[Senate Executive Report 110-5]
[From the U.S. Government Publishing Office]



110th Congress                                              Exec. Rept.
                                 SENATE
 1st Session                                                      110-5

======================================================================



 
                    PROTOCOL AMENDING TAX CONVENTION
                              WITH GERMANY

                                _______
                                

                November 14, 2007.--Ordered to be printed

                                _______
                                

          Mr. Biden, from the Committee on Foreign Relations,
                        submitted the following

                                 REPORT

      [To accompany Treaty Doc. 109-20 and Exchange of Notes dated
                       August 17, 2006 (EC-2046)]

    The Committee on Foreign Relations, to which was referred 
the Protocol Amending the Convention Between the United States 
of America and the Federal Republic of Germany for the 
Avoidance of Double Taxation and the Prevention of Fiscal 
Evasion with Respect to Taxes on Income and Capital and to 
Certain Other Taxes, signed at Berlin on June 1, 2006, along 
with an exchange of notes dated August 17, 2006 (the 
``Protocol'') and a related Joint Declaration, signed at Berlin 
on June 1, 2006 (Treaty Doc. 109-20; EC-2046), having 
considered the same, reports favorably thereon and recommends 
that the Senate give its advice and consent to ratification 
thereof, as set forth in this report and the accompanying 
resolution of advice and consent.

                                CONTENTS

                                                                   Page

  I. Purpose..........................................................2
 II. Background.......................................................2
III. Major Provisions.................................................2
 IV. Entry Into Force; Effective Dates................................5
  V. Implementing Legislation.........................................6
 VI. Committee Action.................................................6
VII. Committee Recommendation and Comments............................6
VIII.Resolution of Advice and Consent to Ratification.................9

 IX. Annex I.--Exchange of Notes (EC-2046)...........................10
  X. Annex II.--Technical Explanation................................14

                               I. Purpose

    The proposed Protocol to the existing tax treaty between 
the United States and Germany is intended to promote closer 
cooperation and further facilitate trade and investment between 
the United States and Germany. The Protocol's principal 
objectives are to eliminate the withholding tax on dividends 
arising from certain direct investments and on certain 
dividends paid to pension funds; strengthen the treaty's 
provisions that prevent the inappropriate use of the treaty by 
third-country residents; provide for mandatory arbitration of 
certain disputes that have not been resolved by the competent 
authorities through the mutual agreement procedure; and 
generally modernize the existing tax treaty with Germany to 
bring it into closer conformity with U.S. tax treaty law and 
policy.

                             II. Background

    The Protocol was signed on June 1, 2006 along with a 
related Joint Declaration signed on the same day. On August 17, 
2006, the United States and Germany exchanged notes to rectify 
certain inaccuracies that were discovered upon review of the 
Protocol. The Protocol, accompanied by the Joint Declaration 
and the exchange of notes, amends the Convention between the 
Federal Republic of Germany for the Avoidance of Double 
Taxation and the Prevention of Fiscal Evasion with Respect to 
Taxes on Income and Capital and to Certain Other Taxes, 
together with a related Protocol, signed at Bonn on August 29, 
1989 (the ``1989 Convention'') (Treaty Doc. 101-10; Exec. Rept. 
101-27). The 1989 Convention replaced an older tax treaty 
concluded in 1954 between the United States and Germany and 
amended by a Protocol in 1965.

                         III. Major Provisions

    A detailed article-by-article analysis of the Protocol may 
be found in the Technical Explanation published by the 
Department of the Treasury on July 17, 2007, which is reprinted 
in Annex II. In addition, the staff of the Joint Committee on 
Taxation prepared an analysis of the Protocol, Document JCX-47-
07 (July 13, 2007), which has been of great assistance to the 
committee in reviewing the Protocol. A summary of the key 
provisions of the Protocol is set forth below.

1. Taxation of Cross-border Dividend Payments

    The Protocol replaces Article 10 of the 1989 Convention, 
which provides rules for the taxation of dividends paid by a 
company that is a resident of one treaty country to a 
beneficial owner that is a resident of the other treaty 
country. The new version of Article 10 generally allows full 
residence-country taxation and limited source-country taxation 
of dividends.
    The Protocol retains both the generally applicable maximum 
rate of withholding at source of 15 percent and the reduced 
five-percent maximum withholding rate for dividends received by 
a company owning at least 10 percent of the voting stock of the 
dividend-paying company. Additionally, with some restrictions 
intended to prevent treaty shopping, dividends paid by a 
subsidiary in one treaty country to its parent company in the 
other treaty country will be exempt from withholding tax in the 
subsidiary's home country if the parent company owns at least 
80 percent of the voting power in the subsidiary for the 12-
month period ending on the date entitlement to the dividend is 
determined. By contrast, the 1989 Convention provides for a 
maximum withholding tax rate of five percent for such 
dividends.
    The Protocol provides that dividends beneficially owned by 
a pension fund may not be taxed by the country in which the 
company paying the dividends is a resident, unless such 
dividends are derived from the carrying on of a business, 
directly or indirectly, by the pension fund.
    The Protocol also includes special rules for dividends 
received from U.S. Regulated Investment Companies (RICs), U.S. 
Real Estate Investment Trusts (REITs), and similar German 
entities. These rules are similar to rules included in other 
recent treaties and protocols.

2. Binding Arbitration

    The Protocol replaces a voluntary arbitration procedure in 
the 1989 Convention with a binding arbitration procedure for 
disputes regarding the application of Articles 4 (Residence) 
(but only insofar as it relates to the residence of a natural 
person); 5 (Permanent Establishment), 7 (Business Profits), 9 
(Associated Enterprises), and 12 (Royalties). This is the first 
time that a binding arbitration mechanism has been included in 
a U.S. bilateral tax treaty, although binding arbitration can 
be found in a variety of other treaties to which the United 
States is a party, including aviation agreements, terrorism 
agreements, bilateral investment treaties, and Friendship, 
Commerce, and Navigation treaties.
    The arbitration procedure in the Protocol is sometimes 
referred to as ``last best offer'' arbitration or ``baseball 
arbitration'' because each of the competent authorities 
proposes one and only one figure for settlement and the 
arbitration board must select one of those figures as the 
award. Under the proposed Protocol, unless a taxpayer or other 
``concerned person'' (in general, a person whose tax liability 
is affected by the arbitration determination) does not accept 
the determination of the arbitration board, it is binding on 
both countries.

3. Scope

    The Protocol replaces Article 1 (Personal Scope) of the 
1989 Convention with a new Article 1 (General Scope) that 
generally conforms with the 2006 U.S. Model Tax Treaty (the 
``U.S. Model'') and reflects subsequent changes in U.S. tax 
law.
    The Protocol generally provides that, with the exception of 
certain benefits, the United States may continue to tax its own 
citizens and residents as if the treaty were not in force. In 
addition, notwithstanding any other provision in the treaty, 
the United States may also tax, in accordance with its law, 
certain former citizens and long-term residents for ten years 
following the loss of such status. This change is consistent 
with section 877 of the Internal Revenue Code, which provides 
special rules for the imposition of U.S. income tax on former 
U.S. citizens and long-term residents for a period of ten years 
following the loss of citizenship or long-term resident status.
    The Protocol also adds an additional paragraph (Article 1, 
paragraph 7), which addresses special issues presented by 
fiscally transparent entities such as partnerships and certain 
estates and trusts. When there is a difference of views between 
the United States and Germany on whether an entity is fiscally 
transparent, the entity in question may be subject to double 
taxation or double non-taxation. Paragraph 7 solves this 
problem by providing that an item of income, profit, or gain 
derived by or through an entity that is fiscally transparent 
under the laws of either treaty country is considered to be the 
income, profit, or gain of a resident of one of the treaty 
countries only to the extent that the item is subject to tax in 
that country as the income, profit, or gain of a resident.

