 877 of the Code applies to former citizens and

long-term residents of the United States whose loss of citizenship or long-term resident status

had as one of its principal purposes the avoidance of tax. Under section 877, the United States

generally treats an individual as having a principal purpose to avoid tax if either of the following

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

for the period of 5 taxable years ending before the date of the loss of status, or (b) the net worth

of such individual as of the date of the loss of status. The thresholds are adjusted annually for

inflation. Section 877(c) provides certain exceptions to these presumptions of tax avoidance.

The notes provide a similar set of factors that will be considered in favor of the taxpayer for

purposes of determining whether one of the principal purposes of a change in status of a former

citizen or long-term resident is the avoidance of tax.

In the notes, the Contracting States agree that the term “long-term resident” of a

Contracting State means an individual (other than a citizen of that State) who is a lawful

permanent resident of that State in at least 8 of the 15 taxable years ending with the taxable year

in which the individual ceased to be a long-term resident. This test is consistent with U.S. law.

Under U.S. law, moreover, an individual is not treated as a lawful permanent resident for any

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

a tax treaty between the United States and the foreign country and the individual does not waive

the benefits of such treaty applicable to residents of the foreign country.

Paragraph 7

Paragraph 7 is included in the Convention because the United Kingdom continues to

maintain a remittance system of taxation for individuals who are resident but not domiciled in

the United Kingdom. Such persons are subject to tax in the United Kingdom on non-U.K. source

income only to the extent the income or gains are remitted to the United Kingdom. Under

paragraph 7, such persons are entitled to the benefits of the Convention in order to reduce or

eliminate tax only to the extent that the relevant income is remitted to or received in the United

Kingdom. For example, if a U.K. resident who is not domiciled in the United Kingdom

maintains a brokerage account in Ireland into which is paid $100 in U.S.-source dividend

income, the United States may impose withholding tax at the statutory rate of 30 percent because

the dividend income will not be taxed in the United Kingdom as it has not been remitted to the

United Kingdom. If the dividend income instead is paid into a brokerage account in London, the

U.K. resident will be subject to tax in the United Kingdom and the United States will reduce the

rate of withholding tax to 15 percent.

Paragraph 8

Paragraph 8 addresses special issues presented by fiscally transparent entities such as

partnerships and certain estates and trusts. In general, paragraph 8 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 paragraph applies to any resident

of a Contracting State who is entitled to income derived through an entity that is treated as

fiscally transparent under the laws of either Contracting State. Entities falling under this

description in the United States include partnerships, common investment trusts under

section 584 and grantor trusts. This paragraph also applies to U.S. limited liability companies

(“LLCs”) that are treated as partnerships for U.S. tax purposes.

Under paragraph 8, an item of income, profit or gain derived by such a fiscally

transparent entity will be considered to be derived by a resident of a Contracting State if a

resident is treated under the taxation laws of that State as deriving the item of income. For

example, if a U.K. company pays interest to an entity that is treated as fiscally transparent for

U.S. tax purposes, the interest will be considered derived by a resident of the U.S. only to the

extent that the taxation laws of the United States treats one or more U.S. residents (whose status

as U.S. residents is determined, for this purpose, under U.S. tax law) as deriving the interest for

U.S. tax purposes. In the case of a partnership, the persons who are, under U.S. tax laws, treated

as partners of the entity would normally be the persons whom the U.S. tax laws would treat as

deriving the interest income through the partnership. Also, it follows that persons whom the

United States treats as partners but who are not U.S. residents for U.S. tax purposes may not

claim a benefit for the interest paid to the entity under the Convention, because they are not

residents of the United States for purposes of claiming this treaty benefit. (If, however, the

country in which they are treated as resident for tax purposes, as determined under the laws of

that country, has an income tax convention with the United Kingdom, they may be entitled to

claim a benefit under that convention.) In contrast, if, for example, an entity is organized under

U.S. laws and is classified as a corporation for U.S. tax purposes, interest paid by a U.K.

company 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.

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

the United Kingdom (e.g., as not fiscally transparent in the first example above where the entity

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

third country is also irrelevant, even if the entity is organized in that third country. The results

follow regardless of whether the entity is disregarded as a separate entity under the laws of one

jurisdiction but not the other, such as a single owner entity that is viewed as a branch for U.S. tax

purposes and as a corporation for U.K. tax purposes. These results also obtain regardless of

where the entity is organized (i.e., in the United States, in the United Kingdom, or, as noted

above, in a third country).

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

the United States, which is treated for U.K. tax purposes as a corporation and is owned by a U.K.

shareholder who is a U.K. resident for U.K. tax purposes, is not considered derived by the

shareholder of that corporation even if, under the tax laws of the United States, the entity is

treated as fiscally transparent. Rather, for purposes of the treaty, the income is treated as derived

by the U.S. entity.

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

either Contracting State. For example, if X, a resident of the United Kingdom, creates a

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

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

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

derived by a resident of the United Kingdom only to the extent that the laws of the United

Kingdom treat X as deriving the income for U.K. tax purposes by application of the U.K. "settlor

trust" rules.

Paragraph 8 is not an exception to the saving clause of paragraph 4. Accordingly, the

notes confirm that paragraph 8 does not prevent a Contracting State from taxing an entity that is

treated as a resident of that State under its tax law. For example, if a U.S. LLC with U.K.

members elects to be taxed as a corporation for U.S. tax purposes, the United States will tax that

LLC on its worldwide income on a net basis, without regard to whether the United Kingdom

views the LLC as fiscally transparent. The portion of the notes relating to Article 24 (Relief

from Double Taxation) provides rules for determining which Contracting State has the primary

right to tax and which State must provide a credit in such circumstances.

Article 2 (Taxes Covered)

This article specifies the U.S. and U.K. taxes to which the Convention applies.

Paragraph 1

This article identifies the taxes to which the Convention applies. Paragraph 1 is based

upon the OECD Model and defines the scope of application of the Convention. The Convention

applies to taxes on income and capital gains imposed on behalf of a Contracting State,

irrespective of the manner in which they are levied. Except with respect to Article 25 (Non-

Discrimination), state and local taxes are not covered by the Convention.

Paragraph 2

Paragraph 2 also is based upon the OECD Model and provides a definition of taxes on

income and on capital gains. The Convention covers taxes on total income or any part of income

and includes tax on gains derived from the alienation of property. The Convention does not

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

Article 25 (Non-Discrimination).

Paragraph 3

Paragraph 3 lists the taxes in force at the time of signature of the Convention to which the

Convention applies.

Subparagraph 3(a) provides that the existing U.S. 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). Although the Convention continues the

coverage of the insurance excise tax provided by the prior Convention, paragraph 5 of Article 7

restricts the availability of benefits under the Convention in the case of insurance policies entered

into as part of a conduit arrangement. Social security taxes (Code sections 1401, 3101, 3111 and

3301) are specifically excluded from coverage, even though they may be regarded as income

taxes.

In the Convention, unlike the prior Convention, the accumulated earnings tax and the

personal holding company 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.

The existing covered taxes of the United Kingdom are identified in subparagraph (b) of

paragraph 3. In the case of the United Kingdom, the Convention applies to the income tax, the

capital gains tax, the corporation tax, and the petroleum revenue tax. Paragraph 3 of Article 24

(Relief from Double Taxation), however, limits the amount of the petroleum revenue tax

allowable as a credit against United States tax.

Paragraph 4

Paragraph 4 provides that the Convention will apply to any taxes that are substantially

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

the existing taxes after July 24, 2001, the date of signature of the Convention. Paragraph 4 also

provides that the U.S. and U.K. competent authorities will notify each other of any changes that

have been made in their laws, both tax laws and non-tax laws, that affect significantly their

obligations under the Convention. Other laws that may affect a Contracting State's obligations

under the Convention may include, for example, laws affecting bank secrecy.

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 (Residence). The term "permanent establishment" is defined in

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

defined in Articles 10, 11 and 12, respectively.

The introduction to paragraph 1 makes clear that the definitions in Article 3 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 (a) defines the term "person" to include an individual, an estate, 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 26 (Mutual Agreement Procedure).

The term "company" is defined in subparagraph (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 same as under the U.S.

Model because the Commentaries to the OECD Model interpret language identical to that of the

Convention in a manner consistent with the U.S. Model.

Subparagraph (c) defines the term “enterprise” as any activity or set of activities that

constitutes a trade or business. Subparagraph (d) provides that the term “business” includes the

performance of professional services and other activities of an independent character. Both

definitions are identical to definitions recently added to the OECD Model in connection with the

deletion of Article 14 (Independent Personal Services) from the OECD Model. The inclusion of

the two definitions is intended to clarify that the performance of professional services or other

activities of an independent character are considered to constitute an enterprise. Accordingly,

income from such activities is dealt with under Article 7 (Business Profits) and not Article 22

(Other Income). The definitions are not included in the U.S. Model because the U.S. Model

continues to include a separate article regarding the treatment of independent personal services.

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

State" are defined in subparagraph (e) as an enterprise carried on by a resident of a Contracting

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

Contracting State need not be carried on in that State. It may be carried on in the other

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

Kingdom would still be a U.S. enterprise).

Subparagraph (f) defines the term "international traffic." The term means any transport by

a ship or aircraft except when the ship or aircraft is operated solely between places within the

other Contracting State. This definition is applicable principally in the context of Article 8

(Shipping and Air Transport). The definition combines with paragraphs 2 and 3 of Article 8 to

exempt from tax by the source State income from the rental of ships or aircraft by lessors that are

operators of ships and aircraft and from the rental of containers by container leasing companies.

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

solely between places within a Contracting State means, for example, that carriage of goods or

passengers solely between New York and Chicago would not be treated as international traffic,

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

relating to the taxation of income from transport, principally Article 8, therefore, would not

apply to income from such carriage. Thus, if the carrier engaged in internal U.S. traffic were a

resident of the United Kingdom (assuming that were possible under U.S. law), the United States

would not be required to exempt the income from that transport under Article 8. The income

would, however, be treated as business profits under Article 7 (Business Profits), and therefore

would be taxable in the United States only if attributable to a U.S. permanent establishment of

the foreign carrier, and then only on a net basis. The gross basis U.S. tax imposed by section 887

would never apply under the circumstances described.

If, however, goods or passengers are carried by a carrier resident in the United Kingdom

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. The notes confirm that this

would be true even if the international carrier transferred the goods at the U.S. port of entry from

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

United States was handled by an independent carrier under contract with the original

international carrier, so long as both parts of the trip were reflected in original bills of lading.

Thus, the result is the same as under the U.S. Model, even though the definition of "international

traffic" follows the OECD Model by focusing on the ship or aircraft rather than on the transport

itself.

Finally, a "cruise to nowhere" (i.e., a cruise beginning and ending in a port in the same

Contracting State with no stops in a foreign port) would not constitute international traffic.

Subparagraph (g) defines the term "competent authority" for the United States and the

United Kingdom 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 Director,

International (LMSB). With respect to interpretative issues, the Director acts with the

concurrence of the Associate Chief Counsel (International) of the Internal Revenue Service. The

U.K. competent authority is the Commissioners of Inland Revenue or their authorized

representative.

The term "United States" is defined in subparagraph (h) 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. The geographical meaning of the term United States also includes the

territorial sea of the United States, and for certain purposes, the definition is extended to include

the sea bed and subsoil of undersea areas adjacent to the territorial sea of the United States. This

extension applies to the extent that the United States exercises sovereignty in accordance with

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

This extension of the definition applies, however, only if the person, property or activity to

which the Convention is being applied is connected with such natural resource exploration or

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

the United States exercised sovereignty for natural resource purposes if that activity was

unrelated to the exploration and exploitation of natural resources.

The term "United Kingdom" is defined in subparagraph (i) to mean Great Britain and

Northern Ireland, including the area of the continental shelf which has or may be designated by

the United Kingdom, in accordance with international law, as an area within which the rights of

the United Kingdom relating to the seabed and the subsoil and their natural resources may be

exercised. The Convention does not apply to the Channel Islands or the Isle of Man.

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

defined in clauses (i) and (ii) of subparagraph (j). This term is relevant for purposes of Articles

19 (Government Service) and 25 (Non-discrimination). With respect to the United States, a

national is (1) an individual who is a citizen of the United States, and (2) any legal person,

partnership or association deriving its status as such from the law in force in the United States.

With respect to the United Kingdom, a national is (1) any British citizen, (2) any British subject

not possessing the citizenship of any other Commonwealth country or territory, provided he has

the right of abode in the United Kingdom; and (3) any legal person, partnership, association or

other entity deriving its status as such from the law in force in the United Kingdom.

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

for purposes of Articles 4 (Residence) and 23 (Limitation on Benefits). The term means: (1) a

Contracting State or a political subdivision or local authority of the Contracting State; and (2) a

person wholly owned by a Contracting State, political subdivision or local authority of the

Contracting State, provided and such person satisfies certain organizational and funding

standards and does not carry on a business. Unlike the U.S. Model, the definition of "qualified

governmental entity" in subparagraph (k) does not include government pension funds, since a

number of the benefits that are relevant only to government pension funds in the U.S. Model are

available to all qualified pension funds in the Convention.

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

United Kingdom, as the context requires.

Subparagraph (m) defines the term “real property,” which replaces the term “immovable

property” in the Prior Convention. This term is relevant for purposes of Article 6 (Income from

Real Property), Article 10 (Dividends), and Article 13 (Gains). Consistent with Treas. Reg.

§ 1.897-1(b), the term “real property” generally includes land and the unsevered products of the

land, improvements, and personal property associated with the use of real property. The term

does not include an interest in land solely as a creditor (e.g., a mortgage interest). “Real

property” specifically includes livestock and equipment used in agriculture and forestry, rights to

which the provisions of general law respecting landed property apply, usufruct of real property

and rights to variable or fixed payments as consideration for the working of, or the right to work,

mineral deposits and other natural resources. Ships, boats and aircraft, however, are not regarded

as real property.

The term “conduit arrangement” is defined in subparagraph (n). The term is used in

paragraph 5 of Article 7 (Business Profits), paragraph 9 of Article 10 (Dividends), paragraph 7 of

Article 11 (Interest), paragraph 5 of Article 12 (Royalties), and paragraph 4 of Article 22 (Other

Income). Those rules generally apply if a resident of a Contracting State receives an item of

income which qualifies for benefits under the Convention, and then that resident pays all, or

substantially all, of that income to a resident of a third state who would not be entitled to

equivalent (or more favorable) benefits with respect to that item of income. The rules will apply,

however, only if one of the main purposes of the transaction is to increase the benefits under the

Convention beyond what the ultimate recipient would have received if he had received the

payment directly.

The term is not used in the OECD or U.S. Model, but is included here at the request of

the United Kingdom in order to ensure that each of the Contracting States can prevent residents

of third countries from improperly obtaining the benefits of the Convention. For the United

Kingdom, these transaction-based anti-abuse rules are a necessary supplement to the entity-based

anti-treaty shopping rules in Article 23 (Limitation on Benefits). On the other hand, U.S.

domestic law provides specific anti-conduit rules (Code section 7701(l) and regulation section

1.881-3, which apply to multiple-party financing transactions), as well as a number of other

domestic anti-abuse principles (such as the business purpose doctrine) that apply in the treaty

context.

The United States intends to interpret the conduit arrangement provisions of the

Convention in accordance with U.S. domestic law, as it may evolve over time. This intention to

interpret the provisions in accordance with U.S. domestic law, as well as the United Kingdom’s

agreement thereto, was confirmed by the exchange of letters attached hereto as “Appendix A.”

Therefore, the inclusion of these rules in the Convention does not constitute an expansion (or

contraction) of U.S. domestic anti-abuse principles (except with respect to the application of

anti-conduit principles to the insurance excise tax, as discussed below under paragraph 5 of

Article 7). The United States intends that the inclusion of these rules only with respect to the

listed articles shall create no negative inference regarding the application of U.S. domestic anti-

abuse rules (e.g., the anti-conduit rules and other anti-abuse rules referred to above) to those

articles, other articles of the Convention, or other U.S. tax treaties. The exchange of letters

referred to above provides examples of how the United States and the United Kingdom intend to

apply the anti-conduit provisions of the Convention.

Subparagraph (o) defines the term “pension scheme” to include any plan, scheme, fund,

trust or other arrangement established in a Contracting State which is generally exempt from

income taxation in that State and which is operated principally to provide pension or retirement

benefits or to earn income for the benefit of one or more such arrangements. The notes provide

an agreed list of existing plans qualifying as "pension schemes" in each Contracting States. In

the case of the United States, the term "pension scheme" includes the following: 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. 401(k) plans qualify as

pension schemes because a 401(k) plan is a type of 401(a) plan. In the case of the United

Kingdom, the term “pension scheme” includes the following: employment-related arrangements

(other than a social security scheme) approved as retirement benefit schemes for the purposes of

Chapter I of Part XIV of the Income and Corporation Taxes Act 1988, and personal pension

schemes approved under Chapter IV of Part XIV of that Act. The reference to entities that are

operated principally to earn income for the benefit of one or more such arrangements is intended

to ensure that income earned by group trusts, which invest the assets of pension schemes but do

not administer pension benefits, will nevertheless qualify for benefits. The term “pension

scheme” also includes any scheme identical or substantially similar to the foregoing schemes that

are established pursuant to legislation introduced after the date of signature of the Convention.

Paragraph 2

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

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

State whose tax is being applied, unless the context requires otherwise. The paragraph makes

clear that if the term is defined under both the tax and non-tax laws of a Contracting State, the

definition in the tax law will take precedence over the definition in the non-tax laws. Finally,

there also may be cases where the tax laws of a State contain multiple definitions of the same

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

should be used.

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

State, or if there is a conflict in meaning under the laws of the two States that creates difficulties

in the application of the Convention, the competent authorities, as indicated in paragraph 3(f) of

Article 25 (Mutual Agreement Procedure), may establish a common meaning in order to prevent

double taxation or to further any other purpose of the Convention. This common meaning need

not conform to the meaning of the term under the laws of either Contracting State.

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

effect at the time the treaty is being applied, not the law as in effect at the time the treaty was

signed. The use of "ambulatory" definitions, however, may lead to results that are at variance

with the intentions of the negotiators and of the Contracting States when the treaty was

negotiated and ratified. The reference in both paragraphs 1 and 2 to the "context otherwise

requir[ing]" a definition different from the treaty definition, in paragraph 1, or from the internal

law definition of the Contracting State whose tax is being imposed, under paragraph 2, refers to a

circumstance where the result intended by the Contracting States is different from the result that

would obtain under either the paragraph 1 definition or the statutory definition. Thus, flexibility

in defining terms is necessary and permitted.

Article 4 (Residence)

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

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

Contracting States may claim the benefits of the Convention. The treaty definition of residence is

to be used only for purposes of the Convention. The fact that a person is determined to be a

resident of a Contracting State under Article 4 does not necessarily entitle that person to the

benefits of the Convention. In addition to being a resident, a person also must qualify for benefits

under Article 23 (Limitation on Benefits) in order to receive benefits conferred on residents of a

Contracting State.

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

as a resident under the respective taxation laws of the Contracting States. 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.

The treatment of fiscally transparent entities is addressed in paragraph 8 of Article 1 of

the Convention, not in Article 4 as in the U.S. Model. This placement was considered more

appropriate because the rules concerning fiscally transparent entities are substantive rules of

general application, not simply a definition of residence.

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 U.K. law by referring to a resident

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

domicile, residence, citizenship, place of management, place of incorporation or any other

similar criterion. Thus, residents of the United States include aliens who are considered U.S.

residents under Code section 7701(b). Paragraphs 2 and 3 address special cases that may arise in

the context of Article 4.

Certain entities that are nominally subject to tax but that in practice are rarely required to

pay tax also would generally be treated as residents and therefore accorded treaty benefits. For

example, RICs, REITs and REMICs are all residents of the United States for purposes of the

treaty. Although the income earned by these entities normally is not subject to U.S. tax in the

hands of the entity, they are taxable to the extent that they do not currently distribute their

profits, and therefore may be regarded as "liable to tax." They also must satisfy a number of

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

A person who is liable to tax in a Contracting State only in respect of income from

sources within that State or capital situated therein or of profits attributable to a permanent

establishment in that State will not be treated as a resident of that Contracting State for purposes

of the Convention. Thus, a consular official of the United Kingdom who is posted in the United

States, who may be subject to U.S. tax on U.S. source investment income, but is not taxable in

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

States for purposes of the Convention. (See Code section 7701(b)(5)(B)). Similarly, an enterprise

of the United Kingdom 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.

Paragraph 2

Paragraph 2 contains an exception to the general rule of paragraph 1 that residence under

internal law also determines residence under the Convention. The exception applies with respect

to a U.S. citizen or alien lawfully admitted for permanent residence (i.e., a "green card" holder).

Under paragraph 1, a person is considered a resident of a Contracting State for purposes of the

Convention if he is liable to tax in that Contracting State by reason of citizenship. Although this

rule applies to both Contracting States, only the United States taxes its non-resident citizens in

the same manner as its residents. In addition, aliens admitted to the United States for permanent

residence (“green card” holders) qualify as U.S. residents under the first sentence of paragraph 1

because they are taxed by the United States as residents, regardless of where they physically

reside.

Under the exception of paragraph 2, a U.S. citizen or green card holder will be treated as

a resident of the United States for purposes of the Convention, and, thereby entitled to treaty

benefits, only if he meets two conditions. First, he must have a substantial presence (see section

7701(b)(3)), permanent home or habitual abode in the United States. This rule requires that the

U.S. citizen or green card holder have a reasonably strong economic nexus with the United

States. Second, he must not be treated as a resident of a state other than the United Kingdom

under any treaty between the United Kingdom and a third state. This rule prevents a U.S. citizen

or green card holder who is a resident of a country other than the United States or the United

Kingdom from choosing the benefits of the Convention over those provided by the treaty

between the United Kingdom and his country of residence. If the U.S. citizen or green card

holder's country of residence does not have a treaty with the United Kingdom, however, then he

will be treated as a resident of the United States as long as he meets the first requirement of an

economic nexus. If such a person is a resident of both the United States and the United Kingdom,

whether or not he is to be treated as a resident of the United States for purposes of the

Convention is determined by the tie-breaker rules of paragraph 4.