4. Business Profits

    The Protocol amends Article 7 (Business Profits) of the 
1989 Convention in two important ways. First, the Protocol 
provides that income derived from the performance of 
independent personal services, such as professional services, 
is included within the meaning of the term ``business 
profits.'' Second, the Protocol provides that the OECD Transfer 
Pricing Guidelines apply by analogy in determining the profits 
attributable to a permanent establishment as defined by the 
treaty. These amendments bring the treaty into closer 
conformity with the U.S. Model.

5. Interest

    The Protocol amends Article 11 (Interest) to add a new 
exception to the general prohibition on source-country taxation 
of interest income. The exception is for interest that is an 
excess inclusion with respect to a residual interest in a U.S. 
real estate mortgage investment conduit.

6. Limitation on Benefits

    The 1989 Convention already contains a ``Limitation on 
Benefits'' provision (Article 28), which is designed to avoid 
treaty-shopping. The Protocol amends the Convention's 
Limitation on Benefits provision so as to strengthen it against 
abuse by third-country residents and bring it into line with 
the U.S. Model and other more recent U.S. tax treaties. Among 
other changes, the new provision provides that a treaty-country 
company whose shares are regularly traded on a recognized stock 
exchange may qualify for treaty benefits if the company 
satisfies one of two tests: either the company's principal 
class of shares must be primarily traded on a recognized stock 
exchange in the company's country of residence or the company's 
primary place of management and control must be in the country 
of residence. This new requirement is intended to ensure an 
adequate connection to the company's claimed country of 
residence.

7. Pension Plans

    The Protocol includes provisions related to cross-border 
pension contributions and earnings, which generally conform 
with the U.S. Model and prevent the taxation of pension 
contributions and earnings when an individual participates in a 
pension plan established in one country while performing 
services in the other, provided certain requirements are met. 
One such requirement is that the competent authority in the 
country where the services are performed must agree that the 
pension plan generally corresponds to a pension plan recognized 
as such for tax purposes by that country. For purposes of this 
requirement, the Protocol provides in paragraph 16 of Article 
XVI a non-exhaustive list of specific types of pension plans in 
the United States and Germany that qualify, making it 
unnecessary to obtain a specific ruling from the competent 
authorities with respect to the pension plans that have been 
identified.

8. Visiting Professors and Teachers; Students and Trainees

    The Protocol amends Article 20 (Visiting Professors and 
Teachers; Students and Trainees) of the 1989 Convention and 
provides that professors or teachers who are residents of one 
treaty country, temporarily present in the other treaty 
country, and are engaged in teaching or research at a 
university, college, or other recognized educational 
institution, will be exempted from tax by the host country on 
any remuneration for such teaching or research for up to two 
years and they will not retroactively lose their exemption from 
the host country's income tax if they stay in excess of two 
years. The Protocol also increases the amount of the exemption 
from host country tax for students and trainees who receive 
certain types of payments.

                 IV. Entry Into Force; Effective Dates

    In accordance with Article 17, the Protocol will enter into 
force upon an exchange of instruments of ratification between 
the United States and Germany.
    The Protocol's provisions shall have effect with respect to 
taxes withheld at source, for amounts paid or credited on or 
after the first day of January of the year in which this 
Protocol enters into force. The Protocol's provisions shall 
have effect with respect to other covered taxes on income for 
any taxable year beginning on or after the first day of January 
next following the date this Protocol enters into force. The 
Protocol's provisions shall have effect with respect to taxes 
on capital for the taxes levied on items of capital owned on or 
after the first day of January next following the date the 
Protocol enters into force.
    Paragraphs 2 and 3 of Article 1 of the Protocol shall have 
effect after the entry into force of this Protocol and shall 
apply in respect of any tax claim irrespective of whether such 
tax claim pre-dates the entry into force of the Protocol or the 
effective date of any of its provisions; and the amendments 
made by Article X of the Protocol shall not have effect with 
respect to individuals who, at the time of the signing of the 
Convention (August 29, 1989), were employed by the United 
States, a political subdivision or local authority thereof.
    The binding arbitration provisions of the Protocol (Article 
XIII) shall have effect with respect to cases that are under 
consideration by the competent authorities as of the date on 
which this Protocol enters into force, and cases that come 
under such consideration after that time.
    If any person entitled to benefits under the 1989 
Convention as unmodified by the Protocol would have been 
entitled to greater benefits under the unmodified 1989 
Convention than under the Convention as modified by the 
Protocol, the Convention as unmodified shall, at the election 
of such person, continue to have effect in its entirety with 
respect to such person for a twelve-month period from the date 
on which the provisions of this Protocol would otherwise have 
effect.

                      V. Implementing Legislation

    As is the case generally with income tax treaties, the 
Protocol is self-executing and thus does not require 
implementing legislation for the United States.

                          VI. Committee Action

    The committee held a public hearing on the Protocol on July 
17, 2007 (a hearing print of this session will be forthcoming). 
Testimony was received by Mr. John Harrington, International 
Tax Counsel, Office of the International Tax Counsel at the 
Department of the Treasury; Thomas A. Barthold, Acting Chief of 
Staff of the Joint Committee on Taxation; the Honorable William 
A. Reinsch, President of the National Foreign Trade Council; 
and Ms. Janice Lucchesi, Chairwoman of the Board, Organization 
for International Development. On October 31, 2007, the 
committee considered the Protocol, and ordered it favorably 
reported by voice vote, with a quorum present and without 
objection.

               VII. Committee Recommendation and Comments

    The Committee on Foreign Relations believes that the 
Protocol will stimulate increased investment, further 
strengthen the provision in the 1989 Convention that prevents 
treaty shopping, and promote closer cooperation and facilitate 
trade and investment between the United States and Germany. The 
committee therefore urges the Senate to act promptly to give 
advice and consent to ratification of the Protocol, as set 
forth in this report and the accompanying resolution of advice 
and consent. The committee has taken note, however, of certain 
issues raised by the Protocol and has certain comments to offer 
the Executive Branch on these matters.

             A. TECHNICAL EXPLANATIONS AND TREATY SHOPPING

    The Protocol was considered by the committee on October 31, 
2007, along with three other tax treaties: (1) The Protocol 
Amending Tax Convention with Finland (Treaty Doc. 109-18); (2) 
The Protocol Amending Tax Convention with Denmark (Treaty Doc. 
109-19); and( 3) The Tax Convention with Belgium (Treaty Doc. 
110-3). In the committee's report regarding the Protocol 
Amending Tax Convention with Finland, also filed this day, the 
committee set forth comments on two issues, which are also 
relevant here.
    First, the committee suggested that the Treasury Department 
consider sharing the Technical Explanation it develops with its 
treaty partners, prior to its public release. Second, the 
committee encouraged the Treasury Department to further 
strengthen anti-treaty-shopping provisions in tax treaties 
whenever possible, with a particular focus on closing the 
loophole created by those U.S. tax treaties currently in force 
that do not have an anti-treaty-shopping provision. A detailed 
discussion regarding these issues can be found in Section VII 
of the committee's report regarding the Protocol Amending Tax 
Convention with Finland (Exec. Rept. 110-4).

                            B. PENSION FUNDS

    The committee welcomes amendments made by the Protocol to 
the 1989 Convention, which would facilitate the ability of U.S. 
businesses to transfer employees abroad when appropriate, while 
preserving their pension benefits. Specifically, as noted in 
Section V of this report, the Protocol includes provisions 
related to cross-border pension contributions and earnings, 
which generally conform to the U.S. Model and prevent the 
taxation of pension contributions and earnings when an 
individual participates in a pension plan established in one 
country while performing services in the other, provided 
certain requirements are met. The Protocol identifies in 
paragraph 16 of Article XVI specific types of qualifying 
pensions, thereby making it unnecessary to obtain a specific 
ruling from the competent authorities with respect to the 
pension plans that have been identified. This pre-approval of 
certain plans is another useful development that should be 
employed where possible in future agreements, as it effectively 
streamlines what can otherwise be a cumbersome process.

                             C. ARBITRATION

    The committee recognizes the potential value that the 
binding arbitration mechanism introduced by the Protocol has 
with respect to the effective implementation and enforcement of 
the Protocol and as such, commends the Treasury Department for 
developing this mechanism. With minor exceptions, the same 
arbitration procedure is in the Tax Treaty with Belgium (Treaty 
Doc. 110-3) also under consideration by the Senate. Moreover, 
the Treasury Department has indicated that binding arbitration 
is likely to be a feature of other tax treaties that will be 
submitted to the Senate in the future and thus, the committee 
takes this opportunity to comment on aspects of the arbitration 
mechanism, which it believes deserve further discussion and 
consideration.
    As a preliminary matter, the committee urges the Executive 
Branch to consider arbitration mechanisms with specific treaty 
countries on a case-by-case basis, rather than opting for a 
particular model, which would be used as the starting point for 
every negotiation. For example, in the context of a treaty 
relationship that is more contentious, providing the 
arbitration board's decisions with precedential value might be 
desirable in order to avoid arbitrating the same dispute 
repeatedly. Or there may be certain contentious subject areas, 
such as transfer-pricing, for which a different approach is 
deemed useful. Several questions for the record regarding the 
arbitration provision, which appear in the Appendix to the 
hearing print of the public hearing held on the Protocol, 
highlight alternative approaches to specific arbitration 
procedures that might be useful in the context of some treaty 
relationships, but not in all.
    Of the substantive issues raised in the hearing record, 
there are three particular matters on which the committee 
offers specific comments: (1) Taxpayer Input; (2) Treaty 
Interpretation; and (3) Selection of Arbiters.

1. Taxpayer Input

    At the hearing on the Protocol, certain questions were 
raised regarding taxpayer input in the arbitration process 
established by the treaty.
    As the Treasury Department noted in its response to a 
question for the record, taxpayers may be, and often are, 
involved during the competent authority negotiation process. In 
fact, the Treasury Department stated that ``the United States 
seeks and encourages such taxpayer input.''
    Direct taxpayer input is not, however, provided for during 
the course of an arbitration proceeding under the Protocol. The 
Treasury Department has assured the committee that although the 
procedure provided for in the Protocol does not allow the 
taxpayer to submit information directly to the arbitration 
board, the taxpayer's ``position on the matter will be taken 
into account by the U.S. competent authority, who may enlist 
additional assistance from the taxpayer throughout the 
process.'' This is almost assuredly true, but it is difficult 
to understand why it would be problematic to provide taxpayers 
with the ability to submit information relevant to the case 
being arbitrated, when they deem necessary. If a taxpayer 
agrees with the Treasury Department that his or her position 
has been sufficiently taken into account by the competent 
authority, the taxpayer would presumably see no need to submit 
additional information to the arbitration board. If, on the 
other hand, the taxpayer believes that the information being 
presented to the arbitration board is not complete or 
incorrect, a procedure that allows a taxpayer to submit 
information would give the taxpayer the opportunity to add to 
or correct the record before the arbitration board.
    The binding arbitration mechanism is intended to be an 
effective and efficient method of resolving disputes in which 
taxpayers are experiencing double taxation under the Protocol. 
The Treasury Department has noted that adding a process for 
taxpayer input could have a negative impact on the efficiency 
of the arbitration mechanism, as it will add to the complexity 
of the proceeding. In addition, it could be a further burden on 
the Treasury Department's resources, if the Department must 
respond to long briefs submitted by taxpayers.
    These are not unreasonable concerns. The committee 
recognizes that there is a balance to be struck in determining 
whether and, if so, how taxpayer input might be added to this 
process. For example, a mechanism for taxpayer input could be 
limited in many respects to ensure that it would not slow the 
process or create an excessive burden on the Treasury 
Department. The committee urges the Treasury Department to give 
this issue greater consideration as it moves forward.

2. Treaty Interpretation

    Paragraph 22(i) of Article XVI lays out the sources to be 
used by an arbitration board when interpreting relevant treaty 
provisions in a particular dispute, rather than simply 
referring to the customary international law rules of treaty 
interpretation, reflected in Section 3 of the Vienna Convention 
on the Law of Treaties. Many of the interpretive materials 
listed would be considered relevant under the Vienna Convention 
rules. The list, however, is not entirely consistent with 
Vienna Convention rules. In response to a question regarding 
the decision to include such a list, the Treasury Department 
stated to the committee as follows:

          In the absence of an agreement to the contrary by the 
        states parties concerned, the United States generally 
        views the customary international law rules of treaty 
        interpretation, as reflected in the Vienna Convention 
        on the Law of Treaties, as applicable to treaties, 
        including tax treaties. The arbitration provisions in 
        the proposed agreements with Germany and Belgium 
        contain references to many interpretive materials that 
        would be considered under the relevant provisions of 
        the Vienna Convention on the Law of Treaties. The types 
        of interpretive materials referenced in the proposed 
        agreements with Germany and Belgium, along with the 
        technical explanations prepared by the Treasury 
        Department and other documents submitted to the Senate 
        as part of the ratification process, generally inform 
        the U.S. view of the meaning of tax treaties. As we 
        move forward on arbitration provisions in future 
        agreements, we are considering appropriate means to 
        reflect customary international law rules of treaty 
        interpretation.

    The committee urges the Treasury Department to ensure in 
future agreements that the interpretive rules for the 
arbitration board are fully consistent with customary 
international law rules of treaty interpretation.

3. Selection of Arbiters

    The arbitration mechanism in the Protocol provides that in 
establishing an arbitration board panel, each government 
appoints a member of the panel, after which those members 
appoint a third member, who will serve as the Chair. In the 
event of a disagreement between the two board members on a 
choice of a Chair, there is an alternative Chair-appointment 
procedure.
    In accordance with this structure, a government may choose 
to appoint to the board a person in the government's employ. In 
fact, it seems likely that given the choice between hiring a 
private-sector expert or a governmental employee that is an 
expert, a government is more likely to choose a government 
employee, if for no other reason than to keep costs down.
    The committee urges the Treasury Department to consider 
alternatives to this process in future tax treaties that would 
prevent governments from choosing their own employees as 
arbiters. Government employees are unlikely to be perceived as 
independent and objective. Consequently, their use on an 
arbitration board may undermine the perceived independence and 
fairness of the entire arbitration process.

     VIII. Text of Resolution of Advice and Consent to Ratification

    Resolved (two-thirds of the Senators present concurring 
therein), The Senate advises and consents to the ratification 
of the Protocol Amending the Convention between the United 
States of America and the Federal Republic of Germany for the 
Avoidance of Double Taxation and the Prevention of Fiscal 
Evasion with Respect to Taxes on Income and Capital and to 
Certain Other Taxes, signed at Berlin on June 1, 2006 and an 
Exchange of Notes dated August 17, 2006 (EC-2046) (Treaty Doc. 
109-20).

               IX. Annex I.--Exchange of Notes (EC-2046)

                                  U.S. Department of State,
                                   Washington, DC, August 17, 2006.
    The Department of State refers the Embassy of the Federal 
Republic of Germany to the Protocol signed in Berlin on June 1, 
2006, Amending the Convention Between the United States of 
America and the Federal Republic of Germany for the Avoidance 
of Double Taxation and the Prevention of Fiscal Evasion with 
Respect to Taxes on Income and Capital and to Certain Other 
Taxes, Signed on 29th August 1989 (hereinafter "Protocol").

    A few inaccuracies were discovered upon review of the 
Protocol. The following seven inaccuracies relate to both 
language versions.

    1. Paragraph 4 of Article 10 (Article IV of the Protocol)

          a) In the German version the words ``ist Absatz 2 
        Buchstabe b nur anzuwenden'' shall be replaced by the 
        words ``sind Absatz 2 Buchstabe b und Absatz 3 
        Buchstabe b nur anzuwenden'' and

          b) in the English version the words ``and 
        subparagraph b) of paragraph 3'' shall be added after 
        the words ``In the case of dividends paid by a REIT 
        subparagraph b) of paragraph 2''.