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 benefits under the Convention. However, a U.S.

citizen who is transferred to Mexico for two years would be entitled to benefits under the

Convention if he maintains a permanent home or habitual abode in the United States and is not a

resident of Mexico for purposes of the U.K.-Mexico tax treaty. If he were treated as a resident of

Mexico under the U.K.-Mexico tax treaty, he could claim only the benefits of that treaty, even if

the Convention would provide greater 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 4 of Article 1 (General 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.

Paragraph 3

Paragraph 3 provides that certain tax-exempt entities such as pension funds and charitable

organizations will be regarded as residents of a Contracting State regardless of whether they are

generally liable for income tax in the State where they are established. The inclusion of this

provision is intended to clarify the generally accepted practice of treating an entity that would be

liable for tax as a resident under the internal law of a State but for a specific exemption from tax

(either complete or partial) as a resident of that state for purposes of paragraph 1.

Subparagraph (a) of paragraph 3 applies to pension schemes, as defined in

subparagraph (o) of paragraph 1 of Article 3 (General Definitions). Subparagraph (b) applies to

any plan, scheme, fund, trust, company or other arrangement established in a Contracting State

that is generally exempt from taxation in that State because it is operated exclusively to

administer or provide employee benefits. The reference to a general exemption is intended to

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

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

business income. Subparagraph (c) applies to an organization that is established exclusively for

religious, charitable, scientific, artistic, cultural, or educational purposes and that is a resident of

a Contracting State. Thus, an exempt section 501(c) organization (such as a U.S. charity) that is

generally exempt from tax under U.S. law is a resident of the United States for all purposes of

the Convention. Subparagraph (d) applies to a qualified governmental entity, as defined in

subparagraph (k) of paragraph 1 of Article 3, if it is the Contracting State itself, is established in

a Contracting State or is a part of that State.

Paragraph 4

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 4 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

"centre of vital interests"). If that test is also inconclusive, or if he does not have a permanent

home available to him in either State, he will be treated as a resident of the Contracting State

where he maintains an habitual abode. If he has an habitual abode in both States or in neither of

them, he will be treated as a resident of the Contracting State of which he is a national. If he is a

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

who will assign a single State of residence.

Paragraph 5

Dual residents other than individuals (e.g., companies, trusts, and estates) are addressed

by paragraph 5. 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. For example, a company is treated as resident in the

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

subdivision. Under U.K. law, a company is treated as a resident of the United Kingdom if it is

either established there or managed and controlled there. Dual residence, therefore, can arise if a

U.S. company is managed and controlled in the United Kingdom. Paragraph 5 provides that the

competent authorities will try to determine a single State of residence for such a company.

If the competent authorities do not reach an agreement on the single State of residence,

that person may not claim any benefit provided by the Convention, except those provided by

paragraph 4 of Article 24 (Relief from Double Taxation), Article 25 (Non-Discrimination), and

Article 26 (Mutual Agreement Procedure). Thus, for example, a State cannot discriminate

against a dual resident company, and such a company can bring issues to the competent

authorities.

Dual resident companies also may be treated as resident for purposes other than that of

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

dividend to a resident of the United Kingdom, the U.S. paying agent would withhold on that

dividend at the appropriate treaty rate because reduced withholding is a benefit enjoyed by the

resident of the United Kingdom, not by the dual resident. The dual resident company that paid

the dividend would, for this purpose, be treated as a resident of the United States under the

Convention. In addition, information relating to dual resident companies can be exchanged under

the Convention because, by its terms, Article 27 (Exchange of Information and Administrative

Assistance) is not limited to residents of the Contracting States.

Paragraph 6

Paragraph 6 carries over the rule from the prior Convention that, for U.K. tax purposes,

the domicile of a woman who is a U.S. national and who was married before January 1, 1974 to a

man domiciled in the United Kingdom will be determined as if such marriage took place on

January 1, 1974.

As discussed above in connection with paragraph 7 of Article 1 (General Scope), the

United Kingdom taxes differently the income of a U.K. resident from sources outside the United

Kingdom, depending upon whether the U.K. resident is domiciled in the United Kingdom. A

U.K. resident domiciled in the United Kingdom is subject to full U.K. taxation on all income,

including income from sources outside the United Kingdom. A U.K. resident domiciled outside

the United Kingdom, however, generally is subject to tax on income from sources outside the

United Kingdom only to the extent such income is remitted to the United Kingdom.

Under U.K. law before January 1, 1974, the domicile of a woman was the same as the

domicile of her husband. This rule was repealed for years beginning after December 31, 1973.

As a transitional rule, however, U.K. law treats a woman married before 1974 as retaining her

husband’s domicile unless and until she changes her domicile by acquisition or revival of another

domicile after 1973. As a consequence, under U.K. law, a female U.S. citizen who married a

U.K. domiciliary male before January 1, 1974, does not have the same opportunity to prove a

domicile outside the United Kingdom as does a male U.S. citizen who married a U.K.

domiciliary female before January 1, 1974. Paragraph 6 of the Convention equalizes the

treatment of male and female U.S. citizens in this situation.

Article 5 (Permanent Establishment)

This Article defines the term "permanent establishment," a term that is significant for

several articles of the Convention. The existence of a permanent establishment in a Contracting

State is necessary under Article 7 (Business Profits) for the taxation by that State of the business

profits of a resident of the other Contracting State. Articles 10, 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 that the recipient has in the source State. The concept is

also relevant in determining which Contracting State may tax certain gains under Article 13

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

The Article follows closely both the OECD Model and the U.S. Model provisions. It does

not differ significantly from the definition of a permanent establishment in the prior Convention.

Paragraph 1

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

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

of an enterprise is wholly or partly carried on. As indicated in the OECD Commentary to Article

5 (see paragraphs 4 through 8), a general principle to be observed in determining whether a

permanent establishment exists is that the place of business must be "fixed" in the sense that a

particular building or physical location is used by the enterprise for the conduct of its business,

and that it must be foreseeable that the enterprise's use of this building or other physical location

will be more than temporary.

Paragraph 2

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

permanent establishment. This list is illustrative and non-exclusive. According to paragraph 2,

the term permanent establishment includes a place of management, a branch, an office, a factory,

a workshop, and a mine, oil or gas well, quarry or other place of extraction of natural resources.

Paragraph 3

This paragraph provides rules to determine whether a building site or a construction or

installation project constitutes a permanent establishment for the contractor, installer, etc. An

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

for more than twelve months. This provision differs from the U.S. Model in that it does not cover

offshore drilling rigs. Special rules regarding exploration and exploitation of natural resources

are found in Article 21 (Offshore Exploration and Exploitation Activities).

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.

In applying this paragraph, time spent by a sub-contractor on a building site is counted as

time spent by the general contractor at the site for purposes of determining whether the general

contractor has a permanent establishment. However, for the sub-contractor itself to be treated as

having a permanent establishment, the sub-contractor's activities at the site must last for more

than 12 months. If a sub-contractor is on a site intermittently, then, for purposes of applying the

12-month rule, time is measured from the first day the sub-contractor is on the site until the last

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

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

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

the Convention. These interpretations are consistent with the generally accepted international

interpretation of the relevant language in paragraph 3 of Article 5 of the Convention.

If the twelve-month threshold is exceeded, the site or project constitutes a permanent

establishment from the first day of activity.

Paragraph 4

This paragraph contains exceptions to the general rule of paragraph 1, listing a number of

activities that may be carried on through a fixed place of business, but which nevertheless do not

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

establishment of the newspaper.

Subparagraph 4(f) provides that a combination of the activities described in the other

subparagraphs of paragraph 4 will not give rise to a permanent establishment if the combination

results in an overall activity that is of a preparatory or auxiliary character. This combination

rule, derived from the OECD Model, differs from that in the U.S. Model. In the U.S. Model, any

combination of otherwise excepted activities is not deemed to give rise to a permanent

establishment, without the additional requirement that the combination, as distinct from each

constituent activity, be preparatory or auxiliary. It is assumed that if preparatory or auxiliary

activities are combined, the combination generally will also be of a character that is preparatory

or auxiliary. If, however, this is not the case, a permanent establishment may result from a

combination of such activities.

Paragraph 5

Paragraphs 5 and 6 specify when activities carried on by an agent on behalf of an

enterprise create a permanent establishment of that enterprise. Under paragraph 5, a dependent

agent of an enterprise is deemed to be a permanent establishment of the enterprise if the agent

has and habitually exercises an authority to conclude contracts that are binding on the enterprise.

If, however, the agent's activities are limited to those activities specified in paragraph 4 which

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

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

The OECD Model uses the term "in the name of that enterprise" rather than "binding on

the enterprise." There is no substantive difference. As indicated in paragraph 32 to the OECD

Commentary on Article 5, paragraph 5 of the Article is intended to encompass a person 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 5 are those relating to the essential business

operations of the enterprise rather than ancillary activities. For example, if the agent has no

authority to conclude contracts in the name of the enterprise with its customers for the sale of the

goods produced by the enterprise, but it can enter into service contracts in the name of the

enterprise for the enterprise's business equipment used in the agent's office, this contracting

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

Paragraph 6

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

Contracting State merely because it carries on business in that State through an independent

agent, including a broker or general commission agent, if the agent is acting in the ordinary

course of his business as an independent agent. Thus, there are two conditions that must be

satisfied: the agent must be both legally and economically independent of the enterprise, and the

agent must be acting in the ordinary course of its business in carrying out activities on behalf of

the enterprise.

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

the questions to be considered are the extent to which the agent operates on the basis of

instructions from the enterprise. An agent that is subject to detailed instructions regarding the

conduct of its operations or comprehensive control by the enterprise is not legally independent.

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

Another relevant factor in determining whether an agent is economically independent is

whether the agent has an exclusive or nearly exclusive relationship with the principal. Such a

relationship may indicate that the principal has economic control over the agent. A number of

principals acting in concert also may have economic control over an agent. The limited scope of

the agent's activities and the agent's dependence on a single source of income may indicate that

the agent lacks economic independence. It should be borne in mind, however, that exclusivity is

not in itself a conclusive test; an agent may be economically independent notwithstanding an

exclusive relationship with the principal if it has the capacity to diversify and acquire other

clients without substantial modifications to its current business and without substantial harm to

its business profits. Thus, exclusivity should be viewed merely as a pointer to further

investigation of the relationship between the principal and the agent. Each case must be

addressed on the basis of its own facts and circumstances.

Paragraph 7

This paragraph clarifies that a company that is a resident of a Contracting State is not

deemed to have a permanent establishment in the other Contracting State merely because it

controls, or is controlled by, a company that is a resident of that other Contracting State, or that

carries on business in that other Contracting State. The determination whether a permanent

establishment exists is made solely on the basis of the factors described in paragraphs 1 through

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

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

between the companies.

Article 6 (Income from Real Property)

Paragraph 1

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

Contracting State derived from real property situated in the other Contracting State may be taxed

in the Contracting State in which the property is situated. Subparagraph (m) of paragraph 1 of

Article 3 (General Definitions) defines the term “real property” for this purpose.

Paragraph 1 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). Given the availability of the net basis taxation under the tax laws of

each of the Contracting States, taxpayers generally should be able to obtain the same tax

treatment in the State where the real property is situated regardless of whether the income is

treated as business profits or income from 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.

Paragraph 2

Paragraph 2 makes clear that all forms of income derived from the exploitation of real

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

lease of real property, the gross rental payment (before deductible expenses incurred by the

lessee) may be treated as income from the property. Income from the disposition of an interest in

real property, however, is not considered "derived" from real property and is not dealt with in

this article. The taxation of that income is addressed in Article 13 (Gains). Also, the interest paid

on a mortgage on real property and distributions by a U.S. Real Estate Investment Trust are not

dealt with in Article 6. Such payments would fall under Articles 10 (Dividends), 11 (Interest) or

13 (Gains). Finally, dividends paid by a United States Real Property Holding Corporation are not

considered to be income from the exploitation of real property: such payments would fall under

Article 10 (Dividends) or 13 (Gains).

Paragraph 3

This paragraph specifies that the basic rule of paragraph 1 (as elaborated in paragraph 2)

applies to income from real property of an enterprise. This clarifies that the situs country may tax

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

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

represents an exception to the general rule under Article 7 (Business Profits) that income must be

attributable to a permanent establishment in order to be taxable in the host state.

Article 7 (Business Profits)

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

of an enterprise of the other Contracting State.

Paragraph 1

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

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

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

5 (Permanent Establishment)) situated there. When that condition is met, the State in which the

permanent establishment is situated may tax the enterprise on the income that is attributable to

the permanent establishment.

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

intended to have the same meaning as under paragraph 7 of Article 7 of the U.S. Model, except

that it now covers income from independent personal services because of the elimination of a

separate article dealing with independent personal services, as discussed in connection with the

definitions of "enterprise" and "business" in the Technical Explanation to Article 3 (General

Definitions) above. Thus, the term “business profits” generally means income derived from any

trade or business.

In accordance with this broad definition, the term “business profits” includes income

attributable to notional principal contracts and other financial instruments to the extent that the

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

to a trade or business (as in the case of a notional principal contract entered into for the purpose

of hedging currency risk arising from an active trade or business). Any other income derived

from such instruments is, unless specifically covered in another article, dealt with under

Article 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 or partners perform

services in the other State through a permanent establishment may be taxed in that other State on

a net basis under Article 7, and not under Article 14 (Income from Employment), which applies

only to income of employees. This change is consistent with the OECD Model, according to

which income derived from professional services or other activities of an independent character

is dealt with under Article 7 as business profits. With respect to the enterprise’s employees

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

Because this article applies to income earned by an enterprise from the furnishing of

personal services, the article also applies to income derived by a partner resident in a Contracting

State that is attributable to personal services performed in the other Contracting State through a

partnership with a permanent establishment in that other State. Income which may be taxed

under this article includes all income attributable to the permanent establishment in respect of the

performance of the personal services carried on by the partnership (whether by the partner

himself, other partners in the partnership, or by employees assisting the partners) and any income

from activities ancillary to the performance of those services (e.g., charges for facsimile

services). Income that is not derived from the performance of personal services and that is not

ancillary thereto (e.g., rental income from subletting office space) is governed by other articles of

the Convention.

The application of Article 7 to a service partnership may be illustrated by the following

example: a partnership formed in the United Kingdom has five partners (who agree to split

profits equally), four of whom are resident and perform personal services only in the United

Kingdom at Office A, and one of whom performs personal services at Office B, a permanent

establishment in the United States. In this case, the four partners of the partnership resident in the

United Kingdom may be taxed in the United States in respect of their share of the income

attributable to the permanent establishment, Office B. The services giving rise to income which

may be attributed to the permanent establishment would include not only the services performed

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

United States and worked on an Office B matter there, the income in respect of those services.

Income from the services performed by the visiting partner would be subject to tax in the United

States regardless of whether the visiting partner actually visited or used Office B while

performing services in the United States.

Paragraph 2

Paragraph 2 provides rules for the attribution of business profits to a permanent

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

it would have earned had it been a distinct and separate enterprise engaged in the same or similar

activities under the same or similar conditions and dealing wholly independently with the

enterprise of which it is a permanent establishment. The "attributable to" concept of paragraph 2

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. However, as stated in paragraph 2, the business profits attributable

to a permanent establishment include only those profits derived from the assets used, risks

assumed, and activities performed by, the permanent establishment. This rule overrides the

"residual force of attraction" rule of section 864(c)(3).

The language of paragraph 2, when combined with paragraph 3 dealing with the

allowance of deductions for expenses incurred for the purposes of earning the profits,

incorporates the arm's-length standard for purposes of determining the profits attributable to a

permanent establishment. As noted below with respect to Article 9, the United States generally

interprets the arm’s length standard in a manner consistent with the OECD Transfer Pricing

Guidelines.

The notes confirm that any of the methods provided by the OECD Transfer Pricing

Guidelines apply, by analogy, in determining the profits attributable to a permanent

establishment. Because transactions between branches of a single legal entity do not have

independent legal significance, the Transfer Pricing Guidelines, which address transactions

between legal entities, can apply only “by analogy”.

Moreover, in applying the Transfer Pricing Guidelines, it is necessary to take into

account the different economics that arise from operating through a single legal entity rather than

through separate legal entities. For example, an entity that operates through branches rather than

separate subsidiaries will have lower capital requirements because all of the assets of the entity

are available to support all of the entity’s liabilities (with some exceptions attributable to local

regulatory restrictions). This is the reason that most commercial banks and some insurance

companies operate through branches rather than subsidiaries. The benefit that comes from such

lower capital costs must be allocated among the branches in an appropriate manner. This issue

does not arise in the case of an enterprise that operates through separate entities, since each entity

will have to be separately capitalized or will have to compensate another entity for providing

capital (usually through a guarantee).

Under U.S. domestic regulations, internal “transactions” generally are not recognized

because they do not have legal significance. In contrast, the rule provided by the notes is that

such internal dealings may be used to allocate income in cases where the dealings accurately

reflect the allocation of risk within the enterprise. One example is that of global trading in

securities. In many cases, banks use internal swap transactions to transfer risk from one branch

to a central location where traders have the expertise to manage that particular type of risk.

Under the Convention, such a bank may also use such swap transactions as a means of allocating

income between the branches, if use of that method is the “best method” within the meaning of

regulation section 1.482-1(c). The books of a branch will not be respected, however, when the

results are inconsistent with a functional analysis. So, for example, income from a transaction

that is booked in a particular branch (or home office) will not be treated as attributable to that

location if the sales and risk management functions that generate the income are performed in

another location.

It is also permissible to use methods other than separate accounting to determine the

arm's length profits of a permanent establishment when such a method would be permissible

under the Transfer Pricing Guidelines. This might occur, for example, 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. Because the use of profits

methods is permissible under paragraph 2, it is not necessary for the Convention to include a

provision corresponding to paragraph 4 of Article 7 of the OECD Model.

The Convention does not include the rule found in Paragraph 4 of the U.S. Model and

paragraph 5 of Article 7 of the OECD Model. The rule 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. The rule in the both Models 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. This result is

inconsistent with the arm's length principle, since a distinct and separate enterprise would have

received some compensation to perform that service. Accordingly, the rule was not included in

the Convention.

Paragraph 3

This paragraph is the same as paragraph 3 of Article 7 of the OECD 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 expenses incurred for

the purposes of the enterprise as a whole, or that part of the enterprise that includes the

permanent establishment. Deductions are to be allowed regardless of which accounting unit of

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

establishment. For example, a portion of the interest expense recorded on the books of the home

office in one State may be deducted by a permanent establishment in the other if properly

allocable thereto. The amount of expense that must be allowed as a deduction is determined by

applying the arm's length principle.

As noted above, the notes provide that the OECD Transfer Pricing Guidelines apply, by

analogy, in determining the profits attributable to a permanent establishment. Accordingly, a

permanent establishment may deduct payments made to its head office or another branch in

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

calculating that amount will depend on the terms of the arrangements between the branches and

head office. For example, the enterprise could have a policy, expressed in writing, under which

each business unit could use the services of lawyers employed by the head office. At the end of

each year, the costs of employing the lawyers would be allocated to each business unit according

to the amount of services used by that business unit during the year. Since this appears to be a

kind of cost-sharing arrangement and the allocation of costs is based on the benefits received by

each business unit, it would be an acceptable means of determining a permanent establishment’s

deduction for legal expenses. Alternatively, the head office could agree to employ lawyers at its

own risk, and to charge an arm’s length price for legal services performed for a particular

business unit. If the lawyers were under-utilized, and the “fees” received from the business units

were less than the cost of employing the lawyers, then the head office would bear the excess

cost. If the “fees” exceeded the cost of employing the lawyers, then the head office would keep

the excess to compensate it for assuming the risk of employing the lawyers. If the enterprise

acted in accordance with this agreement, this method would be an acceptable alternative method

for calculating a permanent establishment’s deduction for legal expenses.

The notes also specify that a permanent establishment cannot be funded entirely with

debt, but must have sufficient capital to carry on its activities as if it were a distinct and separate

enterprise. To the extent that the permanent establishment does not have such capital, a

Contracting State may attribute such capital to the permanent establishment and deny an interest

deduction to the extent necessary to reflect that capital attribution. The method prescribed by

U.S. domestic law for making this attribution is found in Treas. Reg. Section 1.882-5. Section

1.882-5(a)(2) states that the method is to be used in determining the amount of interest expense

attributable to the business profits of a permanent establishment under U.S. tax treaties.

Accordingly, a U.K. taxpayer may continue to use that method for determining its interest

expense if it so chooses.

However, section 1.882-5 does not take into account the fact that some assets are more

risky than other assets. An independent enterprise would need less capital to support a perfectly-

hedged U.S. Treasury security than it would need to support an equity security or other asset

with significant market and/or credit risk. Accordingly, in some cases section 1.882-5 would

require a taxpayer to allocate more capital to the United States (and therefore would reduce the

taxpayer’s interest deduction) than is appropriate. To address these cases, the notes allow a

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

the various jurisdictions in which it does business. In particular, in the case of financial

institutions other than insurance companies, the amount of capital attributable to a permanent

establishment is determined by allocating the institution’s total equity between its various offices

on the basis of the proportion of the financial institution’s risk-weighted assets attributable to

each of them. This recognizes the fact that financial institutions are in many cases required to

risk-weight their assets for regulatory purposes and, in other cases, will do so for business

reasons even if not required to do so by regulators. However, the taxpayer is not required to

apply this treaty method for determining its interest deduction. As noted above, it may choose to

apply the rule of Treas. Reg. Section 1.882-5 instead if that produces less U.S. taxable income in

the taxpayer’s particular circumstances

Paragraph 4

Paragraph 4 provides that profits shall be determined by the same method each year,

unless there is good reason to change the method used. This rule assures consistent tax treatment

over time for permanent establishments. It limits the ability of both the Contracting State and the

enterprise to change accounting methods to be applied to the permanent establishment. It does

not, however, restrict a Contracting State from imposing additional requirements, such as the

rules under Code section 481, to prevent amounts from being duplicated or omitted following a

change in accounting method.