    2. Subparagraph a) of paragraph 4 of Article 10 (Article IV 
of the Protocol)

          a) In the German version the words ``der 
        Nutzungsberechtigte der Dividenden eine naturliche 
        Person ist, die mit nicht mehr als 10 vom Hundert an 
        dem REIT beteiligt ist'' shall be replaced by the words 
        ``der Nutzungsberechtigte der Dividenden eine 
        naturliche Person oder ein Pensionsfonds ist and die 
        naturliche Person oder der Pensionsfonds mit nicht mehr 
        als 10 vom Hundert an dem REIT beteiligt ist'' and

          b) in the English version the words "or a pension 
        fund, in either case"' shall be inserted after the word 
        "individual".

    3. Subparagraph b) of paragraph 4 of Article 23 (Article 
XII of the Protocol)

          a) In the German version, the words "Absatz 3 
        Buchstabe a gilt nicht'' shall be replaced by the words 
        "Absatz 3 Buchstabe b und nicht Buchstabe a gilt'' and

          b) in the English version, the words ``The provisions 
        of subparagraph a) of paragraph 3 shall not" shall be 
        replaced by the words ``The provisions of subparagraph 
        b) and not the provisions of subparagraph a) of 
        paragraph 3 shall''.

    4. Clause bb) of subparagraph e) of paragraph 2 of Article 
28 (Article XIV of the Protocol)

          a) In the German version the full stop shall be 
        replaced by a semicolon and the word ``odor'' and

          b) in the English version, the word "or" shall be 
        added after the semicolon.

    5. Chapeau of Article XIII of the Protocol

          a) In the German version the word ``den'' shall be 
        replaced by the word ``die'' and the word ``Absatz'' 
        shall be replaced by the word ``Absatze'' and

          b) in the English version the word ``paragraph'' 
        shall be replaced by the word ``paragraphs''.

    6. Subparagraph a) of paragraph 8 of the Protocol to the 
Convention (Article XVI of the Protocol)

          a) In the German version the words ``auf 
        Ausschuttungen einer solchen in der Bundesrepublik 
        Deutschland ansassigen Gesellschaft'' shall be inserted 
        after the words ``Artikel 10 Absatz 3 Buchstabe b'' and

          b) in the English version the words ``to dividends 
        paid by such a company that is a resident of the 
        Federal Republic of Germany'' shall be added at the end 
        of the sentence.

    7. Subparagraph h) of paragraph 22 of the Protocol to the 
Convention (Article XVI of the Protocol)

          a) In the German version the number "6" shall be 
        replaced by the word ``neun'' and

          b) in the English version the word ``six'' shall be 
        replaced by the word ``nine''.

    The following three inaccuracies relate to the German 
language version only:

    1. In subparagraph a) of paragraph 11 of Article 10 
(Article IV of the Protocol)
          a) the word ``nach'' shall be inserted before the 
        words ``dem Recht'' and

          b) the word ``wurde'' shall be added after the word 
        ``errichtet''.

    2. In subparagraph f) of paragraph 8 of Article 28 (Article 
XIV of the Protocol) the words``"des Buchstabens f'' shall be 
replaced by the words``des Buchstabens e''.

    3. In paragraph 4 of the Protocol to the Convention 
(Article XVI of the Protocol) the word ``Einzeluntemehmens'' 
shall be replaced by the word ``Einheitsunternehmens''.

    In order to correct the Protocol, the Department of State 
proposes that:

    I. The German language version and the English language 
version be corrected as set out above; and

    II. The corrected texts replace the defective texts as from 
the date on which the Protocol was signed.

    If the Government of the Federal Republic of Germany 
concurs with the proposals contained in paragraphs I. and II. 
above, this note and the note in reply thereto expressing the 
approval of the Government of the Federal Republic of Germany 
shall constitute the correction of the German and English 
language versions of the Protocol, and shall become part of the 
original thereof.

                                       Department of State,
                                       Washington, August 17, 2006.

                                ------                                


        Embassy of the Federal Republic of Germany,
                                             Gz: Wi 551.20,

                        VERBAL NOTE NO. 10412006

    The Embassy of the Federal Republic of Germany presents its 
compliments to the Department of State of the United States of 
America and has the honor to confirm receipt of its Note 
Verbale of August 17, 2006, which reads as follows:

          The Department of State refers the Embassy of the 
        Federal Republic of Germany to the Protocol signed in 
        Berlin on June 1, 2006, Amending the Convention Between 
        the United States of America and the Federal Republic 
        of Germany for the Avoidance of Double Taxation and the 
        Prevention of Fiscal Evasion with Respect to Taxes on 
        Income and Capital and to Certain Other Taxes, Signed 
        on 29th August, 1989 (hereinafter ``Protocol'').

    A few inaccuracies were discovered upon review of the 
Protocol. The following seven inaccuracies relate to both 
language versions.

    1. Paragraph 4 of Article 10 (Article IV of the Protocol)

          a) In the German version the words ``ist Absatz 2 
        Buchstabe b nur anzuwenden'' shall be replaced by the 
        words ``sind Absatz 2 Buchstabe b und Absatz 3 
        Buchstabe b nur anzuwenden'' and

          b) in the English version the words ``and 
        subparagraph b) of paragraph 3'' shall be added after 
        the words ``In the case of dividends paid by a REIT 
        subparagraph b) of paragraph 2''.

    2. Subparagraph a) of paragraph 4 of Article 10 (Article IV 
of the Protocol)

          a) In the German version the words ``der 
        Nutzungsberechtigte der Dividenden eine naturliche 
        Person ist, die mit nicht mehr als 10 vom Hundert an 
        dern REIT beteiligt ist'' shall be replaced by the 
        words ``der Nutzungsberechtigte der Dividenden eine 
        naturliche Person oder ein Pensionsfonds ist und die 
        naturliche Person oder der Pensionsfonds mit nicht mehr 
        als 10 vom Hundert an dem REIT beteiligt ist'' and

          b) in the English version the words ``or a pension 
        fund, in either case'' shall be inserted after the word 
        ``individual''.

    3. Subparagraph b) of paragraph 4 of Article 23 (Article 
XII of the Protocol)

          a) In the German version, the words ``Absatz 3 
        Buchstabe a gilt nicht'' shall be replaced by the words 
        ``Absatz 3 Buchstabe b and nicht Buchstabe a gilt'' and

          b) in the English version, the words ``The provisions 
        of subparagraph a) of paragraph 3 shall not'' shall be 
        replaced by the words ``The provisions of subparagraph 
        b) and not the provisions of subparagraph a) of 
        paragraph 3 shall''.

    4. Clause bb) of subparagraph e) of paragraph 2 of Article 
28 (Article XIV of the Protocol)

          a) In the German version the full stop shall be 
        replaced by a semicolon and the word ``oder'' and

          b) in the English version, the word ``or'' shall be 
        added after the semicolon.

    5. Chapeau of Article XIII of the Protocol

          a) In the German version the word ``den'' shall be 
        replaced by the word ``die'' and the word ``Absatz'' 
        shall be replaced by the word ``Absatze'' and

          b) in the English version the word ``paragraph'' 
        shall be replaced by the word ``paragraphs''.

    6. Subparagraph a) of paragraph 8 of the Protocol to the 
Convention (Article XVI of the Protocol)

          a) In the German version the words ``auf 
        Ausschuttungen einer solchen in der Bundesrepublik 
        Deutschland ansassigen Gesellschaft'' shall be inserted 
        after the words ``Artikel 10 Absatz 3 Buchstabe b'' and

          b) in the English version the words ``to dividends 
        paid by such a company that is a resident of the 
        Federal Republic of Germany'' shall be added at the end 
        of the sentence.

    7. Subparagraph h) of paragraph 22 of the Protocol to the 
Convention (Article XVI of the Protocol)

          In the German version the number ``6'' shall be 
        replaced by the word ``neun'' and b) in the English 
        version the word ``six'' shall be replaced by the word 
        ``nine''. The following three inaccuracies relate to 
        the German language version only: 1. In subparagraph a) 
        of paragraph 11 of Article 10 (Article IV of the 
        Protocol) a) the word ``nach'' shall be inserted before 
        the words ``dem Recht'' and

          b) the word ``wurde'' shall be added after the word 
        ``errichtet''.

    2. In subparagraph f) of paragraph 8 of Article 28 (Article 
XIV of the Protocol) the words ``des Buchstabens f'' shall be 
replaced by the words ``des Buchstabens e''.

    3. In paragraph 4 of the Protocol to the Convention 
(Article XVI of the Protocol) the word ``Einzelunternehmens'' 
shall be replaced by the word ``Einheitsunternehmens''.

    In order to correct the Protocol, the Department of State 
proposes that

    I. The German language version and the English language 
version be corrected as set out above; and

    II. The corrected texts replace the defective texts as from 
the date on which the Protocol was signed.

    If the Government of the Federal Republic of Germany 
concurs with the proposals contained in paragraphs I and II 
above, this note and the note in reply thereto expressing the 
approval of the Government of the Federal Republic of Germany 
shall constitute the correction of the German and English 
language versions of the Protocol, and shall become part of the 
original thereof.''

    The Embassy of the Federal Republic of Germany has the 
honor to inform the Department of State of the United States of 
America that the Government of the Federal Republic of Germany 
agrees to the proposals made by the Government of the United 
States of America. Accordingly, the Note Verbale of the 
Department of State of the United States of America of August 
17, 2006, and this Note in reply thereto constitute an 
Arrangement between the Government of the Federal Republic of 
Germany and the Government of the United States of America 
concerning the correction of the German and English language 
versions of the Protocol, the German and English versions of 
which shall be equally authentic.
    The Embassy of the Federal Republic of Germany avails 
itself of this opportunity to renew to the Department of State 
of the United States of America the assurances of its highest 
consideration.
                               Washington, 17th August 2006

                  X. Annex II.--Technical Explanation


DEPARTMENT OF THE TREASURY TECHNICAL EXPLANATION OF THE PROTOCOL SIGNED 
 AT BERLIN ON JUNE 1, 2006, AMENDING THE CONVENTION BETWEEN THE UNITED 
STATES OF AMERICA AND THE FEDERAL REPUBLIC OF GERMANY FOR THE AVOIDANCE 
OF DOUBLE TAXATION AND THE PREVENTION OF FISCAL EVASION WITH RESPECT TO 
 TAXES ON INCOME AND CAPITAL AND TO CERTAIN OTHER TAXES SIGNED ON 29TH 
                              AUGUST 1989

    This is a technical explanation of the Protocol signed at 
Berlin on June 1, 2006 (the ``Protocol''), amending the 
Convention between the United States of America and the Federal 
Republic of Germany for the avoidance of double taxation and 
the prevention of fiscal evasion with respect to taxes on 
income and capital and to certain other taxes, and the related 
protocol, signed at Bonn on August 29, 1989 (hereinafter the 
``Convention'' and ``Protocol to the Convention'' 
respectively).
    Negotiations took into account the U.S. Department of the 
Treasury's current tax treaty policy and Treasury's Model 
Income Tax Convention, published on September 20, 1996 (the 
``1996 U.S. Model'').\1\ Negotiations also took into account 
the Model Tax Convention on Income and on Capital, published by 
the Organisation for Economic Cooperation and Development (the 
``OECD Model''), and recent tax treaties concluded by both 
countries.
---------------------------------------------------------------------------
    \1\Where appropriate references will also be made to Treasury's 
Model Income Tax Convention, published on November 15, 2006 (the ``2006 
U.S. Model'').
---------------------------------------------------------------------------
    This Technical Explanation is an official guide to the 
Protocol. It explains policies behind particular provisions, as 
well as understandings reached during the negotiations with 
respect to the interpretation and application of the Protocol. 
This technical explanation is not intended to provide a 
complete guide to the Convention as amended by the Protocol. To 
the extent that the Convention has not been amended by the 
Protocol, the Technical Explanation of the Convention remains 
the official explanation. Moreover, Article XVI of the Protocol 
restates and updates the Protocol to the Convention. This 
technical explanation discusses only those aspects of Article 
XVI that amend the Protocol to the Convention. To the extent 
that a paragraph from the Protocol to the Convention has not 
been changed, the technical explanation to the Convention 
remains the official explanation. References in this technical 
explanation to ``he'' or ``his'' should be read to mean ``he or 
she'' or ``his or her.''