Paragraph 5

Paragraph 5 states that the United States generally will not impose the excise tax on

insurance policies issued by foreign insurers if the premiums on such policies are derived by a

U.K. enterprise, whether or not the U.K. enterprise carries on business through a U.S. permanent

establishment. The rule merely confirms the result that obtains under a combination of U.S. law

and other provisions of the Convention. Because the excise tax is a covered tax under Article 2

(Taxes Covered), the United States may not, pursuant to paragraph 1 of Article 7, impose the tax

on the income of any U.K. enterprise that is not attributable to a permanent establishment in the

United States. Under Code section 4373, the tax also may not be imposed on any amount that is

effectively connected with the conduct of a trade or business in the United States. Any amount

attributable, under the Convention, to a permanent establishment in the United States also will be

effectively connected with a U.S. trade or business. Therefore, the tax may not be imposed on

any income of a U.K. enterprise that is attributable to a permanent establishment in the United

States.

This relief from the excise tax, however, does not apply if the policies in question are

entered into as part of a conduit arrangement, as defined in subparagraph (n) of paragraph 1 of

Article 3 (General Definitions). Under current U.S. law, the anti-conduit regulations of section

1.881-3 do not apply with respect to the excise tax. Nevertheless, paragraph 5 of Article 7 of the

Convention permits the United States to apply rules analogous to those of section 1.881-3 to

transactions entered into as part of a conduit arrangement to avoid the imposition of the excise

tax. If the transactions are entered into as part of a conduit arrangement to avoid the imposition

of the excise tax, the excise tax may be applied unless the premiums are attributable to a

permanent establishment maintained by a U.K. enterprise in the United States.

This anti-conduit rule is intended to apply to cases where a resident of a Contracting State

receives an insurance premium, and then pays substantially all of that premium to a resident of a

third state who would not be entitled to equivalent benefits if it received the insurance premium

directly. Even if a transaction meets the structural requirements of the definition included in

Article 3, it will not constitute a conduit arrangement if obtaining the increased benefits

described in the preceding paragraphs was not the main purpose, or one of the main purposes, of

the transaction. The United Kingdom and the United States agree that the terms “main purpose”,

used by the United Kingdom, and “principal purpose”, used by the United States in its domestic

law, are synonymous. Therefore, the United States will interpret the “main purpose”

requirement of this rule in a manner consistent with the anti-conduit rules of regulation section

1.881-3, as it may be amended from time to time, and other U.S. domestic anti-abuse rules that

look to the purposes of a transaction.

Because of the requirement that the arrangement have as one of its main purposes the

avoidance of tax, this rule is somewhat narrower than the exception in other U.S. tax treaties that

cover the insurance excise tax. Such other treaties impose the excise tax whenever a risk is

reinsured with a person who would not be entitled to equivalent benefits, even if the reinsurance

occurs in the ordinary course of business.

These rules are illustrated by the following examples:

Example 1

. USCo is an insurance company resident in United States that is owned by a

United Kingdom parent company, UKCo. XCo, an insurance company organized in a third

country whose tax treaty with the United States does not cover the insurance excise tax, wants to

enter into a reinsurance contract with USCo reinsuring 25 percent of all U.S. risks insured by

USCo. However, XCo would like to avoid the excise tax on reinsurance policies issued by

foreign persons. Accordingly, it proposes to UKCo that UKCo enter into a reinsurance contract

with USCo, after which XCo will reinsure the risk ceded by USCo to UKCo. These transactions

are entered into as proposed. As a result of these agreements, all or substantially all of the

premiums paid by USCo to UKCo will be paid to XCo, and XCo will avoid the excise tax to

which it would have been subject had it received the premium payments directly. Since one of

XCo’s principle purposes in structuring the transaction in this way was to avoid the insurance

excise tax, the arrangement constitutes a conduit arrangement, and UKCo will be subject to the

U.S. insurance excise tax.

Example 2

. The facts are the same as in Example 1, except that UKCo has a permanent

establishment in the United States through which the transaction takes place. Since the

premiums received from USCo are attributable to a permanent establishment which UKCo

maintains in the United States, the United States will not impose an excise tax with respect to the

policy between USCo and UKCo.

Paragraph 6

Paragraph 6 coordinates the provisions of Article 7 and other provisions of the

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

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

except when they specifically provide to the contrary, take precedence over the provisions of

Article 7. For example, the taxation of dividends will be determined by the rules of Article 10

(Dividends), and not by Article 7, except where, as provided in paragraph 6 of Article 10, the

dividend is attributable to a permanent establishment. In the latter case the provisions of Article 7

apply. Thus, an enterprise of one State deriving dividends from the other State may not rely on

Article 7 to exempt those dividends from tax at source if they are not attributable to a permanent

establishment of the enterprise in the other State. By the same token, if the dividends are

attributable to a permanent establishment in the other State, the dividends may be taxed on a net

income basis at the source State full corporate tax rate, rather than on a gross basis under Article

10 (Dividends).

As provided in Article 8 (Shipping and Air Transport), income derived from shipping and

air transport activities in international traffic described in that Article is taxable only in the

country of residence of the enterprise regardless of whether it is attributable to a permanent

establishment situated in the source State.

Paragraph 7

Paragraph 7 incorporates into the Convention the rule of Code section 864(c)(6). Like the

Code section on which it is based, paragraph 7 provides that any income or gain attributable to a

permanent establishment during its existence is taxable in the Contracting State where the

permanent establishment is situated, even if the payment of that income or gain is deferred until

after the permanent establishment ceases to exist. This rule applies with respect to Article 7

(Business Profits), paragraph 5 of Article 10 (Dividends), paragraph 3 of Article 11 (Interest),

paragraph 3 of Article 12 (Royalties) and paragraph 2 of Article 22 (Other Income). A similar

rule is incorporated into paragraph 3 of Article 13 (Gains).

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

that is a resident of the United Kingdom and that maintains a permanent establishment in the

United States winds up the permanent establishment's business and sells the permanent

establishment's inventory and assets to a U.S. buyer at the end of year 1 in exchange for an

interest-bearing installment obligation payable in full at the end of year 3. Despite the fact that

Article 13's threshold requirement for U.S. taxation is not met in year 3 because the company has

no permanent establishment in the United States, the United States may tax the deferred income

payment recognized by the company in year 3.

Relation to Other Articles

This Article is subject to the saving clause of paragraph 4 of Article 1 (General Scope) of

the Convention. Thus, if a citizen of the United States who is a resident of the United Kingdom

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 6 of Article 24 (Relief from Double Taxation), tax those

profits as part of the worldwide income of the citizen, notwithstanding the provision of

paragraph 1 of this Article which would exempt the income from U.S. tax.

The benefits of this Article are also subject to Article 23 (Limitation on Benefits). Thus,

an enterprise of the United Kingdom that derives income effectively connected with a U.S. trade

or business may not claim the benefits of Article 7 unless the resident carrying on the enterprise

qualifies for such benefits under Article 23.

Article 8 (Shipping and Air Transport)

This Article governs the taxation of profits from the operation of ships and aircraft in

international traffic. The term "international traffic" is defined in subparagraph 1(d) of Article 3

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

dealt with not in this Article but in paragraph 4 of Article 13 (Gains).

Paragraph 1

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

operation in international traffic of ships or aircraft are taxable only in that Contracting State.

Because paragraph 6 of Article 7 (Business Profits) defers to Article 8 with respect to shipping

income, such income derived by a resident of one of the Contracting States may not be taxed in

the other State even if the enterprise has a permanent establishment in that other State. Thus, if a

U.S. airline has a ticket office in the United Kingdom, the United Kingdom may not tax the

airline's profits attributable to that office under Article 7. Since entities engaged in international

transportation activities normally will have many permanent establishments in a number of

countries, the rule avoids difficulties that would be encountered in attributing income to multiple

permanent establishments if the income were covered by Article 7 (Business Profits).

Paragraph 2

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

from tax under paragraph 1 is defined in paragraph 2. In addition to income derived directly from

the operation of ships and aircraft in international traffic, this definition also includes certain

items of rental income that are closely related to those activities. First, income of an enterprise of

a Contracting State from the rental of ships or aircraft on a full basis (i.e., with crew) when such

ships or aircraft are used in international traffic is income of the lessor from the operation of

ships and aircraft in international traffic and, therefore, is exempt from tax in the other

Contracting State under paragraph 1. Also, paragraph 2 encompasses income from the lease of

ships or aircraft on a bareboat basis (i.e., without crew) when the income is incidental to other

income of the lessor from the operation of ships or aircraft in international traffic. Thus, the

coverage of Article 8 of the Convention is generally consistent with Article 8 of the OECD

Model although narrower than the U.S. Model, which also covers rentals from bareboat leasing

that are not incidental to the operation of ships or aircraft by the lessee. The classes of income

derived from the rental of ships and aircraft not included in this Article are included in Article 7.

Paragraph 2 also clarifies, consistent with the Commentary to Article 8 of the OECD

Model, that income earned by an enterprise from the inland transport of property or passengers

within either Contracting State falls within Article 8 if the transport is undertaken as part of the

international transport of property or passengers by the enterprise. Thus, as confirmed by the

notes, if a U.S. shipping company contracts to carry property from the United Kingdom to a U.S.

city and, as part of that contract, it transports the property by truck from its point of origin to an

airport in the United Kingdom (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 would apply to income

from lighterage undertaken as part of the international transport of goods.

Finally, certain non-transport activities that are an integral part of the services performed

by a transport company are understood to be covered in paragraph 1, though they are not

specified in paragraph 2. These include, for example, the performance of some maintenance or

catering services by one airline for another airline, if these services are incidental to the provision

of those services by the airline for itself. Income earned by concessionaires, however, is not

covered by Article 8. See paragraphs 7 through 10.1 of the Commentary to Article 8 of the

OECD Model.

Paragraph 3

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

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

transport of goods in international traffic are exempt from tax in the other Contracting State. This

result obtains under paragraph 3 regardless of whether the recipient of the income is engaged in

the operation of ships or aircraft in international traffic, and regardless of whether the enterprise

has a permanent establishment in the other Contracting State. By contrast, Article 8 of the OECD

Model covers only income from the use, maintenance or rental of containers that is incidental to

other income from international traffic.

Paragraph 4

This paragraph clarifies that the provisions of paragraphs 1 and 3 also apply to profits

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

international operating agency. This refers to various arrangements for international cooperation

by carriers in shipping and air transport. For example, airlines from two countries may agree to

share the transport of passengers between the two countries. They each will fly the same number

of flights per week and share the revenues from that route equally, regardless of the number of

passengers that each airline actually transports. Paragraph 4 makes clear that with respect to each

carrier the Article excepts all the income earned by that carrier with respect to the pool, and not

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

Article 8 of the U.S. Model.

Relation to Other Articles

This Article is subject to the saving clause of paragraph 4 of Article 1 (General Scope) of

the Convention. Thus, if a citizen of the United States who is a resident of the United Kingdom

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 6 of Article 24 (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.)

As with other benefits of the Convention, the benefit of exclusive residence country

taxation under Article 8 is available to an enterprise only if it is entitled to benefits under Article

23 (Limitation on Benefits).

Article 9 (Associated Enterprises)

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

U.S. domestic transfer pricing provisions, particularly Code section 482. It provides that when

related enterprises engage in a transaction on terms that are not arm's-length, the Contracting

States may make appropriate adjustments to the taxable income and tax liability of such related

enterprises to reflect what the income and tax of these enterprises with respect to the transaction

would have been had there been an arm's-length relationship between them.

Paragraph 1

This paragraph addresses the situation where an enterprise of a Contracting State is

related to an enterprise of the other Contracting State, and there are arrangements or conditions

imposed between the enterprises in their commercial or financial relations that are different from

those that would have existed in the absence of the relationship. Under these circumstances, the

Contracting States may adjust the income (or loss) of the enterprise to reflect what it would have

been in the absence of such a relationship.

The paragraph identifies the relationships between enterprises that serve as a prerequisite

to application of the Article. As the Commentary to Article 9 of the OECD Model makes clear,

the necessary element in these relationships is effective control, which is also the standard for

purposes of section 482. Thus, the Article applies if an enterprise of one State participates

directly or indirectly in the management, control, or capital of the enterprise of the other State.

Also, the Article applies if any third person or persons participate directly or indirectly in the

management, control, or capital of enterprises of different States. For this purpose, all types of

control are included (i.e., whether or not legally enforceable and however exercised or

exercisable).

The fact that a transaction is entered into between such related enterprises does not, in

and of itself, mean that a Contracting State may adjust the income (or loss) of one or both of the

enterprises under the provisions of this Article. If the conditions of the transaction are consistent

with those that would be made between independent persons, the income arising from that trans-

action should not be subject to adjustment under this Article.

Similarly, the fact that associated enterprises may have concluded arrangements, such as

cost sharing arrangements or general services agreements, is not in itself an indication that the

two enterprises have entered into a non-arm's-length transaction that should give rise to an

adjustment under paragraph 1. Both related and unrelated parties enter into such arrangements

(e.g., joint venturers may share some development costs). As with any other kind of transaction,

when related parties enter into an arrangement, the specific arrangement must be examined to see

whether or not it meets the arm's-length standard. In the event that it does not, an appropriate

adjustment may be made, which may include modifying the terms of the agreement or

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.

It also is understood that the Contracting States preserve their rights to apply internal law

provisions relating to adjustments between related parties. They also reserve the right to make

adjustments in cases involving tax evasion or fraud. Such adjustments -- the distribution,

apportionment, or allocation of income, deductions, credits or allowances -- are permitted even if

they are different from, or go beyond, those authorized by paragraph 1 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

Commentary to Article 9.

This Article also permits tax authorities to deal with thin capitalization issues. They may,

in the context of Article 9, scrutinize more than the rate of interest charged on a loan between

related persons. They also may examine the capital structure of an enterprise, whether a payment

in respect of that loan should be treated as interest, and, if it is treated as interest, under what

circumstances interest deductions should be allowed to the payer. Paragraph 2 of the

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

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

thin capitalization.

Paragraph 2

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

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

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

adjustment (sometimes referred to as a "corresponding adjustment") to the tax liability of the

related person in that other Contracting State. Although the OECD Model does not specify that

the other Contracting State must agree with the initial adjustment before it is obligated to make

the correlative adjustment, the Commentary makes clear that the paragraph is to be read that

way.

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

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

under Article 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, 1999-2 C.B.

296.

The Contracting State making a secondary adjustment will take the other provisions of

the Convention, where relevant, into account. For example, if the effect of a secondary

adjustment is to treat a U.S. corporation as having made a distribution of profits to its parent

corporation in the United Kingdom, the provisions of Article 10 (Dividends) will apply, and the

United States may impose, where appropriate, a withholding tax on the dividend. Also, if under

Article 24 (Relief from Double Taxation), the United Kingdom generally gives a credit for taxes

paid with respect to such dividends, it would also be required to do so in this case.

As stated in the notes, it is understood that, if the amount of interest or royalties paid

exceeds the amount that would have been paid in the absence of a relationship described in

paragraph 4 of Article 11 or paragraph 4 of Article 12, a Contracting State generally will adjust

the amount of deductible interest or royalties paid under the authority of Article 9 and make such

other adjustments as are appropriate. If such an adjustment is made, however, then the

Contracting State making such adjustment will not also impose its domestic rate of withholding

tax with respect to such excess amount. Accordingly, if a U.K. company makes a royalty

payment to its U.S. parent company, and the United Kingdom determines that the amount of the

royalty exceeded an arm's-length amount, the United Kingdom will deny a deduction for the

excess amount. It will not, however, treat the excess amount as a royalty subject to the 20

percent withholding rate applicable to royalties paid by U.K. companies.

The competent authorities are authorized by paragraph 3 of Article 26 (Mutual

Agreement Procedure) to consult, if necessary, to resolve any differences in the application of

these provisions. For example, there may be a disagreement over whether an adjustment made by

a Contracting State under paragraph 1 was appropriate.

If a correlative adjustment is made under paragraph 2, it is to be implemented, pursuant

to paragraph 2 of Article 26 (Mutual Agreement Procedure), notwithstanding any time limits or

other procedural limitations in the law of the Contracting State making the adjustment. If a

taxpayer has entered a closing agreement (or other written settlement) with the United States

prior to bringing a case to the competent authorities, the U.S. competent authority will endeavor

only to obtain a correlative adjustment from the United Kingdom. See, Rev. Proc. 2002-52,

2002-31 I.R.B. 242, Section 7.04.

Relationship to Other Articles

The saving clause of paragraph 4 of Article 1 (General Scope) does not apply to

paragraph 2 of Article 9 by virtue of the exceptions to the saving clause in paragraph 5(a) of

Article 1. Thus, even if the statute of limitations has run, a refund of tax can be made in order to

implement a correlative adjustment. Statutory or procedural limitations, however, cannot be

overridden to impose additional tax, because paragraph 2 of Article 1 provides that the

Convention cannot restrict any statutory benefit.

Article 10 (Dividends)

Article 10 provides rules for the taxation of dividends paid by a company that is a

resident of one Contracting State to a beneficial owner that is a resident of the other Contracting

State. The article provides for full residence country taxation of such dividends and a limited

source-State right to tax. Article 10 also provides rules for the imposition of a tax on branch

profits by the State of source. Finally, the article prohibits a State from imposing taxes on a

company resident in the other Contracting State, other than a branch profits tax, on undistributed

earnings.

Paragraph 1

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

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

dividends paid to them by a company that is a resident of the other Contracting State. For

dividends from any other source paid to a resident, Article 22 (Other Income) grants the

residence country exclusive taxing jurisdiction (other than for dividends attributable to a

permanent establishment in the other State).

Paragraph 2

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

State, subject to the limitations of paragraphs 2 and 3. Paragraph 2 generally limits the rate of

withholding tax in the State of source on dividends paid by a company resident in that State to 15

percent of the gross amount of the dividend. If, however, the beneficial owner of the dividend is

a company resident in the other State and owns shares representing at least 10 percent of the

voting power of the company paying the dividend, then the rate of withholding tax in the State of

source is limited to 5 percent of the gross amount of the dividend. Indirect ownership of voting

shares (through tiers of corporations) is taken into account for the purpose of determining

eligibility for the 5 percent direct dividend rate of withholding tax. Shares are considered voting

shares if they provide the power to elect, appoint or replace any person vested with the powers

ordinarily exercised by the board of directors of a U.S. corporation.

The benefits of paragraph 2 may be granted at the time of payment by means of reduced

rate of withholding tax at source. It also is consistent with the paragraph for tax to be withheld at

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

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

Paragraphs 2 and 3 do 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 25

(Non- Discrimination).

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

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

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

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

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

to Article 10. See also paragraph 24 of the Commentary to Article 1 of the OECD Model.

Companies holding shares through fiscally transparent entities such as partnerships are

considered for purposes of this paragraph to hold their proportionate interest in the shares held

by the intermediate entity. 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 of

withholding tax applies when the company’s proportionate share of the shares held by the

intermediate entity meets the 10 percent threshold. Whether this ownership threshold is satisfied

may be difficult to determine and often will require an analysis of the partnership or trust

agreement.

Paragraph 3

Paragraph 3 provides for exclusive residence country taxation (i.e., a zero rate of

withholding tax) with respect to certain dividends distributed by a company resident in one

Contracting State to a resident in the other Contracting State. As described further below, the

exemption is available with respect to certain intercompany dividends and with respect to

dividends received by tax-exempt pension funds.

Subparagraph (a) of paragraph 3 reduces the rate of withholding tax to zero on dividends

beneficially owned by a company that has owned directly at least 80 percent of the voting power

of the company paying the dividend for the 12-month period ending on the date the dividend is

declared.

Eligibility for the zero rate of withholding tax provided by subparagraph (a) is subject to

an additional restriction which states that companies qualifying for treaty benefits by virtue of

the active trade or business or ownership-base erosion test must have acquired shares

representing 80 percent or more of the voting stock of the company paying the dividends prior to

October 1, 1998. This restriction supplements those imposed under Article 23 (Limitation on

Benefits), and is necessary because of the increased pressure on the Limitation on Benefits tests

resulting from the fact that the Convention is one of the first U.S. tax treaties to provide for a

zero rate of withholding on inter-company dividends. The test is intended to prevent companies

from re-organizing in order to become eligible for the zero rate of withholding tax in

circumstances where the Limitation on Benefits provision does not provide sufficient protection

against treaty-shopping.

For example, assume that ThirdCo is a company resident in a third country, a member of

the European Union other than the United Kingdom. ThirdCo owns directly 100 percent of the

issued and outstanding voting stock of USCo, a U.S. company, and of UKCo, a U.K. company.

UKCo is a substantial company that manufactures widgets; USCo distributes those widgets in

the United States. If ThirdCo contributes to UKCo all the stock of USCo, dividends paid by

USCo to UKCo would qualify for treaty benefits under the active trade or business test of

Paragraph 4 of Article 23. However, allowing ThirdCo to qualify for the zero rate of

withholding tax, which is not available to it under the third state’s treaty with the United States

(if any), would encourage treaty-shopping.

In order to prevent this type of treaty-shopping, the Convention imposes an additional

holding requirement on companies that qualify for benefits only under the "active conduct of a

trade or business" test (paragraph 4 of Article 23) or under the "ownership-base erosion" test

(paragraph 2(f) of Article 23). For those companies, the zero rate of withholding tax is available

only with respect to dividends received from companies that the recipient company owned,

directly or indirectly, prior to October 1, 1998.