                               ARTICLE I

    Article I of the Protocol replaces Article 1 (Personal 
Scope) of the Convention with a new Article 1 (General Scope).
Paragraph 1
    Paragraph 1 of Article 1 provides that the Convention 
applies only to residents of the United States or the Federal 
Republic of Germany, 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 Contracting State, liable to 
tax therein by reason of his domicile, residence, citizenship, 
place of management, place of incorporation, or other similar 
criteria. However, if a person is considered a resident of both 
Contracting States, Article 4 provides rules for determining a 
single Contracting State of residence (or no Contracting State 
of residence). This determination governs for all purposes of 
the Convention.
    Certain provisions are applicable to persons who may not be 
residents of either Contracting State. For example, paragraph 1 
of Article 24 (Nondiscrimination) applies to nationals of the 
Contracting States. Under Article 26 (Exchange of Information 
and Administrative Assistance), information may be exchanged 
with respect to residents of third states.
Paragraph 2
    Paragraph 2 states the generally accepted relationship both 
between the Convention and domestic law of the Contracting 
States and between the Convention and other agreements between 
the Contracting States. That is, no provision in the Convention 
may restrict any exclusion, exemption, deduction, credit or 
other allowance accorded by the tax laws of the Contracting 
States, or (except as provided in paragraph 3 with respect to 
non-discrimination provisions) by any other agreement between 
the Contracting States.
    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 Federal 
Republic of Germany, 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 
Federal Republic of Germany has three separate businesses in 
the United States. One is a profitable permanent establishment 
and the other two are trades or businesses that would earn 
taxable income under the Code but that do not meet the 
permanent establishment threshold tests of the Convention. One 
is profitable and the other incurs a loss. Under the 
Convention, the income of the permanent establishment is 
taxable in the United States, and both the profit and loss of 
the other two businesses are ignored. Under the Code, all three 
would be subject to tax, but the loss would offset the profits 
of the two profitable ventures. The taxpayer may not invoke the 
Convention to exclude the profits of the profitable trade or 
business and invoke the Code to claim the loss of the loss 
trade or business against the profit of the permanent 
establishment. (See Rev. Rul. 84-17, 1984-1 C.B. 308.) If, 
however, the taxpayer invokes the Code for the taxation of all 
three ventures, he would not be precluded from invoking the 
Convention with respect, for example, to any dividend income he 
may receive from the United States that is not effectively 
connected with any of his business activities in the United 
States.
    Similarly, nothing in the Convention can be used to deny 
any benefit granted by any other agreement between the United 
States and the Federal Republic of Germany. 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 Federal Republic of Germany, those 
benefits or protections will be available to residents of the 
Contracting States regardless of any provisions to the contrary 
(or silence) in the Convention.
Paragraph 3
    Paragraph 3 specifically relates to non-discrimination 
obligations of the Contracting States under other agreements. 
The provisions of paragraph 3 are an exception to the rule 
provided in 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 (aa) 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 25 (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 interpretation, 
application, or scope of the Convention.
    Clause (bb) of subparagraph (a) of paragraph 3 provides 
that no other agreement to which the United States and the 
Federal Republic of Germany are parties shall apply with 
respect to a taxation measure unless the competent authorities 
agree that the measure is not within the scope of the non-
discrimination provisions of Article 24 (Nondiscrimination) of 
the Convention. Accordingly, if the non-discrimination 
provisions of this Convention apply to a taxation measure, no 
national treatment or most-favored-nation (``MFN'') obligations 
undertaken by the Contracting States in any other agreement 
shall apply to that taxation measure.
    Subparagraph (b) of paragraph 3 defines a ``measure'' 
broadly. It would include, for example, a law, regulation, 
rule, procedure, decision, administrative action or guidance, 
or any other form of measure.
Paragraph 4
    Subparagraph (a) of paragraph 4 contains the traditional 
saving clause found in all U.S. treaties. The United States 
reserves the right, except as provided in paragraph 5, to tax 
its residents and citizens as provided in its internal law, 
notwithstanding any provisions of the Convention to the 
contrary. For example, if a resident of the Federal Republic of 
Germany 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 Federal 
Republic of Germany 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 Article 1 
preserves the benefits of special foreign tax credit rules 
applicable to the U.S. taxation of certain U.S. income of its 
citizens resident in the Federal Republic of Germany. See 
paragraph 5 of Article 23 (Relief from Double Taxation).
    For purposes of the saving clause, ``residence'' is 
determined under Article 4 (Residence). Thus, an individual who 
is a resident of the United States under the Code (but not a 
U.S. citizen) but who is determined to be a resident of the 
Federal Republic of Germany under the tie-breaker rules of 
Article 4 would be subject to U.S. tax only to the extent 
permitted by the Convention. The United States would not be 
permitted to apply its statutory rules to that person to the 
extent the rules are inconsistent with the 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).
    Subparagraph (b) provides that the United States also 
reserves its right to tax former citizens and former long-term 
residents for a period of ten years following the loss of such 
status. Thus, paragraph 4 allows the United States to tax 
former U.S. citizens and former U.S. long-term residents in 
accordance with section 877 of the Code. Section 877 generally 
applies to a former citizen or long-term resident of the United 
States who relinquishes citizenship or terminates long-term 
residency if either of the following criteria exceed 
established thresholds: (i) the average annual net income tax 
of such individual for the period of five taxable years ending 
before the date of the loss of status, or (ii) the net worth of 
such individual as of the date of the loss of status. The 
average annual net income tax threshold is adjusted annually 
for inflation.
    Paragraph 1 of Article XVI of the Protocol makes clear that 
the definition of a ``long-term resident'' found in section 877 
applies for purposes of subparagraph (b) of paragraph 4 of 
Article 1. Section 877 defines a ``long-term resident'' as an 
individual (other than a U.S. citizen) who is a lawful 
permanent resident of the United States in at least eight of 
the prior 15 taxable years. 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 5
    Paragraph 5 sets forth certain exceptions to the saving 
clause. The referenced provisions are intended to provide 
benefits to citizens and residents even if such benefits do not 
exist under internal law. Paragraph 5 thus preserves these 
benefits for citizens and residents of the United States.
    Subparagraph (a) lists certain provisions of the Convention 
that are applicable to all citizens and residents of the United 
States, 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) Paragraph 6 of Article 13 (Gains) provides 
        special basis adjustment rules for the taxation of 
        gains in a Contracting State derived by an individual 
        who upon ceasing to be a resident of the other 
        Contracting States is treated under the taxation laws 
        of that State as having alienated property and is taxed 
        in that State by reason thereof.
          (3) Paragraph 3, 4 and 5 Article 18 (Pensions, 
        Annuities, Alimony, Child Support, and Social Security) 
        provides exemptions from source or residence State 
        taxation for certain alimony, child support, and social 
        security payments.
          (4) Paragraph 1 of Article 18A (Pension Plans) 
        provides an exemption for certain investment income of 
        pension funds located in the other Contracting State, 
        while paragraph 5 provides benefits for certain 
        contributions by or on behalf of a U.S. citizen to 
        certain pension funds established in the Federal 
        Republic of Germany.
          (5) Paragraph 3 of Article 19 (Government Services) 
        provides that only the Contracting State that makes 
        payments to a resident of the other Contracting State 
        may tax payments which are compensation for injury or 
        damage suffered as a result of hostility or 
        persecution. This refers to German war reparations 
        payments. This prevents the United States from taxing 
        these payments even if they would be taxable under the 
        Code.
          (6) Article 23 (Relief from Double Taxation) confirms 
        to citizens and residents of one Contracting State the 
        benefit of a credit for income taxes paid to the other 
        or an exemption for income earned in the other State.
          (7) Article 24 (Nondiscrimination) protects residents 
        and nationals of one Contracting State against the 
        adoption of certain discriminatory practices in the 
        other Contracting State.
          (8) Article 25 (Mutual Agreement Procedure) confers 
        certain benefits on citizens and residents of the 
        Contracting States in order to reach and implement 
        solutions to disputes between the two Contracting 
        States. For example, the competent authorities are 
        permitted to use a definition of a term that differs 
        from an internal law definition. The statute of 
        limitations may be waived for refunds, so that the 
        benefits of an agreement may be implemented.
    Subparagraph (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 the United 
States (for example, holders of non-immigrant visas), but not 
to citizens or to persons who have acquired permanent resident 
status in the United States. If beneficiaries of these 
provisions travel from the Federal Republic of Germany to the 
United States, and remain in the United States long enough to 
become residents under its internal law, but do not acquire 
permanent residence status in the United States (i.e., they do 
not become ``green card'' holders) and are not citizens of the 
United States, the United State will continue to grant these 
benefits even if they conflict with the Code. The benefits 
preserved by this paragraph are: the beneficial tax treatment 
of pension fund contributions under paragraph 2 of Article 18A 
(Pension Plans), the host country exemptions for government 
service salaries and pensions under Article 19 (Government 
Service), certain income of visiting students and trainees 
under Article 20 (Visiting Professors and Teachers; Students 
and Trainees), and the income of the members of diplomatic 
missions and consular posts under Article 30 (Members of 
Diplomatic Missions and Consular Posts).
Paragraph 6
    Paragraph 6 contains a rule relating to German tax. In much 
the same way that the saving clause preserves U.S. taxing 
rights with respect to its citizens and residents, this 
paragraph preserves German statutory rights with respect to the 
income of German residents. It further provides that if any tax 
imposed by virtue of this paragraph results in double taxation, 
the competent authorities will seek to eliminate the double 
taxation by use of the mutual agreement procedure, particularly 
paragraph 3 of Article 25 (Mutual Agreement Procedure) which 
provides, among other things, for consultation between the 
competent authorities to eliminate double taxation in cases not 
provided for in the Convention.Paragraph 7
    Paragraph 7 addresses special issues presented by fiscally 
transparent entities such as partnerships and certain estates 
and trusts. Because different countries frequently take 
different views as to when an entity is fiscally transparent, 
the risk of both double taxation and double non-taxation are 
relatively high. The intention of paragraph 7 is to eliminate a 
number of technical problems that arguably would have prevented 
investors using such entities from claiming treaty benefits, 
even though such investors would be subject to tax on the 
income derived through such entities. The provision also 
prevents the use of such entities to claim treaty benefits in 
circumstances where the person investing through such an entity 
is not subject to tax on the income in its State of residence. 
The provision, and the corresponding requirements of the 
substantive rules of Articles 6 through 21, should be read with 
those two goals in mind.
    In general, paragraph 7 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 or as disregarded entities for U.S. tax purposes.
    Under paragraph 7, 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 German 
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 
Federal Republic of Germany, 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 German 
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 country of source (e.g., 
as not fiscally transparent in the Federal Republic of Germany 
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 German tax purposes. These results also obtain 
regardless of where the entity is organized (i.e., in the 
United States, in the Federal Republic of Germany, 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 German tax purposes as a corporation and is owned by a 
German shareholder who is a German resident for German 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 Federal Republic of Germany, 
creates a revocable trust in the United States and names 
persons resident in a third country as the beneficiaries of the 
trust, the trust's income would be regarded as being derived by 
a resident of the Federal Republic of Germany only to the 
extent that the laws of the Federal Republic of Germany treat X 
as deriving the income for its tax purposes, perhaps through 
application of rules similar to the U.S. ``grantor trust'' 
rules.
    Paragraph 7 is not an exception to the saving clause of 
paragraph 4. Accordingly, paragraph 7 does not prevent the 
United States from taxing an entity that is treated as a 
resident of the United States under its tax law. For example, 
if a U.S. LLC with members who are residents of the Federal 
Republic of Germany 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 
Federal Republic of Germany views the LLC as fiscally 
transparent.

                               ARTICLE II

    Article II of the Protocol modifies Article 4 (Residence) 
of the Convention by replacing paragraph 1, which defines the 
term ``resident of a Contracting State.'' 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 28 
(Limitation on Benefits) in order to receive benefits conferred 
on residents of a Contracting State.
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 German law by referring to 
a resident as a person who, under the laws of a Contracting 
State, is subject to tax therein by reason of his domicile, 
residence, place of management, place of incorporation or any 
other similar criterion. Thus, residents of the United States 
generally include U.S. citizens, U.S. green card holders, and 
aliens who are considered U.S. residents under Code section 
7701(b). Paragraph 1 also specifically includes the United 
States, the Federal Republic of Germany, and political 
subdivisions and local authorities of the two States as 
residents for purposes of the Convention.
    Certain entities that are nominally subject to tax but that 
in practice are rarely required to pay tax also would generally 
be treated as residents and therefore accorded treaty benefits. 
For example, a U.S. Regulated Investment Company (RIC) and a 
U.S. Real Estate Investment Trust (REIT) are residents of the 
United States for purposes of the treaty. Although the income 
earned by these entities normally is not subject to U.S. tax in 
the hands of the entity, they are taxable to the extent that 
they do not currently distribute their profits, and therefore 
may be regarded as ``liable to tax.'' They also must satisfy a 
number of requirements under the Code in order to be entitled 
to special tax treatment. Subparagraph (b) of paragraph 2 of 
Article XVI of the Protocol clarifies that, for purposes of the 
Convention, German Investment Funds and German 
Investmentaktiengesellschaft (collectively referred to as 
Investmentvermogen) created under the provisions of the 
Investment Act of 2003 (Investmentgesetz) are residents of the 
Federal Republic of Germany and that a U.S. RIC and a U.S. REIT 
are also residents of the United States.
    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 Federal Republic of Germany who is 
posted in the United States, who may be subject to U.S. tax on 
U.S. source investment income, but is not taxable in the United 
States on non-U.S. source income (see Code section 
7701(b)(5)(B)), would not be considered a resident of the 
United States for purposes of the Convention. Similarly, an 
enterprise of the Federal Republic of Germany with a permanent 
establishment in the United States is not, by virtue of that 
permanent establishment, a resident of the United States. The 
enterprise generally is subject to U.S. tax only with respect 
to its income that is attributable to the U.S. permanent 
establishment, not with respect to its worldwide income, as it 
would be if it were a U.S. resident.
    Subparagraph (a) of paragraph 2 of Article XVI of the 
Protocol provides the Federal Republic of Germany shall treat a 
United States citizen or alien lawfully admitted for permanent 
residence (a ``green card holder'') as a resident of the United 
States only if such person has 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 in order to claim German treaty benefits 
under the Convention.

                              ARTICLE III

    Paragraph (a) of Article III of the Protocol replaces 
paragraph 3 of Article 7 (Business Profits) of the Convention. 
This paragraph is the same as paragraph 3 of Article 7 of the 
2006 U.S. Model. Paragraph 3 provides that in determining the 
business profits of a permanent establishment, deductions shall 
be allowed for the expenses incurred for the purposes of the 
permanent establishment, ensuring that business profits will be 
taxed on a net basis. This rule is not limited to expenses 
incurred exclusively for the purposes of the permanent 
establishment, but includes 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.
    Paragraph 4 of Article XVI of the Protocol 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.
    Paragraph 4 of Article XVI of the Protocol states that it 
is understood that the business profits to be attributed to a 
permanent establishment shall include only the profits derived 
from the assets used, risks assumed, and activities performed 
by the permanent establishment. In addition, 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 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. Sec. 1.882-5. Both 
Sec. 1.882-5 and the method prescribed in the Protocol start 
from the premise that all of the capital of the enterprise 
supports all of the assets and risks of the enterprise, and 
therefore the entire capital of the enterprise must be 
allocated to its various businesses and offices.
    However, Sec. 1.882-5 does not take into account the fact 
that some assets create more risk for the enterprise than do 
other assets. An independent enterprise would need less capital 
to support a perfectly-hedged U.S. Treasury security than it 
would need to support an equity security or other asset with 
significant market and/or credit risk. Accordingly, in some 
cases Sec. 1.882-5 would require a taxpayer to allocate more 
capital to the United States, and therefore would reduce the 
taxpayer's interest deduction more, than is appropriate. To 
address these cases, paragraph 4 of Article XVI of the Protocol 
allows a taxpayer to apply a more flexible approach that takes 
into account the relative risk of its assets in the various 
jurisdictions in which it does business. In particular, in the 
case of financial institutions other than insurance companies, 
the amount of capital attributable to a permanent establishment 
is determined by allocating the institution's total equity 
between its various offices on the basis of the proportion of 
the financial institution's risk-weighted assets attributable 
to each of them. This recognizes the fact that financial 
institutions are in many cases required to risk-weight their 
assets for regulatory purposes and, in other cases, will do so 
for business reasons even if not required to do so by 
regulators. However, risk-weighting is more complicated than 
the method prescribed by Sec. 1.882-5. Accordingly, to ease 
this administrative burden, taxpayers may choose to apply the 
principles of Treas. Reg. Sec. 1.882-5(c) to determine the 
amount of capital allocable to its U.S. permanent 
establishment, in lieu of determining its allocable capital 
under the risk-weighed capital allocation method provided by 
the Protocol, even if it has otherwise chosen to apply the 
principles of Article 7 rather than the effectively connected 
income rules of U.S. domestic law.
    Paragraph 4 of Article XVI of the Protocol provides an 
alternative to the analogous but somewhat different 
``effectively connected'' concept in Code section 864(c). In 
effect, the Protocol allows the United States to tax the lesser 
of two amounts of income: the amount determined by applying 
U.S. rules regarding the calculation of effectively connected 
income and the amount determined under the Protocol. That is, a 
taxpayer may choose the set of rules that results in the lowest 
amount of taxable income, but may not mix and match.
    In some cases, the amount of income ``attributable to'' a 
permanent establishment under the Protocol may be greater than 
the amount of income that would be treated as ``effectively 
connected'' to a U.S. trade or business under section 864. For 
example, a taxpayer that has a significant amount of foreign 
source royalty income attributable to a U.S. branch may find 
that it will pay less tax in the United States by applying 
section 864(c) of the Code, rather than the rules of the 
Protocol, if the foreign source royalties are not derived in 
the active conduct of a trade or business and thus would not be 
effectively connected income. But, as described in the 
Technical Explanation to Article 1(2), if it does so, it may 
not then use the Protocol principles to exempt other income 
that would be effectively connected to the U.S. trade or 
business. Conversely, if it uses the Protocol principles to 
exempt other effectively connected income that is not 
attributable to its U.S. permanent establishment, then it must 
include the foreign source royalties in its net taxable income 
even though such royalties would not constitute effectively 
connected income.
    In the case of financial institutions, the use of internal 
dealings to allocate income within an enterprise may produce 
results under the Protocol that are significantly different 
than the results under the effectively connected income rules. 
For example, income from interbranch notional principal 
contracts may be taken into account under the Protocol, 
notwithstanding that such transactions may be ignored for 
purposes of U.S. domestic law. Under the consistency rule 
described above, a financial institution that conducts 
different lines of business through its U.S. permanent 
establishment may not choose to apply the rules of the Code 
with respect to some lines of business and the Protocol of the 
Convention with respect to others. If it chooses to use the 
rules of the Protocol to allocate its income from its trading 
book, it may not then use U.S. domestic rules to allocate 
income from its loan portfolio.
    The profits attributable to a permanent establishment may 
be from sources within or without a Contracting State. However, 
as stated in the Protocol, 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.
    The language of the Protocol, 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 arm's length method consists of applying the OECD 
Transfer Pricing Guidelines, but taking into account the 
different economic and legal circumstances of a single legal 
entity (as opposed to separate but associated enterprises). 
Thus, any of the methods used in the Transfer Pricing 
Guidelines, including profits methods, may be used as 
appropriate and in accordance with the Transfer Pricing 
Guidelines. However, the use of the Transfer Pricing Guidelines 
applies only for purposes of attributing profits within the 
legal entity. It does not create legal obligations or other tax 
consequences that would result from transactions having 
independent legal significance.
    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 Protocol 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.
    Because the use of profits methods is permissible under the 
Protocol, it is not necessary for the Convention to include a 
provision corresponding to paragraph 4 of Article 7 of the OECD 
Model.
    Paragraph (b) of Article III of the Protocol provides that 
income from the performance of professional services and other 
activities of an independent character are business profits.