Accordingly, in the example above, UKCo will not qualify for the zero rate of

withholding tax on dividends unless it owned USCo before October 1, 1998. If it did own USCo

before October 1, 1998, then it will continue to qualify for the zero rate of withholding tax on

dividends so long as it qualifies for benefits under at least one of the tests of Article 23. So, for

example, if ThirdCo decided to get out of the widget business and sold its stock in UKCo to

FWCo, a company that is resident in a country with which the United States does not have a tax

treaty, UKCo would continue to qualify for the zero rate of withholding tax on dividends so long

as it continued to meet the requirements of the active trade or business test of Article 23(4) or,

possibly, the competent authority discretionary test of Article 23(6).

The result would be different under the "ownership-base erosion" test of Article 23(2)(f).

For example, assume UKCo is a passive holding company owned by UK individuals, which was

established in 1996 to hold the shares of USCo. UKCo qualifies for benefits only under the

ownership-base erosion test of Article 23(2)(f). If the UK individuals sold their stock in UKCo

to FWCo, UKCo would lose all the benefits accorded to residents of the UK under the

Convention (including the zero withholding rate on dividends) because the company would no

longer qualify for benefits under Article 23 (unless, of course, the U.S. competent authority were

to grant benefits under Article 23(6)).

Other methods of qualifying under Limitation on Benefits do not raise the same concerns.

Accordingly, a resident of a Contracting State that satisfies Limitation on Benefits by virtue of

being a publicly-traded company or a subsidiary of a publicly-traded company does not have to

meet the October 1, 1998 holding requirement. Thus, a U.K. resident company that meets the

listing and trading requirements of Article 23(2)(c) will be entitled to the zero withholding rate

on dividends no matter when it acquired the shares of the U.S. company (subject to the 12-month

holding period requirement of Article 10(3)(a)).

Under Article 10(3)(a)(iii), a company that is a resident of a Contracting State may also

qualify for the zero rate of withholding tax on dividends if it satisfies the derivative benefits test

of paragraph 3 of Article 23, even if it acquired the U.S. company after September 30, 1998

(subject to the 12-month holding period requirement). Qualification for the zero rate of

withholding tax through the application of the derivative benefits test currently is quite limited

because of the definition of "equivalent beneficiary." Under that definition, as of the date of the

signing of the Convention no U.K. subsidiary of a third-country company would qualify under

the derivative benefits test of paragraph 3 of Article 23 because the United States had no other

treaties with EU, EEA or NAFTA countries that reduce the rate of withholding tax on dividends

to zero. Accordingly, a company could qualify for the zero rate of withholding tax pursuant to

Article 10(3)(a)(iii) only if it is owned by seven or fewer U.S. or U.K. residents who fall within a

limited category of "qualified persons." For example, it would apply to certain U.K.

corporations that are closely-held by a few U.K. resident individuals or charities.

The provision would become more relevant if the United States were to enter into other

treaties that reduce the rate of withholding tax on intercompany dividends to zero. For example,

if the United States entered into a treaty with Country X, a member of the European Union,

which eliminated the rate of withholding tax on intercompany dividends, then it would be

possible for U.K. companies owned by companies resident in Country X to qualify for the

benefits provided by subparagraph 3(a) of this Article by satisfying the requirements of the

derivative benefits test of paragraph 3 of Article 23. The derivative benefits provision would also

be relevant if the United Kingdom were to enact a positive rate of withholding tax on dividends.

The definition of "equivalent beneficiary" is also intended to ensure that certain joint

ventures, not just wholly-owned subsidiaries, can qualify for benefits. For example, assume that

the United States has entered into a treaty with Country X, a member of the European Union,

that includes a provision identical to Article 10(3)(a). USCo is 100 percent owned by UKCo,

which in turn is owned 49 percent by a U.K. publicly-traded company and 51 percent by XCo a

publicly-traded company that is resident in Country X. The definition of "equivalent

beneficiary" includes a rule of application that is intended to ensure that such joint ventures

qualify for benefits. Under that rule, each of the shareholders is treated as owning the shares

held by UKCo for purposes of determining whether it would be entitled to an equivalent rate of

withholding tax. This rule is necessary because of the high ownership threshold for qualification

for the zero rate of withholding tax. The standard rule is that the shareholders would be treated

as owning only their proportionate share of the shares held by UKCo. If that rule were applied

here, neither shareholder would be an equivalent beneficiary, since neither would meet the 80

percent ownership test with respect to USCo.

If a company does not qualify for the zero rate of withholding tax under any of the

foregoing tests, it may request a determination from the relevant competent authority pursuant to

paragraph 6 of Article 23. Benefits will be granted with respect to an item of income if the

competent authority of the Contracting State in which the income arises determines that the

establishment, acquisition or maintenance of such resident and the conduct of its operations did

not have as one of its principal purposes the obtaining of benefits under the Convention.

In making its determination under Article 23(6) with respect to income arising in the

United States, the U.S. competent authority will consider the obligations imposed upon the

United Kingdom by its membership in the European Community. In particular, the United States

will have regard to any legal requirements for the facilitation of the free movement of capital

among Member States of the European Community. The competent authority will also consider

the differing internal tax systems, tax incentive regimes and tax treaty policies of the relevant

Member States.

For example, in the case above where UKCo was denied the zero rate of withholding tax

because it was acquired by FWCo, the competent authority would consider whether FWCo were

a resident of a Member State of the European Community or European Economic Area. If it

were, that would be a factor in favor of a determination that UKCo is entitled to the benefits of

the zero rate of withholding tax on dividends. This would be particularly true if the U.S.

business was a relatively small portion of the business acquired. However, that positive factor

could be outweighed by negative factors. One negative factor could be a determination by the

U.S. competent authority that FWCo benefited from a tax incentive regime that eliminated any

domestic taxation. The competent authority would also consider facts that might indicate that an

acquisition was not undertaken "under ordinary business conditions" but instead was undertaken

to acquire the U.K.-U.S. "bridge." These might include the fact that the U.K. company was

acquired even though all or substantially all of the business activities acquired consisted of the

U.S. business; the fact that existing U.S. operations were restructured in an attempt to benefit

from the zero withholding rate; or the fact that FWCo was owned by residents of a country that is

not a Member State of the European Union. Finally, another significant negative factor would be

if the U.S. competent authority faced difficulties in learning the identity of FWCo's owners, such

as an uncooperative taxpayer or legal barriers such as "economic espionage" or other limitations

on the effective exchange of information in the country of which FWCo is a resident.

Subparagraph (b) of paragraph 3 provides for exclusive residence-State taxation (i.e., a

zero rate of withholding tax) for dividends beneficially owned by a pension scheme, as defined

in Article 3(1)(o), provided that such dividends are not derived from the carrying on of a

business, directly or indirectly, by the pension scheme.

Paragraph 4

Paragraph 4 modifies in particular cases the maximum rates of withholding tax at source

provided in paragraphs 2 and 3. The first sentence of paragraph 4 provides that dividends paid by

a pooled investment vehicle are not eligible for the 5 percent maximum rate of withholding tax in

subparagraph (a) of paragraph 2, or the zero rate of withholding tax in subparagraph (a) of

paragraph 3. As described below, the zero rate of withholding tax provided by subparagraph (b)

of paragraph 3 (with respect to dividends paid to a pension plan) will be available with respect to

dividends paid by a pooled investment vehicle in certain circumstances.

The term “pooled investment vehicle” is defined in subparagraph (b) of paragraph 10 of

this Article. According to this definition, a pooled investment vehicle is a person with three

attributes. First, its assets must consist wholly or mainly of real property, or of shares, securities

or currencies, or of derivative contracts relating to shares, securities or currencies or real

property. Second, its gross income must consist wholly or mainly of dividends, interest, gains

from the alienation of assets and rents and other income and gains from the holding and

alienation of real property. Third, it must be exempt from tax in respect of its income, profits or

gains in the State of which it is a resident; or subject to tax at a special rate in that State; or

entitled to a deduction for dividends paid to its shareholders in computing the amount of its

income, profits or gains. This definition encompasses a U.S. regulated investment company

(“RIC”) or a U.S. real estate investment trust (“REIT”).

The second sentence of paragraph 4 provides that the 15 percent maximum rate of

withholding tax in subparagraph (b) of paragraph 2, and the zero rate of withholding tax of

subparagraph (b) of paragraph 3 (with respect to dividends paid to pensions) are applicable to

dividends paid by certain types of pooled investment vehicles. The pooled investment vehicles

that qualify for reduced rates under this sentence include those with assets consisting wholly or

mainly of shares, securities or currencies, or derivative contracts relating to shares, securities or

currencies. Thus, dividends paid by REITs do not qualify under this sentence, but dividends paid

by RICs qualify for the 15 percent maximum rate of withholding tax under the second sentence

of paragraph 4 and the zero rate of withholding tax applicable to dividends paid to pension

schemes.

The third sentence of paragraph 4 applies to pooled investment vehicle not covered by the

second sentence of paragraph 4 (e.g., REITs). Under this sentence, pension schemes will qualify

for the zero rate of withholding tax with respect to dividends paid by such pooled investment

schemes, provided that the pension scheme holds an interest of not more than 10 percent in the

pooled investment vehicle. Other investors will qualify for the 15 percent maximum rate of

withholding tax if one of three conditions is met. First, the dividend may qualify for the 15

percent rate of withholding tax if the beneficial owner is an individual holding an interest in the

pooled investment vehicle of not more than 10 percent. Second, the dividend may qualify for the

15 percent rate of withholding tax 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 stock of the pooled investment vehicle. Third, the dividend may qualify

for the 15 percent rate of withholding tax if the beneficial owner of the dividend is a person

holding an interest in the pooled investment vehicle of not more than 10 percent and the vehicle

is “diversified.” The term “diversified” is defined in subparagraph (c) of paragraph 10.

Under this definition, a pooled investment vehicle such as a REIT will be considered

diversified if the value of no single interest in real property exceeds 10 percent of the vehicle’s

total interests in real property. For purposes of this rule, foreclosure property is not considered an

interest in real property. With respect to partnership interests held by a pooled investment

vehicle, the vehicle will be treated as owning directly a proportionate share of the interests in real

property held by the partnership.

The restrictions set out above are intended to prevent the use of these entities to gain

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

Contracting State. For example, a company resident in the United Kingdom that wishes to hold a

diversified portfolio of U.S. corporate shares could hold the portfolio directly and pay a U.S.

withholding tax at a rate of 15 percent on all of the dividends that it receives. Alternatively, it

could hold the same diversified portfolio by purchasing 10 percent or more of the interests in a

RIC. If the RIC is a pure conduit, there may be no U.S. tax cost to interposing the RIC in the

chain of ownership. Absent the special rule in paragraph 4, such use of the RIC could transform

portfolio dividends, taxable in the United States under the Convention at a 15 percent rate of

withholding tax, into direct investment dividends taxable at a zero or 5 percent rate of

withholding tax.

Similarly, a resident of the United Kingdom directly holding U.S. real property would

pay U.S. tax either at a 30 percent rate of withholding tax on the gross income or at graduated

rates on the net income. 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 that otherwise would be imposed. Paragraph 4

prevents this result and thereby avoids a disparity between the taxation of direct real estate

investments and real estate investments made through REIT conduits. In the cases covered by the

exceptions, the holding in the REIT is not considered the equivalent of a direct holding in the

underlying real property.

Paragraph 5

Paragraph 5 excludes from the general source country limitations under paragraph 2 and

3 dividends paid with respect to holdings that form part of the business property of a permanent

establishment situated in the source country. Such dividends will be taxed on a net basis using

the rates and rules of taxation generally applicable to residents of the State in which the

permanent establishment is located, as modified by the Convention. An example of dividends

paid with respect to the business property of a permanent establishment would be dividends

derived by a dealer in stock or securities from stock or securities that the dealer held for sale to

customers.

In the case of a permanent establishment that once existed in the State but that no longer

exists, the provisions of paragraph 5 also apply, by virtue of paragraph 7 of Article 7 (Business

Profits), to dividends that would be attributable to such a permanent establishment if it did exist

in the year of payment or accrual. See the Technical Explanation of paragraph 7 of Article 7.

Paragraph 6

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

restricted by paragraph 6 to cases in which the dividends are paid to a resident of that State or are

attributable to a permanent establishment 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 6, 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 (Taxes Covered). Accordingly,

under the provisions of Article 7 (Business Profits), the United States may not impose those

taxes on the income of a resident of the other State except to the extent that income is attributable

to a permanent establishment in the United States. Paragraph 6 further confirms the restriction on

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 7

Paragraph 7 permits a State to impose a branch profits tax on a company resident in the

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

"company" is defined in Article 3.

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 (Income from Real Property), or realizes gains

taxable in that State under paragraph 1 of Article 13 (Gains). The tax is limited, however, to the

aforementioned items of income that are included in the "dividend equivalent amount."

As stated in the notes, the term “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. 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

(Income from Real Property), 7 (Business Profits) or 13 (Gains), 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 United States may not impose its branch profits tax on the business profits of a

corporation resident in the United Kingdom 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 (Income from Real Property) or paragraph 1 of Article 13

(Gains).

The United Kingdom currently does not impose a branch profits tax. If the United

Kingdom were to impose such a tax, the base of such a tax would be limited to an amount

analogous to the U.S. dividend equivalent.

The branch profits tax will not be imposed, however, if certain requirements are met. In

general, these requirements provide rules for a branch that parallel the rules for when a dividend

paid by a subsidiary will be subject to exclusive residence-country taxation (i.e., a zero rate of

withholding tax). Accordingly, the branch profits tax may not be imposed in the case of a

company which, before October 1, 1998, was engaged in activities constituting a permanent

establishment (whether or not the permanent establishment was actually profitable during that

period) or to income or gains that are of a type that would be subject to the provisions of Article

6 or paragraph 1 of Article 13. In addition, paragraph 7 does not apply to a company which is a

qualified person by reason of subparagraph (c) of paragraph 2 of Article 23 (Limitation on

Benefits) (i.e., a publicly-traded company). Finally, paragraph 7 does not apply to a company

entitled to benefits with respect to dividends under paragraph 3 (the derivative benefits test) or

paragraph 6 (the competent authority discretionary test) of Article 23 with respect to the dividend

equivalent amount.

Thus, for example, if a U.K. company would be subject to the branch profits tax with

respect to profits attributable to a U.S. branch and not reinvested in that branch, paragraph 7 may

apply to eliminate the branch profits tax if that branch was established in the United States before

October 1, 1998 and the other requirements of the Convention (e.g., Limitation on Benefits) are

met. If, by contrast, a U.K. company that did not have a branch in the United States before

October 1, 1998, takes over after October 1, 1998, the activities of a branch belonging to a third

party, then the branch profits tax would apply, unless the U.K. company is a qualified person

under subparagraph (c) of paragraph 2 of Article 23 or entitled to benefits under paragraph 3 or

paragraph 6 of that Article.

Moreover, the transfer of assets from a branch that meets the requirements for an

exemption under paragraph 7 into a subsidiary that meets the requirements of paragraph 3 should

not change this result. Accordingly, in that case, it is expected that the U.S. competent authority

will exercise its discretion to treat the new parent-subsidiary group as qualified for the zero rate

of withholding tax as well, so long as the U.K. parent meets the 80-percent ownership

requirement of paragraph 3(a) of Article 10 with respect to the subsidiary.

Paragraph 8

Paragraph 8 provides that the branch profits tax permitted by paragraph 7 shall not be

imposed at a rate of withholding tax exceeding the maximum direct investment dividend rate of

withholding tax of five percent. This rule will apply only if the conditions described above in

relation to paragraph 7 are not met.

Paragraph 9

Paragraph 9 provides that Article 10 will not apply to any dividend paid under, or as part

of, a conduit arrangement. The term “conduit arrangement” is defined in subparagraph (n) of

paragraph 1 of Article 3 (General Definitions). As discussed in the Technical Explanation to that

provision, the United States will interpret this rule co-extensively and consistently with U.S.

domestic law, including in particular the rules of regulation section 1.881-3 and other regulations

adopted under the authority of section 7701(l) of the Code.

Paragraph 10

Paragraph 10 provides definitions of certain terms used in Article 10. Subparagraph (a)

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. Finally, a payment

denominated as interest that is made by a thinly capitalized corporation may be treated as a

dividend to the extent that the debt is recharacterized as equity under the laws of the source State.

In the case of the United States, the term dividend includes amounts treated as a dividend

under U.S. law upon the sale or redemption of shares or upon a transfer of shares in a

reorganization. See, e.g., Rev. Rul. 92-85, 1992-2 C.B. 69 (sale of foreign subsidiary's stock to

U.S. sister company is a deemed dividend to extent of subsidiary's and sister's earnings and

profits). Further, a distribution from a U.S. publicly traded limited partnership, which is taxed as

a corporation under U.S. law, is a dividend for purposes of Article 10. However, a distribution by

a limited liability company is not characterized by the United States as a dividend and, therefore,

is not a dividend for purposes of Article 10, provided the limited liability company is not

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

Subparagraphs (b) and (c) define the terms “pooled investment vehicle” and

“diversified,” respectively. These terms are discussed above in connection with paragraph 4 of

Article 10.

Relation to Other Articles

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

saving clause of paragraph 4 of Article 1 (General Scope) permits the United States to tax

dividends received by its residents and citizens, subject to the special foreign tax credit rules of

paragraph 6 of Article 24 (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 23 (Limitation on

Benefits). Thus, if a resident of the United Kingdom is the beneficial owner of dividends paid by

a U.S. company, the shareholder must qualify for treaty benefits under at least one of the tests of

Article 23 in order to receive the benefits of this Article.

Article 11 (Interest)

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

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

Paragraph 1

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

beneficially owned by its residents and arising in the other Contracting State.

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

under the internal law of the State of source. The beneficial owner of the interest for purposes of

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

laws of the State of source. Thus, if interest arising in a Contracting State is received by a

nominee or agent that is a resident of the other State on behalf of a person that is not a resident of

that other State, the interest is not entitled to the benefits of Article 11. However, interest

received by a nominee on behalf of a resident of that other State would be entitled to benefits.

These limitations are confirmed by paragraph 8 of the OECD Commentary to Article 11. See

also paragraph 24 of the OECD Commentary to Article 1.

Paragraph 2

The term "interest" as used in Article 11 is defined in paragraph 2 to include, inter alia,

income from debt claims of every kind, whether or not secured by a mortgage. Penalty charges

for late payment are excluded from the definition of interest. Interest that is paid or accrued

subject to a contingency is within the ambit of Article 11. This includes income from a debt

obligation carrying the right to participate in profits. The term does not, however, include

amounts that are treated as dividends under Article 10 (Dividends).

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

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

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

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

original issue discount ("OID")), which may be wholly or partially realized on the disposition of

a debt instrument (section 1273), (ii) amounts that are imputed interest on a deferred sales

contract (section 483), (iii) amounts treated as interest or OID under the stripped bond rules

(section 1286), (iv) amounts treated as original issue discount under the below-market interest

rate rules (section 7872), (v) a partner's distributive share of a partnership's interest income

(section 702), (vi) the interest portion of periodic payments made under a "finance lease" or

similar contractual arrangement that in substance is a borrowing by the nominal lessee to finance

the acquisition of property, (vii) amounts included in the income of a holder of a residual interest

in a REMIC (section 860E), because these amounts generally are subject to the same taxation

treatment as interest under U.S. tax law, and (viii) interest with respect to notional principal

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

Paragraph 3

Paragraph 3 provides an exception to the exclusive residence taxation rule of paragraph 1

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

establishment in the State of source and the interest is attributable to that permanent

establishment. In such cases the provisions of Article 7 (Business Profits) will apply and the

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

In the case of a permanent establishment that once existed in the State but that no longer

exists, the provisions of paragraph 3 also apply, by virtue of paragraph 7 of Article 7 (Business

Profits), to interest that would be attributable to such a permanent establishment if it did exist in

the year of payment or accrual. See the Technical Explanation of paragraph 7 of Article 7.

Paragraph 4

Paragraph 4 provides that, in cases involving special relationships between persons,

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

would have been made absent such special relationships (i.e., an arm's-length interest payment).

Any excess amount of interest paid remains taxable according to the laws of the United States

and the United Kingdom, respectively, with due regard to the other provisions of the Convention.

Thus, if the excess amount would be treated under the source country's law as a distribution of

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

tax would be subject, if appropriate, to the rate limitations of Article 10 (Dividends).

The notes further clarify the application of this paragraph. As stated there, if the amount

of interest paid exceeds the amount that would have been paid in the absence of a relationship

described in paragraph 4 of Article 11, a Contracting State generally will adjust the amount of

deductible interest paid under the authority of Article 9 and make such other adjustments as are

appropriate. If such an adjustment is made, however, then the Contracting State making such

adjustment will not also impose its domestic rate of withholding tax with respect to such excess

amount. Accordingly, if a U.K. company makes an interest payment to its U.S. parent company,

and the United Kingdom determines that the amount of the interest exceeded an arm's-length

amount, the United Kingdom will deny a deduction for the excess amount. It will not, however,

treat the excess amount as interest subject to the 20 percent withholding rate applicable to

interest paid by U.K. companies.

The term "special relationship" is not defined in the Convention. In applying this

paragraph the United States considers the term to include the relationships described in Article 9

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

section 482 of the Code.

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

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

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

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

paragraph 2. Consistent with Article 9 (Associated Enterprises), the United States would apply

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

Paragraph 5

Paragraph 5 provides an anti-abuse exception to paragraph 1 for so-called “contingent

interest.” Under subparagraph (a) of paragraph 5, interest arising in one of the Contracting States

that is determined by reference to the receipts, sales, income, profits or other cash flow of the

debtor or a related person, to any change in the value of any property of the debtor or a related

person or to any dividend, partnership distribution or similar payment made by the debtor to a

related person, also may be taxed in the Contracting State in which it arises, and according to the

laws of that State. If the beneficial owner is a resident of the other Contracting State, however,

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

prescribed in subparagraph (b) of paragraph 2 of Article 10 (Dividends)).

Subparagraph (b) of paragraph 5 provides an exception to the anti-abuse rule stated in

subparagraph (a). Under subparagraph (b), the anti-abuse rule will not apply to any interest

solely because it is paid under an arrangement providing for a reduction or an increase in

payment amount in the event of an improvement or deterioration, respectively, in the factors by

reference to which the amount of interest payable is determined. Thus, for example, interest will

not become contingent interest solely by virtue of a provision in the agreement that calls for an

increase in the rate charged upon the deterioration of the credit position of the borrower.

Paragraph 6

Paragraph 6 provides an anti-abuse exception to paragraph 1 for excess inclusions from

U.S. real estate mortgage investment conduits (“REMICs”). Paragraph 6 serves as a backstop to

Code section 860G(b). That section generally requires that a foreign person holding a residual

interest in a REMIC take into account for U.S. tax purposes "any excess inclusion" and "amounts

includible . . . [under the REMIC provisions] when paid or distributed (or when the interest is

disposed of)

. . . ."

Without a full tax at source, non-U.S. transferees of residual interests would have a

competitive advantage over U.S. transferees at the time these interests are initially offered.

Absent this rule, the United States 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 such interests. In many cases, the transfer to the

foreign person is simply disregarded under Reg. § 1.860G-3. Paragraph 6 also serves to indicate

that excess inclusions from REMICs are not considered “other income” subject to Article 22

(Other Income) of the Convention.

Paragraph 6 is analogous to subparagraph (b) of paragraph 5 of the U.S. Model, except

that in the Convention the provision is drafted to apply bilaterally. Thus, for example, paragraph

6 does not refer to the long-term Federal rate used to determine the amount of an excess

inclusion, but rather to “the return on comparable debt instruments as specified by the domestic

law of that State.” Nevertheless, for U.S. tax purposes, the withholding tax imposed “to the

extent that the amount of interest paid exceeds the return on comparable debt instruments as

specified by the domestic law of that State” is the withholding tax that would be imposed upon

an excess inclusion with respect to a residual interest in a REMIC under section 860G(b).

Paragraph 7

Paragraph 7 provides that Article 11 will not apply to any interest paid under, or as part

of, a conduit arrangement. The term “conduit arrangement” is defined in subparagraph (n) of

paragraph 1 of Article 3 (General Definitions). As discussed in the Technical Explanation to that

provision, the United States will interpret this rule co-extensively and consistently with U.S.

domestic law, including in particular the rules of regulation section 1.881-3 and other regulations

adopted under the authority of section 7701(l) of the Code.

Relation to Other Articles

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

saving clause of paragraph 4 of Article 1 (General Scope) permits the United States to tax its

residents and citizens, subject to the special foreign tax credit rules of paragraph 6 of Article 24

(Relief from Double Taxation), as if the Convention had not come into force.

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

Benefits). Thus, if a resident of the United Kingdom is the beneficial owner of interest paid by a

U.S. corporation, the shareholder must qualify for treaty benefits under at least one of the tests of

Article 23 in order to receive the benefits of this Article.

Article 12 (Royalties)

Article 12 provides rules for the taxation of royalties arising in one Contracting State and

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

Paragraph 1

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

beneficially owned by its residents and arising in the other Contracting State.

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

under the internal law of the State of source. The beneficial owner of the royalty for purposes of

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

laws of the State of source. Thus, if a royalty arising in a Contracting State is received by a

nominee or agent that is a resident of the other State on behalf of a person that is not a resident of

that other State, the royalty is not entitled to the benefits of Article 12. However, a royalty

received by a nominee on behalf of a resident of that other State would be entitled to benefits.

These limitations are confirmed by paragraph 4 of the OECD Commentary to Article 12. See

also paragraph 24 of the OECD Commentary to Article 1.

Paragraph 2

Paragraph 2 defines the term “royalties,” as used in Article 12, to include any

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

other work (such as computer software and cinematographic films); for the use of, or the right to

use, any patent, trademark, design or model, plan, secret formula or process, or other like right or

property; or for information concerning industrial, commercial, or scientific experience. The

term “royalties” also includes gain derived from the alienation of any right or property that

would give rise to royalties, to the extent the gain is contingent on the productivity, use, or

further alienation thereof. Gains that are not so contingent are dealt with under Article 13

(Gains). The term “royalties,” however, does not include income from leasing personal property.

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

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

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

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

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

1969-2 C.B. 301.

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

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

definition of royalties. It is intended that, with respect to any subsequent technological advances

in the field of radio or television broadcasting, consideration received for the use of such

technology will also be included in the definition of royalties.

If an artist who is resident in one Contracting State records a performance in the other

Contracting State, retains a copyrighted interest in a recording, and receives payments for the

right to use the recording based on the sale or public playing of the recording, then the right of

such other Contracting State to tax those payments is governed by Article 12. See Boulez v.

Commissioner, 83 T.C. 584 (1984), aff'd, 810 F.2d 209 (D.C. Cir. 1986). By contrast, if the artist

earns in the other Contracting State income covered by Article 16 (Entertainers and Sportsmen),

for example, endorsement income from the artist’s attendance at a film screening, and if such

income also is attributable to one of the rights described in Article 12 (e.g., the use of the artist’s

photograph in promoting the screening), Article 16 and not Article 12 is applicable to such

income.

Computer software generally is protected by copyright laws around the world. Under the

Convention, consideration received for the use, or the right to use, computer software is treated

either as royalties or as business profits, depending on the facts and circumstances of the

transaction giving rise to the payment.

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

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

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

license for copyright law purposes is not dispositive. For example, a typical retail sale of "shrink

wrap" software generally will not be considered to give rise to royalty income, even though for

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

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

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

considered business profits.

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

"know-how") has the meaning ascribed to it in paragraph 11 of the Commentary to Article 12 of

the OECD Model. Consistent with that meaning, the term may include information that is

ancillary to a right otherwise giving rise to royalties, such as a patent or secret process.

Know-how also may include, in limited cases, technical information that is conveyed

through technical or consultancy services. It does not include general educational training of the

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

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

paragraph 11 of the Commentary to Article 12 of the OECD Model, the term "royalties" does not

include payments received as consideration for after-sales service, for services rendered by a

seller to a purchaser under a guarantee, or for pure technical assistance.

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

architectural, engineering, legal, managerial, medical, software development services). For

example, income from the design of a refinery by an engineer (even if the engineer employed

know-how in the process of rendering the design) or the production of a legal brief by a lawyer is

not income from the transfer of know-how taxable under Article 12, but is income from services

taxable under either Article 7 (Business Profits) or Article 14 (Income from Employment).

Professional services may be embodied in property that gives rise to royalties, however. Thus, if

a professional contracts to develop patentable property and retains rights in the resulting property

under the development contract, subsequent license payments made for those rights would be

royalties.

Paragraph 3

Paragraph 3 provides an exception to the rules of paragraph 1 that limit the rate of source

country taxation of royalties. This paragraph applies in cases where the beneficial owner of the

royalties carries on business through a permanent establishment in the State of source and the

royalties are attributable to that permanent establishment. In such cases the provisions of Article

7 (Business Profits) will apply.

The provisions of paragraph 7 of Article 7 (Business Profits) apply to this paragraph. For

example, royalty income that is attributable to a permanent establishment and that accrues during

the existence of the permanent establishment, but is received after the permanent establishment

no longer exists, remains taxable under the provisions of Article 7 (Business Profits), and not

under this Article.

Paragraph 4

Paragraph 4 provides that in cases involving special relationships between the payer and

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

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

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

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

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

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

to the rate limitations of Article 10 (Dividends).

The notes further clarify the application of this paragraph. As stated there, if the amount

of royalties paid exceeds the amount that would have been paid in the absence of a relationship

described in paragraph 4 of Article 12, a Contracting State generally will adjust the amount of

deductible royalties paid under the authority of Article 9 and make such other adjustments as are

appropriate. If such an adjustment is made, however, then the Contracting State making such

adjustment will not also impose its domestic rate of withholding tax with respect to such excess

amount. Accordingly, if a U.K. company makes a royalty payment to its U.S. parent company,

and the United Kingdom determines that the amount of the royalty exceeded an arm's-length

amount, the United Kingdom will deny a deduction for the excess amount. It will not, however,

treat the excess amount as a royalty subject to the 22 percent withholding rate applicable to

royalties paid by U.K. companies.

Paragraph 5

Paragraph 5 provides that Article 12 will not apply to any royalty paid under, or as part

of, a conduit arrangement. The term “conduit arrangement” is defined in subparagraph (n) of

paragraph 1 of Article 3 (General Definitions). As discussed in the Technical Explanation to that

provision, the United States will interpret this rule co-extensively and consistently with U.S.

domestic law, including in particular the rules of regulation section 1.881-3 and other regulations

adopted under the authority of section 7701(l) of the Code.

Relation to Other Articles

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

saving clause of paragraph 4 of Article 1 (General Scope) permits the United States to tax its

residents and citizens, subject to the special foreign tax credit rules of paragraph 6 of Article 24

(Relief from Double Taxation), as if the Convention had not come into force.

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

Benefits). Thus, if a resident of the United Kingdom is the beneficial owner of royalties paid by a

U.S. corporation, the shareholder must qualify for treaty benefits under at least one of the tests of

Article 23 in order to receive the benefits of this Article.

Article 13 (Gains)

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

alienation of property to the State of residence or the State of source and defines the terms

necessary to apply the Article.

Paragraph 1

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

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

permits the United States to apply section 897 of the Code to tax gains derived by a resident of

the United Kingdom that are attributable to the alienation of real property situated in the United

States (as defined in paragraph 2). Gains attributable to the alienation of real property include

gains from any other property that is treated as a real property interest within the meaning of

paragraph 2.

Paragraph 2

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

include assets that might not be considered real property under the definition of subparagraph

1(m) of Article 3 (Definitions), which is limited to interests in the real property itself. For

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

includes exploration and exploitation rights with respect to the sea bed and sub-soil of that other

State and their natural resources, including rights to interests in or the benefit of such assets. In

the case of the United States, such rights would be treated as real property pursuant to section

897 so the specific rule in Article 13 is not necessary. Such rights would not be treated as real

property under U.K. domestic law, so the rule is necessary to provide consistent treatment.

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

includes a “United States real property interest,” when the United States is the other Contracting

State under paragraph 1. The term “United States real property interest” includes shares in a U.S.

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

testing dates. See I.R.C. § 897(c). The term “United States real property interest” also

encompasses an interest in a foreign company that has elected to be treated as a U.S. company

for this purpose. See I.R.C. § 897(i). In applying paragraph 1 the United States will look through

capital gain distributions made by a REIT. Accordingly, distributions made by a REIT are

taxable under paragraph 1 of Article 13 (not under Article 10 (Dividends)) when they are

attributable to gains derived from the alienation of real property.

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

includes, when the United Kingdom is the other Contracting State, shares, including rights to

acquire shares, other than shares in which there is regular trading on a stock exchange, deriving

their value or the greater part of their value directly or indirectly from real property situated in

the United Kingdom. The term also includes an interest in a partnership or trust, to the extent the

assets of the partnership or trust consist of real property situated in the United Kingdom, or of

shares referred to in the preceding sentence.

Paragraph 3

Paragraph 3 of Article 13 deals with the taxation of certain gains from the alienation of

property, other than real property, forming part of the business property of a permanent

establishment that an enterprise of a Contracting State has in the other Contracting State. This

also includes gains from the alienation of such a permanent establishment (alone or with the

whole enterprise). Such gains may be taxed in the State in which the permanent establishment is

located.

A resident of the United Kingdom that is a partner in a partnership doing business in the

United States generally will have a permanent establishment in the United States as a result of

the activities of the partnership, assuming that the activities of the partnership rise to the level of

a permanent establishment. Rev. Rul. 91-32, 1991-1 C.B. 107. Further, under paragraph 3, the

United States generally may tax a partner's distributive share of income realized by a partnership

on the disposition of personal (movable) property forming part of the business property of the

partnership in the United States.

The gains subject to paragraph 3 may be taxed in the State in which the permanent

establishment is located, regardless of whether the permanent establishment exists at the time of

the alienation. This rule incorporates the rule of section 864(c)(6) of the Code. Accordingly,

income that is attributable to a permanent establishment, but that is deferred and received after

the permanent establishment no longer exists, may nevertheless be taxed by the State in which

the permanent establishment was located.

Paragraph 4

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

from the alienation of ships or aircraft operated in international traffic by the enterprise

alienating the ship or aircraft, from containers used in international traffic, and from property

(other than real property) pertaining to the operation or use of such ships, aircraft, or containers.

Under paragraph 4, such income is taxable only in the Contracting State in which the

alienator is resident. Notwithstanding paragraph 3, the rules of this paragraph apply even if the

income is attributable to a permanent establishment maintained by the enterprise in the other

Contracting State. This result is consistent with the allocation of taxing rights under Article 8

(Shipping and Air Transport).

Paragraph 5

Paragraph 5 grants to the State of residence of the alienator the exclusive right to tax

gains from the alienation of property other than property referred to in paragraphs 1 through 4.

For example, gain derived from shares (other than shares described in paragraphs 2 or 3), debt

instruments and various financial instruments, may be taxed only in the State of residence, to the

extent such income is not otherwise characterized as income taxable under another article (e.g.,

Article 10 (Dividends) or Article 11 (Interest)). Similarly, gain derived from the alienation of

tangible personal property, other than tangible personal property described in paragraph 3, may

be taxed only in the State of residence of the alienator. Gain derived from the alienation of any

property, such as a patent or copyright, that produces income taxable under Article 12

(Royalties) is taxable under Article 12 and not under this article, provided that such gain is of the

type described in subparagraph 3(b) of Article 12 (i.e., it 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.

Paragraph 6

Paragraph 6 allows each Contracting State to tax gains derived by certain non-residents

who used to be residents of that Contracting State. The rule is included in the Convention in

order to allow the United Kingdom to apply its domestic law regarding such sales. Under U.K.

law, a former resident who re-establishes residence in the United Kingdom within five years will

remain subject to tax in the United Kingdom on any gains realized during the period of non-

residence. The analogous U.S. rules of section 877 are preserved by paragraph 6 of Article 1

(General Scope).

Although the rules allow each of the Contracting States to apply their domestic anti-abuse

rules, the foreign tax credit rules provided in paragraphs 2 and 4 of Article 24 (Relief from

Double Taxation) ensure that the Contracting State applying an anti-abuse rule to a resident of

the other Contracting State maintains only a residual right to tax. The primary right to tax

remains with the country of residence. Accordingly, pursuant to subparagraph (b) of paragraph 2

of Article 24, if the gains subject to this rule are derived while the former U.K. resident was a

resident of the United States, then such gains are considered to be gains from sources within the

United States. Pursuant to paragraph 4 of Article 24, the United Kingdom will grant a foreign tax

credit for U.S. tax imposed upon those gains.

Example.

In year 1, U.K. resident A purchases stock in a Country X company for

$1,000. A moves to the United States in year 2, when the fair market value of the stock is

$2,000. In year 3, while A is still a U.S. resident, A sells the Country X stock. In year 4, after

the sale of the Country X stock, A moves back to the United Kingdom and re-establishes

residence. Under Article 13 (6), both the United States and the United Kingdom may tax the gain

on the sale of the property in year 3. Under Article 24, however, the gain from the sale of the

Country X stock is deemed to be from sources within the United States because A was a U.S.

resident when the sale occurred and gains from the stock could be taxed by the United Kingdom

only pursuant to paragraph 6 of Article 13 (that is, the stock could not be taxed under paragraph

1 or 3 of Article 13). Thus the United Kingdom is required to provide a foreign tax credit for

U.S. taxes paid with respect to gain on the disposition of the Country X stock.

Relation to Other Articles

Notwithstanding the foregoing limitations on taxation of certain gains by the State of

source, the saving clause of paragraph 4 of Article 1 (General Scope) permits the United States

to tax its citizens and residents as if the Convention had not come into effect. Thus, any

limitation in this Article on the right of the United States to tax gains does not apply to gains of a

U.S. citizen or resident.

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

Benefits). Thus, only a resident of a Contracting State that satisfies one of the conditions in

Article 23 is entitled to the benefits of this Article.

Article 14 (Income from Employment)

Article 14 apportions taxing jurisdiction over remuneration derived by a resident of a

Contracting State as an employee between the States of source and residence.

Paragraph 1

The general rule of Article 14 is contained in paragraph 1. Remuneration derived by a

resident of a Contracting State as an employee may be taxed by the State of residence, and the

remuneration also may be taxed by the other Contracting State to the extent derived from

employment exercised (i.e., services performed) in that other Contracting State. Paragraph 1 also

provides that the more specific rules of Articles 15 (Directors' Fees), 17 (Pensions, Social

Security, Annuities, Alimony and Child Support), and 19 (Government Service) apply in the case

of employment income described in one of those articles. Thus, even though the State of source

has a right to tax employment income under Article 14, it may not have the right to tax that

income under the Convention if the income is described, for example, in Article 17 (Pensions,

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

under the provisions of that article.

The Convention refers to “salaries, wages and other similar remuneration,” while the U.S.

Model refers to “salaries, wages and other remuneration.” The U.S. Model language was

intended to make clear that Article 14 applies to any form of compensation, including payments

in kind, regardless of whether the remuneration is “similar” to salaries or wages. The U.S. Model

language is no longer necessary because of a recent addition to the Commentary to Article 16 of

the OECD Model; paragraph 1.1 now confirms that payments in kind are covered by the Article.

Consistently with section 864(c)(6) of the Code, Article 14 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 14 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 14 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.

The notes contain special rules regarding employee share or stock options. As a general

matter, the notes clarify that any benefits, income or gains enjoyed by employees under share- or

stock-option plans are regarded as “other similar remuneration” subject to Article 14. The notes

also provide a specific rule for allocation of taxing rights where: (1) an employee has been

granted a stock or share option in the course of employment in one of the Contracting States, (2)

he has exercised that employment in both States during the period between grant and exercise of

the option, (3) he remains in that employment at the date of the exercise, and (4), under the

domestic law of the Contracting States, he would be taxable by both Contracting States in respect

of the option gain. In this situation, each Contracting State may tax as State of source only that

portion of the option gain which relates to the period or periods between the grant and the

exercise of the option during which the individual has exercised the employment in that

Contracting State. The portion attributable to a Contracting State will be determined by

multiplying the gain by a fraction, the numerator of which is the number of days during which

the employee exercised his employment in that State and the denominator of which will be the

total number of days between grant and exercise of the option. The competent authorities of the

Contracting States will endeavor to resolve by mutual agreement any difficulties or doubts

arising as to the interpretation or application of Article 14 and Article 24 (Relief from Double

Taxation) in relation to employee stock or share option plans.

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: (1) the individual is present in the other Contracting State for a period or periods not

exceeding 183 days in any 12-month period that begins or ends during the relevant (i.e., the year

in which the services are performed) calendar year; (2) the remuneration is paid by, or on behalf

of, an employer who is not a resident of that other Contracting State; and (3) the remuneration is

not borne by a permanent establishment that the employer has in that other State. In order for the

remuneration to be exempt from tax in the source State, all three conditions must be satisfied.

This exception is identical to that set forth in the U.S. and OECD Models.

The 183-day period in condition (a) is to be measured using the "days of physical

presence" method. Under this method, the days that are counted include any day in which a part

of the day is spent in the host country. See Rev. Rul. 56-24, 1956-1 C.B. 851. Thus, days that

are counted include the days of arrival and departure; weekends and holidays on which the

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

before, during or after the employment period, unless the individual's presence before or after the

employment can be shown to be independent of his presence there for employment purposes; and

time during periods of sickness, training periods, strikes, etc., when the individual is present but

not working. If illness prevented the individual from leaving the country in sufficient time to

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

while in transit between two points outside the host country is not counted. These rules are

consistent with the description of the 183-day period in paragraph 5 of the Commentary to

Article 15 in the OECD Model.

Conditions (b) and (c) are intended to ensure that a Contracting State will not be required

to allow a deduction to the payer for compensation paid and at the same time to exempt the

employee on the amount received. Accordingly, if a foreign person pays the salary of an

employee who is employed in the host State, but a host State corporation or permanent

establishment reimburses the payer with a payment that can be identified as a 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 is understood to

encompass all expenses that economically are incurred and not merely expenses that are

currently deductible for tax purposes. Accordingly, the expenses referred to include expenses

that are capitalizable as well as those that are currently deductible. Further, salaries paid by

residents that are exempt from income taxation may be considered to be borne by a permanent

establishment notwithstanding the fact that the expenses will be neither deductible nor

capitalizable since the 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. Such remuneration may be taxed only in the State of residence of the

employee if the services are performed as a member of the regular complement of the ship or

aircraft. The "regular complement" includes the crew. In the case of a cruise ship, for example, it

may also include others, such as entertainers, lecturers, etc., employed by the shipping company

to serve on the ship throughout its voyage. The use of the term "regular complement" is intended

to clarify that a person who exercises his employment as, for example, an insurance salesman

while aboard a ship or aircraft is not covered by this paragraph.

Relation to other Articles

Notwithstanding the foregoing limitations on taxation of certain income by the State of

source, the saving clause of paragraph 4 of Article 1 (General Scope) permits the United States

to tax its citizens and residents as if the Convention had not come into effect. Thus, any

limitation in this Article on the right of the United States to tax income from employment does

not apply to income of a U.S. citizen or resident.

Article 15 (Directors' Fees)

This Article provides that a Contracting State may tax the fees and other compensation

paid by a company that is a resident of that State for services performed in that State by a

resident of the other Contracting State in his capacity as a director of the company. This rule is

an exception to the more general rules of Articles 7 (Business Profits) and 14 (Income from

Employment). Thus, for example, in determining whether a director's fee paid to a non-employee

director is subject to tax in the country of residence of the company, it is not relevant to establish

whether the fee is attributable to a permanent establishment in that State.

The analogous OECD provision reaches a different result in certain cases. Under the

OECD Model provision, a resident of one Contracting State who is a director of a company that

is resident in the other Contracting State is subject to tax in that other State in respect of his

directors' fees regardless of where the services are performed. The United States has entered a

reservation with respect to the OECD provision. Under this Convention, the State of residence of

the company may tax nonresident directors with no time or dollar threshold, but only with

respect to remuneration for services performed in that State.

The Convention refers to “similar payments,” while the U.S. Model refers to “other

compensation.” The U.S. Model language was intended to make clear that Article 15 applies to

any form of compensation, including payments in kind, regardless of whether the remuneration

is “similar” to directors' fees. The U.S. Model language is no longer necessary because of a

recent addition to the Commentary to Article 16 of the OECD Model; paragraph 1.1 now

confirms that payments in kind are covered by the Article.

Article 15 is subject to the saving clause of paragraph 4 of Article 1 (General Scope).

Thus, if a U.S. citizen who is a resident of the United Kingdom is a director of a U.S.

corporation, the United States may tax his full remuneration regardless of where he performs his

services.

Article 16 (Entertainers and Sportsmen)

This Article deals with the taxation in a Contracting State of entertainers and sportsmen

resident in the other Contracting State from the performance of their services as such. The

Article applies both to the income of an entertainer or sportsman who performs services on his

own behalf and one who performs services on behalf of another person, either as an employee of

that person, or pursuant to any other arrangement. The rules of this Article take precedence, in

some circumstances, over those of Articles 7 (Business Profits) and 14 (Income from

Employment).

This Article applies only with respect to the income of entertainers and sportsmen. Others

involved in a performance or athletic event, such as producers, directors, technicians, managers,

coaches, etc., remain subject to the provisions of Articles 7 and 14. In addition, except as

provided in paragraph 2, income earned by juridical persons is not covered by Article 16.

Paragraph 1

Paragraph 1 describes the circumstances in which a Contracting State may tax the

performance income of an entertainer or sportsman who is a resident of the other Contracting

State. Under the paragraph, income derived by an individual resident of a Contracting State from

activities as an entertainer or sportsman exercised in the other Contracting State may be taxed in

that other State if the amount of the gross receipts derived by the performer exceeds $20,000 (or

its equivalent in pounds sterling) for the taxable year. The $20,000 includes expenses reimbursed

to the individual or borne on his behalf. If the gross receipts exceed $20,000, the full amount, not

just the excess, may be taxed in the State of performance.

The OECD Model provides for taxation by the country of performance of the

remuneration of entertainers or sportsmen with no dollar or time threshold. This Convention

introduces 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.

Tax may be imposed under paragraph 1 even if the performer would have been exempt

from tax under Article 7 (Business Profits) or 14 (Income from Employment). On the other hand.

if the performer would be exempt from host-country tax under Article 16, but would be taxable

under either Article 7 or 14, tax may be imposed under either of those Articles. Thus, for

example, if a performer derives remuneration from his activities in an independent capacity, and

the performer does not have a permanent establishment in the host State, he may be taxed by the

host State in accordance with Article 16 if his remuneration exceeds $20,000 annually, despite

the fact that he generally would be exempt from host State taxation under Article 7. However, a

performer who receives less than the $20,000 threshold amount and therefore is not taxable

under Article 17, nevertheless may be subject to tax in the host country under Article 7 or 14 if

the tests for host-country taxability under the relevant Article are met. For example, if an

entertainer who is an independent contractor earns $14,000 of income in a State for the calendar

year, but the income is attributable to his permanent establishment in the State of performance,

that State may tax his income under Article 7.

Since it frequently is not possible to know until year-end whether the income an

entertainer or sportsman derived from performances in a Contracting State will exceed $20,000,

nothing in the Convention precludes that Contracting State from withholding tax during the year

and refunding it after the close of the year if the taxability threshold has not been met.

As explained in paragraph 9 of the Commentary to Article 17 of the OECD Model,

Article 16 of the Convention applies to all income connected with a performance by the

entertainer, such as appearance fees, award or prize money, and a share of the gate receipts.

Income derived from a Contracting State by a performer who is a resident of the other

Contracting State from other than actual performance, such as royalties from record sales and

payments for product endorsements, is not covered by this Article, but by other articles of the

Convention, such as Article 12 (Royalties) or Article 7 (Business Profits). For example, if an

entertainer receives royalty income from the sale of live recordings, the royalty income would be

exempt from source state tax under Article 12, even if the performance was conducted in the

source country, although the entertainer could be taxed in the source country with respect to

income from the performance itself under Article 16 if the dollar threshold is exceeded.

In determining whether income falls under Article 16 or another article, the controlling

factor will be whether the income in question is predominantly attributable to the performance

itself or to other activities or property rights. For instance, a fee paid to a performer for

endorsement of a performance in which the performer will participate would be considered to be

so closely associated with the performance itself that it normally would fall within Article 16.

Similarly, a sponsorship fee paid by a business in return for the right to attach its name to the

performance would be so closely associated with the performance that it would fall under Article

16 as well. As indicated in paragraph 9 of the Commentary to Article 17 of the OECD Model,

however, a cancellation fee would not be considered to fall within Article 16 but would be dealt

with under Article 7 (Business Profits) or 14 (Income from Employment).

As indicated in paragraph 4 of the Commentary to Article 17 of the OECD Model, where

an individual fulfills a dual role as performer and non-performer (such as a player-coach or an

actor-director), but his role in one of the two capacities is negligible, the predominant character

of the individual's activities should control the characterization of those activities. In other cases

there should be an apportionment between the performance-related compensation and other

compensation.

Consistently with Article 14 (Income from Employment), Article 16 also applies

regardless of the timing of actual payment for services. Thus, a bonus paid to a resident of a

Contracting State with respect to a performance in the other Contracting State during a particular

taxable year would be subject to Article 16 for that year even if it was paid after the close of the

year.

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) or

income from employment (Article 14). Thus, even if the "employer" has no permanent

establishment in the host country, its income may be subject to tax there under the provisions of

paragraph 2. Taxation under paragraph 2 is on the person providing the services of the

performer. This paragraph does not affect the rules of paragraph 1, which apply to the performer

himself. The income taxable by virtue of paragraph 2 is reduced to the extent of salary payments

to the performer, which fall under paragraph 1.

For purposes of paragraph 2, income is deemed to accrue to another person (i.e., the

person providing the services of the performer) if that other person has control over, or the right

to receive, gross income in respect of the services of the performer. Direct or indirect

participation in the profits of a person may include, but is not limited to, the accrual or receipt of

deferred remuneration, bonuses, fees, dividends, partnership income or other income or

distributions.

Paragraph 2 does not apply if the person receiving the income 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 the United Kingdom, and promoters of the

performance in the United Kingdom pay the circus, which, in turn, pays salaries to the circus

performers. The circus is determined to have no permanent establishment in the United

Kingdom. Since the circus performers do not participate in the profits of the circus, but merely

receive their salaries out of the circus' gross receipts, the circus is protected by Article 7 and its

income is not subject to host-country tax. Whether the salaries of the circus performers are

subject to host-country tax under this Article depends on whether they exceed the $20,000

threshold in paragraph 1.

Since pursuant to Article 1 (General Scope) the Convention only applies to persons who

are residents of one of the Contracting States, if the star company is not a resident of one of the

Contracting States, then taxation of the income is not affected by Article 16 or any other

provision of the Convention.

This exception from paragraph 2 for non-abusive cases is not found in the OECD Model.

The United States has entered a reservation to the OECD Model on this point.

Relationship to other Articles

This Article is subject to the provisions of the saving clause of paragraph 4 of Article 1

(General Scope). Thus, if an entertainer or a sportsman who is resident in the United Kingdom 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 6 of Article 24 (Relief from Double Taxation). In

addition, benefits of this Article are subject to the provisions of Article 23 (Limitation on

Benefits).

Article 17 (Pensions, Social Security, Annuities, Alimony, and Child Support)

This article deals with the taxation of private (i.e., non-government service) pensions and

annuities, social security benefits, alimony and child support payments.

Paragraph 1

Paragraph 1 provides as a general rule, in subparagraph (a), that the State of residence of

the beneficial owner has the exclusive right to tax pensions and other similar remuneration. For

this purpose, a payment is treated as a pension or other similar remuneration if it is a payment

under a pension scheme, as defined in sub-paragraph (o) of paragraph 1 of Article 3 (General

Definitions). While the term "pension" generally would include both periodic and lump-sum

payments, paragraph 2 of the Article provides specific rules to deal with lump-sum payments, so

they are not subject to the general rule of paragraph 1.

However, the State of residence, under subparagraph (b), must exempt from tax any

amount of such pensions or other similar remuneration that would be exempt from tax in the

State in which the pension scheme is established if the recipient were a resident of that State.

Thus, for example, a distribution from a U.S. "Roth IRA" to a U.K. resident would be exempt

from tax in the United Kingdom to the same extent the distribution would be exempt from tax in

the United States if it were distributed to a U.S. resident. The same is true with respect to

distributions from a traditional IRA to the extent that the distribution represents a return of non-

deductible contributions. Similarly, if the distribution were not subject to tax when it was “rolled

over” into another U.S. IRA (but not, for example, to a U.K. pension scheme), then the

distribution would be exempt from tax in the United Kingdom.

Paragraph 2

Paragraph 2 is intended to deal with a particular type of double non-taxation that arose

under the prior Convention because the United Kingdom does not tax lump-sum distributions

from pension funds. Under the prior Convention, a lump-sum payment was treated in the same

way as any other pension, and was taxable only in the country of residence of the beneficial

owner. Accordingly, a person who anticipated receiving a lump-sum distribution from a U.S.

pension scheme with respect to employment in the United States could avoid U.S. withholding

tax on the distribution by establishing residence in the United Kingdom for the year in which he

received the distribution. The person would not be subject to tax in either the United States or

the United Kingdom with respect to the lump-sum distribution, resulting in a significant

windfall.

Paragraph 2 prevents this unanticipated benefit by providing that, notwithstanding the

exclusive residence-country taxation of paragraph 1, any lump-sum payment derived by a

resident of a Contracting State from a pension scheme established in the other Contracting State

shall be taxable in that other State.

Paragraph 3

Paragraph 3 provides for exclusive residence-country taxation of social security benefits.

Like the prior Convention, but unlike the U.S. Model, the Convention 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 4

Under paragraph 4, any annuity that is derived and beneficially owned by an annuitant

who is a resident of a Contracting State is taxable only in that State. The term “annuity” means a

stated sum paid periodically at stated times during the life of the annuitant, or during a specified

or ascertainable period of time, under an obligation to make the payments in return for adequate

and full consideration (other than in return for services rendered). The term "annuity" does not

include any distributions from a pension scheme that are described in paragraph 1. An annuity

received in consideration for services rendered would be treated as deferred compensation and

generally taxable in accordance with Article 7 (Business Profits) or Article 14 (Income from

Employment), not Article 17.

Paragraph 5

Paragraph 5 generally covers periodic payments made pursuant to a written separation

agreement or a decree of divorce, separate maintenance, or compulsory support. Paragraph 5

exempts from tax in both Contracting States such payments made by a resident of one of the

Contracting States to a resident of the other Contracting State, unless the payments are

deductible in the payer’s State of residence. Thus, child support payments from a resident of a

Contracting State to a resident of the other Contracting State are taxable in neither Contracting

State, assuming that the payments are not deductible to the payer. By contrast, deductible

alimony payments made by a resident of a Contracting State to a resident of the other

Contracting State are taxable, exclusively, in the recipient’s State of residence. Although the

structure of the Article is different, the results are the same as under the U.S Model provisions.

Relation to other Articles

Subparagraph 1(a) is subject to the saving clause of paragraph 4 of Article 1 (General

Scope) while subparagraph 1(b) is not, by reason of the exception in subparagraph 5(a) of Article

1. Thus, a U.S. citizen who is a resident of the United Kingdom and receives a pension will be

subject to U.S. tax on the payment, notwithstanding the rules in those paragraphs that give the

State of residence of the recipient the exclusive taxing right. However, a U.S. citizen who

receives a distribution from a pension scheme established in the United Kingdom will be taxable

on only the portion of the pension distribution that is taxable in the United Kingdom.

Paragraphs 2 and 4 of Article 17 also are subject to the saving clause. Accordingly, a

U.S. citizen who is a resident of the United Kingdom will be subject to U.S. tax on a lump-sum

distribution from a pension scheme or an annuity, notwithstanding the rules in those paragraphs

that give exclusive taxation rights to the State of source or residence, as the case may be.

Paragraphs 3 and 5 are exceptions to the saving clause. Accordingly, a U.S. citizen who is a

resident of the United Kingdom will not be subject to U.S. tax on any U.S. social security

benefits, child support payments or alimony.

Article 18 (Pension Schemes)

Article 18 deals with cross-border pension contributions. It is intended to remove

barriers to the flow of personal services between the Contracting States that could otherwise

result from discontinuities in the laws of the Contracting States regarding the deductibility of

pension contributions. Such discontinuities may arise where 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.

There is no comparable set of rules in the OECD Model, although the issue is discussed

in detail in the Commentary to Article 18 (Pensions). The U.S. Model deals with this issue in

paragraph 6 of Article 18 (Pensions, Social Security, Annuities, Alimony and Child Support).

Paragraph 1

Paragraph 1 provides that if a resident of a Contracting State participates in a pension

scheme established in the other Contracting State, the State of residence will not tax the income

of the pension scheme with respect to that resident until a distribution is made from the pension

scheme. Thus, for example, if a U.S. citizen contributes to a U.S. qualified plan while working in

the United States and then establishes residence in the United Kingdom, paragraph 1 prevents the

United Kingdom from taxing currently the plan’s earnings and accretions with respect to that

individual. When the resident receives a distribution from the pension scheme, that distribution

may be subject to tax in the State of residence, subject to paragraphs 1 and 2 of Article 17

(Pensions, Social Security, Annuities, Alimony, and Child Support).

Paragraph 2

Paragraph 2 provides certain benefits with respect to cross-border contributions to a

pension scheme, subject to the limitations of paragraphs 3 and 4 of the Article. It is irrelevant for

purposes of paragraph 2 whether the participant establishes residence in the State where the

individual renders services (the “host State”). The benefits provided in paragraph 2 are similar to

the benefits the U.S. Model provides with respect to contributions.

Subparagraph (a) of paragraph 2 allows an individual who exercises employment or self-

employment in a Contracting State to deduct or exclude from income in that Contracting State

contributions made by or on behalf of the individual during the period of employment or self-

employment to a pension scheme established in the other Contracting State. Thus, for example, if

a participant in a U.S. qualified plan goes to work in the United Kingdom, the participant may

deduct or exclude from income in the United Kingdom contributions to the U.S. qualified plan

made while the participant works in the United Kingdom. Subparagraph (a), however, applies

only to the extent of the relief allowed by the host State (

e.g.

, the United Kingdom in the

example) for contributions to a pension scheme established in that State.

Subparagraph (b) of paragraph 2 provides that, in the case of employment, accrued

benefits and contributions by or on behalf of the individual’s employer, during the period of

employment in the host State, will not be treated as taxable income to the employee in that State.

Subparagraph (b) also allows the employer a deduction in computing business profits in the host

State for contributions to the plan. For example, if a participant in a U.S. qualified plan goes to

work in the United Kingdom, the participant’s employer may deduct from its business profits in

the United Kingdom contributions to the U.S. qualified plan for the benefit of the employee

while the employee renders services in the United Kingdom.

As in the case of subparagraph (a), subparagraph (b) applies only to the extent of the

relief allowed by the host State for contributions to pension schemes established in that State.

Therefore, where the United States is the host State, 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 is calculated

as if the individual were the only employee covered by the plan.

Paragraph 3

Paragraph 3 limits the availability of benefits under paragraph 2. Under subparagraph (a)

of paragraph 3, paragraph 2 does not apply to contributions to a pension scheme unless the

participant already was contributing to the scheme, or his employer already was contributing to

the scheme with respect to that individual, before the individual began exercising employment in

the State where the services are performed (the “host State”). This condition would be met if

either the employee or the employer was contributing to a scheme that was replaced by the

scheme to which he is contributing. The rule regarding successor schemes would apply if, for

example, the employer has been taken over by a company that replaces the existing scheme with

its own scheme, rolling membership in the old scheme over into the new scheme.

In addition, under subparagraph (b) of paragraph 3, the competent authority of the host

State must determine that the recognized plan to which a contribution is made in the other

Contracting State generally corresponds to the plan in the host State. According to the notes, it is

understood for this purpose that U.S. pension schemes eligible for the benefits of paragraph 2

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 4

Paragraph 4 limits the availability of benefits under paragraph 2 of this article.

Paragraph 4 provides a special rule in cases where income dealt with by the Convention is

taxable to a resident of a Contracting State only if and to the extent it is remitted to or received

by that person. In such cases, paragraph 4 reduces proportionately the deduction or exclusion of

contributions to a pension scheme under subparagraph (a) of paragraph 2 based upon the amount

of income subject to tax in the State of residence. Although this rule is written in bilateral

fashion, it presently applies to residents of the United Kingdom only, because the United States

does not tax on a remittance basis. Paragraph 4 would apply, for example, if a U.S. citizen

resident in the United Kingdom earns income in the United States that is not subject to tax in the

United Kingdom because the income is not remitted to the United Kingdom. In this case,

paragraph 4 would reduce proportionately the amount of any deduction or exclusion allowed in

the United Kingdom to the U.S. citizen by subparagraph (a) of paragraph 2 for contributions to a

U.S. pension scheme.

Paragraph 5

Paragraph 5 generally provides U.S. tax treatment for certain contributions by or on

behalf of U.S. citizens resident in the United Kingdom to pension schemes established in the

United Kingdom that is comparable to the treatment that would be provided for contributions to

U.S. schemes. Under subparagraph (a) of paragraph 5, a U.S. citizen resident in the United

Kingdom may exclude or deduct for U.S. tax purposes certain contributions to a pension scheme

established in the United Kingdom. Qualifying contributions generally include contributions

made during the period the U.S. citizen exercises an employment in the United Kingdom if

expenses of the employment are borne by a U.K. employer or U.K. permanent establishment.

Similarly, with respect to the U.S. citizen’s participation in the U.K. pension scheme, accrued

benefits and contributions during that period generally are not treated as taxable income in the

United States.

The U.S. tax benefit allowed by paragraph 5, however, is limited to the lesser of the

amount of relief allowed for contributions and benefits under a pension scheme established in the

United Kingdom and, under subparagraph (b), the amount of relief that would be allowed for

contributions and benefits under a generally corresponding pension scheme established in the

United States.

Subparagraph (c) provides that the benefits an individual obtains under paragraph 5 are

counted when determining that individual’s eligibility for benefits under a pension scheme

established in the United States. Thus, for example, contributions to a U.K. pension scheme may

be counted in determining whether the individual has exceeded the annual limitation on

contributions to an individual retirement account.

Under subparagraph (d), paragraph 5 does not apply to pension contributions and benefits

unless the competent authority of the United States has agreed that the pension scheme

established in the United Kingdom generally corresponds to a pension scheme established in the

United States. The notes provide that certain pension schemes have been determined to

"generally correspond" to schemes in the other country. Since paragraph 5 applies only with

respect to persons employed by a U.K. employer or U.K. permanent establishment, however, the

relevant U.K. plans are those that correspond to employer plans in the United States.

Accordingly, it applies with respect to retirement benefit schemes for the purpose of Chapter I of

Part XIV of the Income and Corporation Taxes Act 1988.

Relation to other Articles

Paragraph 1 is not subject to the saving clause of paragraph 4 of Article 1 (General

Scope) by reason of the exception in subparagraph 5(a) of Article 1. Accordingly, a U.S. citizen

who is a resident of the United Kingdom will not be subject to tax in the United States on the

earnings and accretions of a U.K. pension fund with respect to that U.S. citizen. Paragraph 2 is

not subject to the saving clause by reason of subparagraph 5(b) of Article 1. Accordingly, the

benefits of paragraph 2 will be available to residents of the United States who are not citizens of

the United States nor admitted for permanent resident ("green card" holders) in the United States.

Paragraph 5 is not subject to the saving clause of paragraph 4 of Article 1 by reason of the

exception in subparagraph 5(a) of Article 1. Accordingly, U.S. citizens who are resident in the

United Kingdom will receive the benefits provided by paragraph 5 with respect to contributions

made to pension schemes established in the United Kingdom.

Article 19 (Government Service)

Paragraph 1

Subparagraphs (a) and (b) of paragraph 1 deal with the taxation of government

compensation (other than a pension addressed in paragraph 2). Subparagraph (a) provides that

remuneration paid from the public funds of one of the States or its political subdivisions or local

authorities to any individual who is rendering services to that State, political subdivision or local

authority is exempt from tax by the other State (the "host State"). Under subparagraph (b), such

payments are, however, taxable exclusively in the other State (i.e., the host State) if the services

are rendered in that other State and the individual is a resident of that State who is either a

national of that State or a person who did not become resident of that State solely for purposes of

rendering the services.

This paragraph follows the OECD Model, but differs from the U.S. Model in applying

only to government employees and not to independent contractors engaged by governments to

perform services for them.

The remuneration described in paragraph 1 is subject to the provisions of this paragraph

and not to those of Articles 14 (Income from Employment), 15 (Directors' Fees) or 16

(Entertainers and Sportsmen). If, however, the recipient of the income is employed by a business

conducted by a local government, paragraph 3 provides that those other Articles will apply.

Paragraph 2

Paragraph 2 deals with the taxation of pensions paid by, or out of funds created by, one of

the States, or a political subdivision or a local authority thereof, to an individual in respect of

services rendered to that State or subdivision or authority. Subparagraph (a) provides that such

pensions are taxable only in that State. Subparagraph (b) provides an exception under which such

pensions are taxable only in the other State if the individual is a resident of, and a national of,

that other State.

Pensions paid to retired civilian and military employees of a Government of either State

are intended to be covered under paragraph 2. When benefits paid by a State in respect of

services rendered to that State or a subdivision or authority are in the form of social security

benefits, however, those payments are covered by paragraph 2 of Article 17 (Pensions, Social

Security, Annuities, Alimony, and Child Support). The result will differ depending upon

whether Article 17 or 19 applies, since social security benefits are generally taxable exclusively

by the residence country while government pensions are generally taxable exclusively by the

source country. The result will be the same only when the payment is made to a resident and

national of the other Contracting State. In such a case, government pensions, like social security

payments, are taxable only in the residence country.

Paragraph 3

Paragraph 3 specifies that paragraphs 1 and 2 do not apply to remuneration and pensions

paid for services performed in connection with a business carried on by a Contracting State or a

political subdivision of local authority thereof. In such cases, the remuneration and pensions are

subjected instead to the provisions of Articles 14 (Income from Employment), 15 (Directors'

Fees), 16 (Entertainers and Sportsmen) and 17 (Pensions, Social Security, Annuities, Alimony,

and Child Support). This provision conforms to the OECD Model.

Relation to other Articles

Under paragraph 5(b) of Article 1 (General Scope), the saving clause (paragraph 4 of

Article 1) does not apply to the benefits conferred by one of the States under Article 19 if the

recipient of the benefits is neither a citizen of that State, nor a person who has been admitted for

permanent residence there (i.e., in the United States, a "green card" holder). Thus, for example, a

resident of the United Kingdom who, in the course of rendering services to the government of

the United Kingdom becomes a resident of the United States (but not a permanent resident),

would be entitled to the exemption from source State taxation provided by paragraph 1. In

addition, an individual who receives a pension paid by the Government of the United Kingdom

in respect of services rendered to that Government is taxable on that pension only in the United

Kingdom unless the individual is a U.S. citizen or acquires a U.S. green card.

Article 20 (Students)

Article 20 provides rules regarding the taxation of students and business apprentices.

Persons who meet the tests of the article will be exempt from tax with respect to designated

classes of income in the State they are visiting (the “host State”). Several conditions must be

satisfied for an individual to be entitled to the benefits of this article.

First, the visitor must have been, either at the time of his arrival in the host State or

immediately before, a resident of the other Contracting State.

Second, the purpose of the visit must be the full-time education or training of the visitor. Thus, if

the visitor comes principally to work in the host State but also is a part-time student, he is not

entitled to the benefits of this article, even with respect to any payments he may receive from

abroad for his maintenance or education, and regardless of whether or not he is in a degree

program. Whether a student is to be considered full-time will be determined by the rules of the

educational institution where he is studying. A person who visits the host State to obtain business

training and who also receives a salary from his employer for providing services would not be

entitled to the benefits of this article with respect to the payments for services.

Third, a student must be studying at a university, college, or other recognized educational

institution of a similar nature. The phrase “university, college, or other recognized educational

institution of a similar nature” clarifies that a qualifying educational institution is one that offers

a diversified curriculum for full-time students. An educational institution further is understood

to be an institution that normally maintains a regular faculty and normally has a regular body of

students in attendance at the place where the educational activities are carried on. An educational

institution will be considered to be recognized if it is accredited by an authority that generally is

responsible for accreditation of institutions in the particular field of study. This requirement does

not apply to business trainees or apprentices.

The host-country exemption in Article 20 applies only to payments arising outside the

host State that are received by the student, apprentice or business trainee for the purpose of his

maintenance, education or training. A payment will be considered to arise outside the host State

if the payer is located outside the host State. Thus, if an employer from one of the Contracting

States sends an employee to the other Contracting State for training, the payments the trainee

receives from abroad from his employer for his maintenance or training while he is present in the

host State will be exempt from tax in the host State. Where appropriate, substance prevails over

form in determining the identity of the payer. Thus, for example, payments made directly or

indirectly by a U.S. person with whom the visitor is training, but which have been routed through

a source outside the United States (e.g., a foreign bank account), are not treated as arising outside

the United States for this purpose.

In the case of an apprentice or business trainee, the benefits of this article will extend

only for a period of one year from the time that the visitor first arrives in the host State. If,

however, an apprentice or trainee remains in the host State for a second year, thus losing the

benefits of the article, he does not retroactively lose the benefits of the article for the first year.

The saving clause of paragraph 4 of Article 1 (General Scope) does not apply to this

article with respect to an individual who is neither a citizen of the host State nor has been

admitted for permanent residence there. The saving clause, however, does apply with respect to

citizens and permanent residents of the host State. Accordingly, a U.S. citizen who is a resident

of the United Kingdom 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. Under subparagraph (b) of paragraph 5 of Article 1, however, a U.K.

resident who is not a U.S. citizen, and who visits the United States as a student and remains long

enough to become a resident under U.S. law, but does not become a permanent resident (i.e.,

does not acquire a green card), will be entitled to the full benefits of the article.

Article 20A (Teachers)

Paragraph 1

Paragraph 1 of Article 20A provides that a professor or teacher who visits one of the

Contracting States for a period not exceeding two years, for the purpose of teaching or engaging

in research at a university, college, or other recognized educational institution in that Contracting

State, and who is immediately before that visit a resident of the other Contracting State, will be

exempted from tax by the first-mentioned Contracting State on any remuneration for such

teaching or research for a period not exceeding two years from the date he first visits that State

for the purpose of teaching or engaging in research. Since this two year period is determined

from the date he first visits the Contracting State, periodic vacations outside the first-mentioned

Contracting State, or a brief return to the other Contracting State will not toll the running of the

two year period. Like the existing Convention, if the two-year period beginning from the date of

his arrival is exceeded, the exemption will be lost retroactively. Thus, if a person comes to a

Contracting State for the purpose of teaching and stays for a period in excess of two years, the

exemption will not apply for the first two years.

A person who meets the qualifications for this exemption may again claim its benefits if

he first re-establishes his residence in the other Contracting State. In such case, the person

claiming these benefits on a subsequent occasion must first satisfy the competent authority of the

first-mentioned Contracting State that he had become a resident of the other State for a

substantial period of time (normally at least one year).

Paragraph 2

Under paragraph 2, the Contracting State in which the teaching or research is performed

may apply this exemption either to current payments to a professor or teacher in anticipation of

fulfillment of the requirements of paragraph 1 or by way of withholding and refund. Thus, the

recipient may be required to report and pay taxes on such income on a current basis and seek a

refund of taxes paid upon fulfillment of the requirements of paragraph 1.

Paragraph 3

Pursuant to paragraph 3, this Article only applies to income from research undertaken in

the public interest which is not primarily for the benefit of a private person or persons. For

example, research projects which are undertaken to discover or perfect product processes,

designs, etc., which are expected to be commercially exploited by the researcher or his present

(or former) employer do not qualify under this Article.

Relation to other Articles

The saving clause of paragraph 4 of Article 1 (General Scope) does not apply to this

article with respect to an individual who is neither a citizen of the host State nor has been

admitted for permanent residence there. The saving clause, however, does apply with respect to

citizens and permanent residents of the host State. Accordingly, a U.S. citizen who is a resident

of the United Kingdom and who visits the United States to teach at a university will not be

exempt from U.S. tax on his salary. Under subparagraph (b) of paragraph 5 of Article 1,

however, a person who is not a U.S. citizen, and who visits the United States as a teacher 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 21 (Offshore Exploration and Exploitation Activities)

This article deals exclusively with the taxation of activities carried on by a resident of one

of the Contracting States on the continental shelf of the other Contracting State in connection

with the exploration or exploitation of the natural resources of the shelf, principally activities

connected with exploration for oil by offshore drilling rigs. In the U.S. and OECD Models, the

income from these activities is subject to the standard rules found in the other articles of the

Models (

e.g.

, the business profits and personal services articles). In the Convention, this Article

overrides Article 7 (Business Profits) to the extent this Article is inconsistent with Article 7. The

provision carries over, with some modifications, from the prior Convention.

Paragraph 1

Paragraph 1 states that the provisions of this article apply, notwithstanding any other

provision of the Convention, to activities carried on offshore in a Contracting State in connection

with the exploration or exploitation of the sea bed and subsoil and their natural resources situated

in that State. These activities are referred to as "exploration activities" and "exploitation

activities" and include, but are not limited to, the exploration for and extraction of oil, minerals,

and natural gas.

Although there are no explicit references to other articles, the implicit references are

principally to Articles 5 (Permanent Establishment), 7 (Business Profits), and 14 (Income from

Employment). For example, if a drilling rig of a U.S. enterprise is present on the continental

shelf of the United Kingdom for 10 months and would, therefore, not give rise to a permanent

establishment because of the 12-month construction site rule of paragraph 3 of Article 5, the rig

would, nevertheless, be deemed to create a permanent establishment under paragraph 2 of Article

21.

Paragraph 2

Paragraphs 2 and 3 provide the basic rules for determining when an enterprise is deemed

to have a permanent establishment as a result of offshore activities. The general rule is that all

exploitation activities give rise to a permanent establishment, while exploration activities create a

permanent establishment only if they continue for a period exceeding, in the aggregate, 30 days

in a twelve-month period. Accordingly, paragraph 2 provides that, subject to the exception of

paragraph 3, an enterprise of one Contracting State carrying on exploration activities or

exploitation activities in the other Contracting State will be deemed to be carrying on business

through a permanent establishment situated therein.

Paragraph 3

Paragraph 3 provides that an enterprise of a Contracting State carrying on exploration

activities in the other Contracting State will not create a permanent establishment therein unless

the activities are carried on there for a period or periods aggregating more than 30 days within

any period of twelve months. This 30-day time period carries over from the prior Convention.

Paragraph 3 also provides rules for aggregating the activities of related parties for

purposes of determining whether the 30-day threshold has been exceeded. If the enterprise

carrying on the offshore activities is associated with another enterprise, and that associated

enterprise also is carrying on substantially similar exploration activities in the host State, the

former enterprise shall be deemed to be carrying on all such activities. The aggregation rule is

intended to prevent taxpayers from avoiding the time threshold by artificially splitting activities

between different entities. Thus, the rule will not apply to the extent that the activities of the two

persons are being carried on at the same time. For purposes of paragraph 3, an enterprise is

associated with another if one participates directly or indirectly in the management, control or

capital of the other or if the same persons participate directly or indirectly in the management,

control or capital of both enterprises.

Paragraph 4

Paragraph 4 provides thresholds for the taxation of income from employment in respect

of offshore activities. As a general rule, the Contracting State where the activities are carried on

(the "host State") may tax salaries, wages, and other similar remuneration derived by an

individual who is a resident of the other State in respect of employment exercised in connection

with the offshore activities described in the preceding paragraphs of this article, to the extent that

the duties are performed offshore in the host State.

If, however, such employment is carried on for a period or periods aggregating 30 days or

less in any 12-month period, only the State of residence of the employee, and not the host State,

may tax the income of the employee in respect of such employment. This provision may in

certain circumstances give rise to a taxing right in the host State that would not exist in the

absence of this Article.

Relation to other Articles

This Article is subject to the saving clause of paragraph 4 of Article 1 (General Scope).

Thus, the United States may tax the income of a resident of the United Kingdom who is a U.S.

citizen even if, under the provisions of this Article, a resident of the United Kingdom would not

be subject to U.S. tax. As with any benefit of the Convention, a person claiming a benefit under

this Article must be entitled to the benefit under the provisions of Article 23 (Limitation on

Benefits).

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. 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 are not generally dealt with under Article 22 because

partnership distributions generally do not constitute income. Under the Code, partners include in

income their distributive share of partnership income annually, and partnership distributions

themselves generally do not give rise to income. This would also be the case under U.S. law with

respect to distributions from trusts. Under the Code, 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. The Convention provides a

specific carve-out with respect to income paid out of trusts or the estates of deceased persons in

order to provide the same result in the United Kingdom as would apply under U.S. domestic law.

The notes confirm that distributions from trusts or the estates of deceased persons will be

characterized according to the character of the underlying income.

Paragraph 1

The general rule of Article 22 is contained in paragraph 1. Items of income not dealt with

in other articles and beneficially owned by a resident of a Contracting State will be taxable only

in the State of residence. This exclusive right of taxation applies whether or not the residence

State exercises its right to tax the income covered by the Article.

The reference in this paragraph to "items of income beneficially owned by a resident of a

Contracting State" rather than simply "items of income of a resident of a Contracting State," as in

the OECD Model, is intended merely to make explicit the implicit understanding in other treaties

that the exclusive residence taxation provided by paragraph 1 applies only when a resident of a

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. However, income received by a nominee on behalf of a resident of that other State would

be entitled to benefits.

The term "beneficially owned" is not defined in the Convention, and is, therefore, defined

as under the internal law of the country imposing tax (i.e., the source country). The person who

beneficially owns the income for purposes of Article 22 is the person to which the income is

attributable for tax purposes under the laws of the source State.

Paragraph 2

This paragraph provides an exception to the general rule of paragraph 1 for income, other

than income from real property, that is attributable to a permanent establishment maintained in a

Contracting State by a resident of the other Contracting State. The taxation of such income is

governed by the provisions of Article 7 (Business Profits). Therefore, income arising outside the

United States that is attributable to a permanent establishment maintained in the United States by

a resident of the United Kingdom 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.

Paragraph 3

Paragraph 3 is not found in the U.S. or OECD Models, but is suggested in the

Commentary to Article 21 of the OECD Model. The paragraph restricts the operation of

Article 22 where, by reason of a special relationship between the payer and the beneficial owner

or between both of them and some other person, the amount of other income paid exceeds the

amount which would have been agreed upon by the parties had they stipulated at arm’s length.

This rule applies, for example, to payments pursuant to non-traditional financial instruments,

such as equity swaps. Article 22 applies in such a case only to the arm’s-length amount, and the

excess part of the payment remains taxable according to the laws of the two Contracting States,

due regard being had to the other provisions of the Convention.

Paragraph 4

Paragraph 4 provides that Article 22 will not apply to any income paid under, or as part

of, a conduit arrangement. The term “conduit arrangement” is defined in subparagraph (n) of

paragraph 1 of Article 3 (General Definitions). As discussed in the Technical Explanation to that

provision, the United States will interpret this rule co-extensively and consistently with U.S.

domestic law, including in particular the rules of regulation section 1.881-3 and other regulations

adopted under the authority of section 7701(l) of the Code.

Relation to Other Articles

This Article is subject to the saving clause of paragraph 4 of Article 1 (General Scope).

Thus, the United States may tax the income of a resident of the United Kingdom that is not dealt

with elsewhere in the Convention, if that resident is a citizen of the United States.

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

Benefits). Thus, only a resident of a Contracting State that satisfies one of the conditions in

Article 23 is entitled to the benefits of this Article.

Article 23 (Limitation on Benefits)

Purpose of Limitation on Benefits Provisions

The United States views an income tax treaty as a vehicle for providing treaty benefits to

residents of the two Contracting States. This statement begs the question of who is to be treated

as a resident of a Contracting State for the purpose of being granted treaty benefits. The

Commentaries to the OECD Model authorize a tax authority to deny benefits, under substance-

over-form principles, to a nominee in one State deriving income from the other on behalf of a

third-country resident. In addition, although the text of the OECD Model does not contain

express anti-abuse provisions, the Commentary to Article 1 contains an extensive discussion

approving the use of such provisions in tax treaties in order to limit the ability of third state

residents to obtain treaty benefits. The United States holds strongly to the view that tax treaties

should include provisions that specifically prevent misuse of treaties by residents of third

countries. Consequently, all recent U.S. income tax treaties contain comprehensive Limitation on

Benefits provisions.

A treaty that provides treaty benefits to any resident of a Contracting State permits "treaty

shopping": the use, by residents of third states, of legal entities established in a Contracting State

with a principal purpose to obtain the benefits of a tax treaty between the United States and the

other Contracting State. It is important to note that this definition of treaty shopping does not

encompass every case in which a third state resident establishes an entity in a U.S. treaty partner,

and that entity enjoys treaty benefits to which the third state resident would not itself be entitled.

If the third country resident had substantial reasons for establishing the structure that were

unrelated to obtaining treaty benefits, the structure would not fall within the definition of treaty

shopping set forth above.

Of course, the fundamental problem presented by this approach is that it is based on the

taxpayer's 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 23 sets forth a series of objective tests. The assumption underlying each of

these tests is that a taxpayer that satisfies the requirements of the test 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

4 is that a third country resident that establishes a "substantial" operation in the United Kingdom

and that derives income from a similar activity in the United States would not do so primarily to

avail itself of the benefits of the Convention; it is presumed in such a case that the investor had a

valid business purpose for investing in the United Kingdom, and that the link between that trade

or business and the U.S. activity that generates the treaty-benefited income manifests a business

purpose for placing the U.S. investments in the entity in the United Kingdom. It is considered

unlikely that the investor would incur the expense of establishing a substantial trade or business

in the United Kingdom simply to obtain the benefits of the Convention. A similar rationale

underlies other tests in Article 23.

While these tests provide useful surrogates for identifying actual intent, these mechanical

tests cannot account for every case in which the taxpayer was not treaty shopping. Accordingly,

Article 23 also includes a provision (paragraph 6) authorizing the competent authority of a

Contracting State to grant benefits. While an analysis under paragraph 6 may well differ from

that under one of the other tests of Article 23, its objective is the same: to identify investors

whose residence in the other State can be justified by factors other than a purpose to derive treaty

benefits.

Article 23 and the anti-abuse provisions of domestic law complement each other, as

Article 23 effectively determines whether an entity has a sufficient nexus to the Contracting State

to be treated as a resident for treaty purposes, while domestic 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 23 then will be applied to the beneficial owner to determine if that person is

entitled to the benefits of the Convention with respect to such income.

Each of the substantive provisions of Article 23 states that benefits shall be granted only

if the resident of a Contracting State satisfies any other specified conditions for claiming

benefits. This means, for example, that a publicly-traded company that satisfies the conditions of

subparagraph 2(c) will be eligible for the exemption from withholding tax on dividends at source

only if it also satisfies the 12-month holding period requirement of subparagraph 3(a) of Article

10 (Dividends). Moreover, a company that is eligible for benefits with respect to dividend

income pursuant to either paragraph 4 of Article 23 or subparagraph (d) or (f) of paragraph 2 will

not be eligible for the withholding tax exemption of subparagraph 3(a) of Article 10 unless it also

satisfies the October 1, 1998 requirement of clause (i) of subparagraph 3(a).

Structure of the Article

Article 23 follows the form used in other recent U.S. income tax treaties. Paragraph 1

states the general rule that a resident of a Contracting State is entitled to benefits otherwise

accorded to residents only to the extent that the resident satisfies the requirements of the Article

and any other specified conditions for the obtaining of such benefits. Paragraph 2 lists a series of

attributes of a resident of a Contracting State, any one of which suffices to make such resident a

"qualified person" and thus entitled to all the benefits of the Convention. Paragraph 3 provides a

so-called "derivative benefits" test under which certain categories of income may qualify for

benefits. Paragraph 4 sets forth the active trade or business test, under which a person not

entitled to benefits under paragraph 2 may nonetheless be granted benefits with regard to certain

types of income. Paragraph 5 limits the benefits available under the other provisions of the

Article in certain cases involving the issuance of "tracking stock" and similar instruments.

Paragraph 6 provides that benefits may also be granted if the competent authority of the State

from which the benefits are claimed determines that it is appropriate to grant benefits in that

case. Paragraph 7 defines the terms used specifically in this Article.

Paragraph 1

Paragraph 1 provides that, except as otherwise provided, a resident of a Contracting State

will be entitled to all the benefits of the Convention otherwise accorded to residents of a

Contracting State only if the resident is a “qualified person” as defined in paragraph 2 of Article

23.

The benefits otherwise accorded to residents under the Convention include all limitations

on source-based taxation under Articles 6 through 22, the treaty-based relief from double

taxation provided by Article 24 (Relief from Double Taxation), and the protection afforded to

residents of a Contracting State under Article 25 (Non-discrimination). Some provisions do not

require that a person be a resident in order to enjoy the benefits of those provisions. For example,

Article 19 (Government Service) may apply to an employee of a Contracting State who is

resident in neither State. Article 26 (Mutual Agreement Procedure) is not limited to residents of

the Contracting States, and Article 28 (Diplomatic Agents and Consular Officers) applies to

diplomatic agents or consular officials regardless of residence. Article 23 accordingly does not

limit the availability of treaty benefits under these provisions.

Paragraph 2

Paragraph 2 has seven subparagraphs, each of which describes a category of residents

that constitute "qualified persons" and thus are entitled to all benefits of the Convention. It is

intended that the provisions of paragraph 2 will be self-executing. 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.

Individuals -- Subparagraph 2(a)

Subparagraph (a) provides that individual residents of a Contracting State will be entitled

to all treaty benefits. If such an individual receives income as a nominee on behalf of a third

country resident, benefits may be denied under the respective articles of the Convention by the

requirement that the beneficial owner of the income be a resident of a Contracting State.

Qualified Governmental Entities -- Subparagraph 2(b)

Subparagraph (b) provides that qualified governmental entities, as defined in

subparagraph 1(k) of Article 3 (Definitions), also will be entitled to all benefits of the

Convention. As described in Article 3, in addition to federal, state and local governments, the

term "qualified governmental entity" encompasses certain government-owned corporations and

other entities.

Publicly-Traded Corporations -- Subparagraph 2(c)

Subparagraph (c) of paragraph 2 applies to two categories of companies: publicly traded

companies and subsidiaries of publicly traded companies. Clause (i) of subparagraph (c)

generally provides that a company will be a qualified person if the principal class of its shares is

listed on a recognized U.S. or U.K. stock exchange and is regularly traded on one or more

recognized stock exchanges.

The term “recognized stock exchange” is defined in subparagraph (a) of paragraph 7 as

(1) 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; (2) the London Stock Exchange

and any other recognized investment exchange within the meaning of the Financial Services Act

1986 or the Financial Services and Markets Act 2000; (3) the Irish Stock Exchange, the Swiss

Stock Exchange and the stock exchanges of Amsterdam, Brussels, Frankfurt, Hamburg,

Johannesburg, Madrid, Milan, Paris, Stockholm, Sydney, Tokyo, Toronto, and Vienna; and (4)

any other stock exchange agreed upon by the competent authorities of the Contracting States.

The term “principal class of shares” is defined in subparagraph (b) of paragraph 7.

Clause (i) defines the term to mean the common shares of the company representing the majority

of the aggregate voting power and value of the company. If the company does not have a class of

ordinary or common shares representing the majority of the aggregate voting power and value of

the company, then the “principal class of shares” is that class or any combination of classes of

shares that represents, in the aggregate, a majority of the voting power and value of the company.

In addition, clause (ii) of subparagraph (b) defines the term “shares” to include depository

receipts for shares or trust certificates for shares.

A class of shares will be “regularly traded” in a taxable period, under subparagraph (e)

of paragraph 7, if the aggregate number of shares of that class traded on one or more recognized

exchanges during the twelve months ending on the day before the beginning of that taxable

period is at least six percent of the average number of shares outstanding in that class during that

twelve-month period. For this purpose, the notes provide that if a class of shares was not listed

on a recognized stock exchange during this twelve-month period, the class of shares will be

treated as regularly traded only if the class meets the aggregate trading requirements for the

taxable period in which the income arises. Trading on one or more recognized stock exchanges

may be aggregated for purposes of meeting the “regularly traded” standard of subparagraph (e).

For example, a U.S. company could satisfy the definition of “regularly traded” through trading,

in whole or in part, on a recognized stock exchange located in the United Kingdom or certain

third countries. Authorized but unissued shares are not considered for purposes of subparagraph

(e).

A company resident in a Contracting State is entitled to the benefits of the Convention

under clause (ii) of subparagraph (c) of paragraph 2 if five or fewer direct and indirect owners of

at least 50 percent of the aggregate vote and value of the company’s shares are publicly traded

companies described in clause (i). Thus, for example, a U.K. company, all the shares of which

are owned by another U.K. company, would qualify for benefits under the Convention if the

principal class of shares of the U.K. parent company were listed on the London Stock Exchange

and regularly traded on the Irish stock exchange. However, the U.K. company would not qualify

for benefits under clause (ii) if the publicly traded parent company were a resident of Ireland, not

of the United States or the United Kingdom. Furthermore, if the U.K. parent indirectly owned the

U.K. company through a chain of subsidiaries, each such subsidiary in the chain, as an

intermediate owner, must be a resident of the United States or the United Kingdom for the U.K.

company to meet the test in clause (ii).

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. However, both

subparagraphs are subject to the rules of paragraph 5, relating to certain arrangements pursuant

to which holders of a class of stock in a resident of a Contracting State receive a disproportionate

share of the income arising from the other Contracting State.

The rules of paragraph 5 may interact with the rules of this paragraph in order to deny

benefits in whole or in part. The following example illustrates this interaction.

Example

. UKCo is a corporation resident in the United Kingdom. UKCo has two

classes of shares: Common and Preferred. The Common shares are listed on the London Stock

Exchange and are substantially and regularly traded. The Preferred shares have no voting rights

and are entitled to receive dividends equal in amount to interest payments that UKCo receives

from unrelated borrowers in the United States. The Preferred shares are owned entirely by a

single investor that is a resident of a country with which the United States does not have a tax

treaty. The Common shares account for more than 50 percent of the value of UKCo and for 100

percent of the voting power. Because the owner of the Preferred shares is entitled to receive

payments corresponding to the U.S. source interest income earned by UKCo, the Preferred

shares are subject to the rules of paragraph 5. Because the owner of the Preferred shares is not

an "equivalent beneficiary" within the meaning of subparagraph 7(d), UKCo will be denied

benefits with respect to a portion of the interest payments. Benefits will be denied to the extent

that the owner of the Preferred shares receives a greater proportion of the U.S. income than he

would have received had he owned comparable Common shares.

Publicly-Traded Persons -- Subparagraph 2(d)

Subparagraph (d) of paragraph 2 applies to two categories of person that are not

individuals or companies under the laws of one of the Contracting States: publicly traded entities

and entities owned either by publicly traded companies or by publicly traded entities that are not

companies. Clause (i) of subparagraph (d) provides that a person other than a company will be a

qualified person if the principal class of “units” in that person is listed on a recognized U.S. or

U.K. stock exchange and is regularly traded on one or more recognized stock exchanges.

With respect to a person, the term “units” is defined in subparagraph (c) of paragraph 7 as

shares and any other instrument, other than debt claims, granting an entitlement to share in the

assets or income of, or receive a distribution from, the person. The term “principal class of units”

means the class of units which represents the majority of the value of the person. If no single

class of units represents such a majority, the “principal class of units” is any combination of

classes that, in the aggregate, represent more than fifty percent of the value of the person. The

term “regularly traded,” for purposes of subparagraph (d) of paragraph 2, is defined in

subparagraph (e) of paragraph 7, as described above. Trading on one or more recognized stock

exchanges may be aggregated for purposes of this requirement and authorized but unissued units

are not considered for purposes of subparagraph (d).

A person other than an individual or a company is a qualified person under clause (ii) of

subparagraph (d) if the direct or indirect owners of at least fifty percent of the beneficial interests

in the entity are entities that satisfy the publicly traded test of subparagraphs (c) or (d). Thus, for

example, a U.K. trust, a majority of the shares of ownership in which are owned by a second

U.K. trust, would be a qualified person if the principal class of units of the second U.K. trust

were listed on the London Stock Exchange and regularly traded on the Irish Stock Exchange.

However, the first U.K. trust would not qualify for benefits under clause (ii) if the second U.K.

trust were a resident of Ireland, not of the United States or the United Kingdom.

Subparagraph (d) applies generally to trusts the shares of ownership in which are publicly

traded and to trusts that are owned by publicly traded entities. From the U.S. perspective, this

provision relating to publicly traded trusts is redundant, since the United States would generally

consider such trusts to be companies covered by the parallel provision under subparagraph (c).

The rules of paragraph 5 may interact with the rules of this paragraph in order to deny

benefits in whole or in part. The following example illustrates this interaction.

Example 1.

UKT1 is a U.K. unit investment trust that was organized to invest in U.S.

stocks. It is one of a family of unit investment trusts organized by the same investment manager,

each of which invests in stocks of a single country. Investors who want a diversified global

portfolio invest in UKT2, a unit investment trust that holds a controlling interest in each of the

individual country funds and is regularly traded on the London Stock Exchange. UKT2 owns 60

percent of UKT1's outstanding units; the rest are widely held. UKT1 qualifies for benefits.

Example 2

. UKT1 is a U.K. unit investment trust that holds a diversified global portfolio

of stocks. UKT2 is a unit investment trust that owns 60 percent of the units in UKT1. UKT2

issues a number of classes of units to accommodate the investment strategies of its unitholders.

It lists all of its classes of units on the London Stock Exchange and meets the regular trading test.

One class of units tracks the performance of a portfolio of U.S. technology companies. Since

UKT2 controls UKT1, and the holders of that class of units will receive a disproportionate share

of UKT1's income from U.S. sources, paragraph 5 will apply. Accordingly, UKT1 will be

denied benefits with respect to a portion of the income received with respect to the technology

companies in the portfolio if a majority of that class of shares is owned by persons who are not

equivalent beneficiaries within the meaning of paragraph 7(d).

Tax Exempt Organizations -- Subparagraph 2(e)

Subparagraph (e) of paragraph 2 provides rules by which the tax-exempt organizations

described in paragraph 3 of Article 4 (Residence) may be "qualified persons." A tax-exempt

pension scheme or employee benefit arrangement described in subparagraphs (a) or (b) of

paragraph 3 of Article 4 is a qualified person if more than fifty percent of the beneficiaries,

members or participants of the organization are individuals resident in either Contracting State.

For purposes of this provision, the term "beneficiaries" should be understood to refer to the

persons receiving benefits from the organization. On the other hand, a tax-exempt organization

described in subparagraph (c) of paragraph 3 of Article 4 (Residence) is automatically a qualified

person, without regard to the residence of its beneficiaries or members. Entities qualifying under

this subparagraph generally are those that are exempt from tax in their State of residence and that

are organized and operated exclusively to fulfill religious, charitable, scientific, artistic, cultural,

or educational purposes.

Ownership/Base Erosion -- Subparagraph 2(f)

Subparagraph 2(f) provides an additional test that applies to any form of legal entity that

is a resident of a Contracting State. This test would not apply to U.K. trusts since the trust itself

is not subject to tax as a resident of the United Kingdom; instead the United Kingdom taxes the

trustee of the trust. U.S. complex trusts would be treated as residents of the United States

because they are subject to tax in their own right. Such trusts therefore could claim benefits

under this test or the test provided in subparagraph (g) that is specific to trusts.

The test provided in subparagraph (f), the so-called ownership and base erosion test, is a

two-part test. Both prongs of the test must be satisfied for the resident to be entitled to benefits

under subparagraph 2(f).

The ownership prong of the test, under clause (i), requires that 50 percent or more of the

aggregate voting power and value of the person be owned directly or indirectly on at least half

the days of the person’s taxable year by persons who are themselves qualified persons under

certain other tests of paragraph 2—subparagraphs (a), (b), or (e), or clause (i) of subparagraphs

Trusts may be entitled to benefits under this provision if they are treated as residents

under Article 4 (Residence) and they otherwise satisfy the requirements of this subparagraph. For

purposes of this subparagraph, the beneficial interests in a trust will be considered to be owned

by its beneficiaries in proportion to each beneficiary's actuarial interest in the trust. The interest

of a remainder beneficiary will be equal to 100 percent less the aggregate percentages held by

income beneficiaries. A beneficiary's interest in a trust will not be considered to be owned by a

person entitled to benefits under the other provisions of paragraph 2 if it is not possible to

determine the beneficiary's actuarial interest. Consequently, if it is not possible to determine the

actuarial interest of any beneficiaries in a trust, the ownership test under clause i) cannot be

satisfied, unless all possible beneficiaries are persons entitled to benefits under the other

subparagraphs of paragraph 2.

The base erosion prong of clause (ii) of subparagraph (f) disqualifies a person if fifty

percent or more of the person’s gross income for the taxable period is paid or accrued to a person

or persons who are not residents of either Contracting State, in the form of payments deductible

for tax purposes in the payer’s State of residence. For this purpose, the notes state that the term

“gross income” means total revenues derived by a resident of a Contracting State from its

principal operations, less the direct costs of obtaining such revenues. In the case of the United

States, the term “gross income” has the same meaning as such term in section 61 of the Code and

the regulations thereunder.

To the extent they are deductible from the taxable base, trust distributions are deductible

payments. However, depreciation and amortization deductions, which do not represent payments

or accruals to other persons, are disregarded for this purpose. Deductible payments also do not

include arm’s length payments in the ordinary course of business for services or tangible

property or with respect to financial obligations to banks that are residents of either Contracting

State, or that have a permanent establishment in either Contracting State to which the payment is

attributable.

The rules of paragraph 5 may interact with the rules of this paragraph as they apply to

companies in order to deny benefits in whole or in part. The following example illustrates this

interaction.

Example

. A group of U.K. resident individuals established an investment club. The

investment club purchases stocks through HoldCo, a U.K. company owned by the U.K. resident

individuals in proportion to their contributions to the investment club. The rules of the

investment club prevent the club from borrowing. One of the club's investments was an 80

percent interest in a U.S. biotech company, USCo, which was made in early 1997. USCo

developed an unusual gene therapy, resulting in a substantial increase in the value of USCo

stock. The members of the club wanted to sell some of the shares of USCo in order to diversify

their holdings, but did not want to be subject to capital gains tax in the United Kingdom.

Instead, HoldCo issued a class of preferred shares that track the dividends paid by USCo to

HoldCo in exchange for a capital contribution from Investor. Investor is an individual resident in

another EU member country. HoldCo meets the test for eligibility for the zero rate of

withholding tax under paragraph 3(a) of Article 10 because it qualifies for benefits under the

ownership-base erosion test and it has owned a direct 80 percent interest in USCo since before

October 1, 1998. However, HoldCo would not be entitled to a zero rate of withholding tax on a

portion of the dividends paid by USCo to the extent the preferred shares result in Investor

receiving its proportionate share of the income of HoldCo since Investor is not an equivalent

beneficiary within the meaning of paragraph 7(d).

Trusts -- Subparagraph (g)

Subparagraph (g) of paragraph 2 provides an additional means by which a trust can be a

"qualified person." A trust or its trustee (acting in its capacity as such) will be a "qualified

person" if the trust meets an ownership test and a base erosion test. The United Kingdom asked

that this test be included because it was unclear how each country would apply the standard

"ownership-base erosion" test of subparagraph (f) to trusts, since the United Kingdom treats the

trustee as the taxpayer with respect to trusts. U.S. complex trusts, which are taxpayers in their

own right, could also qualify under the ownership-base erosion test of subparagraph (f) if there

were some advantage to applying that test rather than the test of subparagraph (g).

Under the ownership test, at least 50 percent of the beneficial interest in the trust must be

held by certain qualified persons or, alternatively, by “equivalent beneficiaries.” The qualified

persons that satisfy the ownership test of subparagraph (g) generally are individuals, qualified

governmental entities, publicly-traded companies or entities, and tax-exempt organizations.

The term “equivalent beneficiary” is defined in subparagraph (d) of paragraph 7. This

definition may be met in two alternative ways, the first of which has two requirements.

Under the first alternative, a person may be an equivalent beneficiary because it is

entitled to equivalent benefits under a treaty between the country of source and the country in

which the person is a resident. This alternative has two requirements.

The first requirement is that the person must be a resident of a Member State of the

European Community, a European Economic Area state, or a party to the North American Free

Trade Agreement (collectively, “qualifying States”).

The second requirement is that the person must be entitled to equivalent benefits under an

applicable treaty. To satisfy this requirement, the person must be entitled to all the benefits of a

comprehensive treaty between the Contracting State from which benefits of the Convention are

claimed and a qualifying State. For this purpose, however, if the treaty in question does not have

a comprehensive limitation on benefits article, this requirement only is met if the person would

be a "qualified person" under the tests in Paragraph 2 applicable to individuals, qualified

governmental entities, publicly-traded companies or entities, and tax-exempt organizations. In

addition, with respect to dividends, interest, or royalties, the person must be entitled to a rate of

tax that is at least as low as the rate that would apply under the Convention to such income.

The second alternative for satisfying the "equivalent beneficiary" test is available only to

residents of one of the two Contracting States. U.S. or U.K. residents who are qualified persons

by reason of subparagraphs a), b), c)(i), d)(i), or e) of paragraph 2 are equivalent beneficiaries for

purposes of the relevant tests in Article 23. Thus, a U.K. individual will be an equivalent

beneficiary without regard to whether the individual would have been entitled to receive the

same benefits if it received the income directly. A resident of a third country cannot be a

"qualified person" by reason of those paragraphs or any other rule of the treaty, and therefore do

not qualify as equivalent beneficiaries under this alternative. Thus, any resident of a third

country can be an equivalent beneficiary only if it would have been entitled to equivalent

benefits had it received the income directly.

For example, assume that a U.S. company pays interest to UKT, a trust resident in the

United Kingdom. UKT has three equal beneficiaries, a U.K. resident individual and two

individuals resident in Italy. The U.K. individual is an equivalent beneficiary by reason of

Article 23(7)(d)(ii). However, the Italian individuals are not equivalent beneficiaries since, if

each had received directly his share of the interest, that portion would be subject to a withholding

tax of fifteen percent under the income tax treaty between the United States and Italy. This rate is

higher than the rate that would apply under the Convention. Therefore, UKT does not meet the

second requirement by virtue of clause (i) of subparagraph (d).

The base erosion test of subparagraph (g) of paragraph 2 is similar to the base erosion test

in clause (ii) of subparagraph (f) of paragraph 2. A trust or trustee meets the base erosion test in

subparagraph (g) if less than 50 percent of its gross income for the taxable period is paid or

accrued, directly or indirectly, to a person or persons who are not residents of either Contracting

State in the form of payments deductible for tax purposes in the trust or trustee’s State of

residence. As in the case of the subparagraph (f) base erosion test, deductible payments do not

include arm’s length payments in the ordinary course of business for services or tangible

property or with respect to financial obligations to banks that are residents of either Contracting

State or that have a permanent establishment in either Contracting State to which the payment is

attributable. For this purpose, the notes state that the term “gross income” means total revenues

derived by a resident of a Contracting State from its principal operations, less the direct costs of

obtaining such revenues. In the case of the United States, the term “gross income” has the same

meaning as such term in section 61 of the Code and the regulations thereunder.

Paragraph 3

Paragraph 3 sets forth a derivative benefits test that applies to all treaty benefits. In

general, a derivative benefits test entitles the resident of a Contracting State to treaty benefits if

the owner of the resident would have been entitled to the same benefit had the income in

question flowed directly to that owner. Paragraph 3 provides a derivative benefits test under

which a company that is a resident of a Contracting State may be entitled to the benefits of the

Convention with respect to certain items of income. To qualify under this paragraph, the

company must meet an ownership test and a base erosion test.

Subparagraph (a) sets forth the ownership test. Under this test, seven or fewer equivalent

beneficiaries must own shares representing at least 95 percent of the aggregate voting power and

value of the company. Ownership may be direct or indirect. The term “equivalent beneficiary” is

defined in subparagraph (d) of paragraph 7. This definition may be met in two alternative ways,

the first of which has two requirements.

Under the first alternative, a person may be an equivalent beneficiary because it is

entitled to equivalent benefits under a treaty between the country of source and the country in

which the person is a resident. This alternative has two requirements.

The first requirement is that the person must be a resident of a Member State of the

European Community, a European Economic Area state, or a party to the North American Free

Trade Agreement (collectively, “qualifying States”).

The second requirement of the definition of “equivalent beneficiary” is that the person

must be entitled to equivalent benefits under an applicable treaty. To satisfy the second

requirement, the person must be entitled to all the benefits of a comprehensive treaty between the

Contracting State from which benefits of the Convention are claimed and a qualifying State. For

this purpose, however, if the treaty in question does not have a comprehensive limitation on

benefits article, this requirement only is met if the person would be a "qualified person" under

the tests in Paragraph 2 applicable to individuals, qualified governmental entities, publicly-traded

companies or entities, and tax-exempt organizations. In addition, to satisfy the second

requirement by virtue of clause (i) of subparagraph (d) with respect to dividends, interest, or

royalties, the person must be entitled to a rate of tax that is at least as low as the rate that would

apply under the Convention to such income.

In order to satisfy the additional requirement necessary to qualify as an “equivalent

beneficiary” under paragraph 7(d)(i) with respect to dividends, interest, or royalties, the person

must be entitled to a rate of withholding tax that is at least as low as the withholding tax rate that

would apply under the Convention to such income. Thus, the rates to be compared are: (1) the

rate of withholding tax that the source State would have imposed if a qualified resident of the

other Contracting State was the beneficially owner of the income; and (2) the rate of withholding

tax that the source State would have imposed if the third State resident received the income

directly from the source State. For example, USCo is a wholly owned subsidiary of UKCo, a

company resident in the United Kingdom. UKCo is wholly owned by FCo, a corporation

resident in France. Assuming UKCo satisfies the requirements of paragraph 3(a) of Article 10

(Dividends), UKCo would be eligible for a zero rate of withholding tax. The dividend

withholding rate in the treaty between the United States and France is 5 percent. Thus, if FCo

received the dividend directly from USCo, FCo would have been subject to a 5 percent rate of

withholding tax on the dividend. Because FCo would not be entitled to a rate of withholding tax

that is at least as low as the rate that would apply under the Convention to such income (i.e.,

zero), FCo is not an equivalent beneficiary within the meaning of paragraph 7(d)(i) of Article 23

with respect to zero rate of withholding tax on dividends.

The requirement that a person be entitled to "all the benefits" of a comprehensive tax

treaty eliminates those persons that qualify for benefits with respect to only certain types of

income. Accordingly, the fact that a French parent of a U.K. company is engaged in the active

conduct of a trade or business in France and therefore would be entitled to the benefits of the

U.S.-France treaty if it received dividends directly is not sufficient for purposes of this

paragraph. Further, the French company cannot be an equivalent beneficiary if it qualifies for

benefits only with respect to certain income as a result of a "derivative benefits" provision in the

U.S.-France treaty. However, it would be possible to look through the French company to its

parent company to determine whether the parent company is an equivalent beneficiary.

The following example illustrates the "all the benefits" requirement. A U.K. resident

company, Y, owns all of the shares in a U.S. resident company, Z. Y is wholly owned by X, a

German resident company that would not qualify for all of the benefits of the U.S.-Germany

income tax treaty but may qualify for benefits with respect to certain items of income under the

“active trade or business” test of the U.S.-Germany treaty. X, in turn, is wholly owned by W, a

French resident company that is substantially and regularly traded on the Paris Stock Exchange.

Z pays a dividend to Y. Y qualifies for benefits under paragraph 3 of Article 23, assuming that

the requirements of subparagraph 3(b) of Article 23 are met. Y is directly owned by X, which is

not an equivalent beneficiary within the meaning of subparagraph 7(d)(i) of Article 23 (X does

not qualify for all of the benefits of the U.S.-Germany tax treaty). However, Y is also indirectly

owned by W and W may be an equivalent beneficiary. Y would not be entitled to the zero rate of

withholding tax on dividends available under the Convention because W is not an equivalent

beneficiary with respect to the zero rate of withholding tax since W is not eligible for such rate

under the U.S.-France income tax treaty. W qualifies as an equivalent beneficiary with respect to

the 5 percent maximum rate of withholding tax because (a) it is a French resident company

whose shares are substantially and regularly traded on a recognized stock exchange, within the

meaning of the Limitation on Benefits Article of the U.S.-France income tax treaty and (b) the

dividend withholding rate in the treaty between the United States and France is 5 percent.

Accordingly, U.S. withholding tax on the dividend from Z to Y will be imposed at a rate of 5

percent in accordance with subparagraph 2(a) of Article 10.