                               ARTICLE IV

    Article IV of the Protocol replaces Article 10 (Dividends) 
of the Convention. 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 21 (Other Income) 
grants the residence country exclusive taxing jurisdiction 
(other than for dividends attributable to a permanent 
establishment in the other State).
Paragraph 2
    The State of source also may tax dividends beneficially 
owned by a resident of the other State, subject to the 
limitations of paragraphs 2 and 3. Paragraph 2 generally limits 
the rate of withholding tax in the State of source on dividends 
paid by a company resident in that State to 15 percent of the 
gross amount of the dividend. If, however, the beneficial owner 
of the dividend is a company resident in the other State and 
owns directly shares representing at least 10 percent of the 
voting power of the company paying the dividend, then the rate 
of withholding tax in the State of source is limited to 5 
percent of the gross amount of the dividend. Shares are 
considered voting shares if they provide the power to elect, 
appoint or replace any person vested with the powers ordinarily 
exercised by the board of directors of a U.S. corporation.
    The benefits of paragraph 2 may be granted at the time of 
payment by means of reduced rate of withholding tax at source. 
It also is consistent with the paragraph for tax to be withheld 
at the time of payment at full statutory rates, and the treaty 
benefit to be granted by means of a subsequent refund so long 
as such procedures are applied in a reasonable manner.
    The determination of whether the ownership threshold for 
subparagraph (a) of paragraph 2 is met for purposes of the 5 
percent maximum rate of withholding tax is made on the date on 
which entitlement to the dividend is determined. Thus, in the 
case of a dividend from a U.S. company, the determination of 
whether the ownership threshold is met generally would be made 
on the dividend record date.
    Paragraph 2 does not affect the taxation of the profits out 
of which the dividends are paid. The taxation by a Contracting 
State of the income of its resident companies is governed by 
the internal law of the Contracting State, subject to the 
provisions of paragraph 4 of Article 24 (Nondiscrimination).
    The term ``beneficial owner'' is not defined in the 
Convention, and is, therefore, defined as under the internal 
law of the country imposing tax (i.e., the source country). The 
beneficial owner of the dividend for purposes of Article 10 is 
the person to which the dividend income is attributable 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 
Commentary to Article 10 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 applies when the company's proportionate share of 
the shares held by the intermediate entity meets the 10 percent 
threshold, and the company meets the requirements of Article 
1(7) (i.e., the company's country of residence treats the 
intermediate entity as fiscally transparent) with respect to 
the dividend. Whether this ownership threshold is satisfied may 
be difficult to determine and often will require an analysis of 
the partnership or trust agreement.
Paragraph 3
    Paragraph 3 provides exclusive residence-country taxation 
(i.e., an elimination of withholding tax) with respect to 
certain dividends distributed by a company that is a resident 
of one Contracting State to a resident of the other Contracting 
State. As described further below, this elimination of 
withholding tax is available with respect to certain inter-
company dividends and with respect to certain pension funds.
    Subparagraph (a) of paragraph 3 provides for the 
elimination of withholding tax on dividends beneficially owned 
by a company that has owned 80 percent or more of the voting 
power of the company paying the dividend for the 12-month 
period ending on the date entitlement to the dividend is 
determined. The determination of whether the beneficial owner 
of the dividends owns at least 80 percent of the voting power 
of the paying company is made by taking into account only stock 
owned directly.
    Eligibility for the elimination of withholding tax provided 
by subparagraph (a) is subject to additional restrictions based 
on, but supplementing, the rules of Article 28 (Limitation on 
Benefits). Accordingly, a company that meets the holding 
requirements described above will qualify for the benefits of 
paragraph 3 only if it also: (1) meets the ``publicly traded'' 
test of subparagraph 2(c) of Article 28 (Limitation on 
Benefits), (2) meets the ``ownership-base erosion'' and 
``active trade or business'' tests described in subparagraph 
2(f) and paragraph 4 of Article 28 (Limitation on Benefits), 
(3) meets the ``derivative benefits'' test of paragraph 3 of 
Article 28 (Limitation on Benefits), or (4) is granted the 
benefits of subparagraph 3(a) of Article 10 by the competent 
authority of the source State pursuant to paragraph 7 of 
Article 28 (Limitation on Benefits).
    These restrictions are necessary because of the increased 
pressure on the Limitation on Benefits tests resulting from the 
fact that the United States has relatively few treaties that 
provide for such elimination of withholding tax on inter-
company dividends. The additional restrictions are intended to 
prevent companies from re-organizing in order to become 
eligible for the elimination 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 that does not have a tax treaty with the United 
States providing for the elimination of withholding tax on 
inter-company dividends. ThirdCo owns directly 100 percent of 
the issued and outstanding voting stock of USCo, a U.S. 
company, and of GCo, a German company. GCo is a substantial 
company that manufactures widgets; USCo distributes those 
widgets in the United States. If ThirdCo contributes to GCo all 
the stock of USCo, dividends paid by USCo to GCo would qualify 
for treaty benefits under the active trade or business test of 
paragraph 4 of Article 28. However, allowing ThirdCo to qualify 
for the elimination 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, paragraph 
3 requires GCo to meet the ownership-base erosion requirements 
of subparagraph 2(f) of Article 28 in addition to the active 
trade or business test of paragraph 4 of Article 28. Because 
GCo is wholly owned by a third country resident, GCo could not 
qualify for the elimination of withholding tax on dividends 
from USCo under the combined ownership-base erosion and active 
trade or business tests of paragraph 3(a)(bb). Consequently, 
GCo would need to qualify under another test in paragraph 3(a) 
or obtain discretionary relief from the competent authority 
under Article 28(7). For purpose of Article 3(a)(bb), it is not 
sufficient for a company to qualify for treaty benefits 
generally under the active trade or business test or the 
ownership-base erosion test unless it qualifies for treaty 
benefits under both.
    Alternatively, companies that are publicly traded or 
subsidiaries of publicly-traded companies will generally 
qualify for the elimination of withholding tax. Thus, a company 
that is a resident of the Federal Republic of Germany and that 
meets the requirements of Article 28(2)(c) (aa) or (bb) will be 
entitled to the elimination of withholding tax, subject to the 
12-month holding period requirement of Article 10(3)(a).
    In addition, under Article 10(3)(a)(cc), a company that is 
a resident of a Contracting State may also qualify for the 
elimination of withholding tax on dividends if it satisfies the 
derivative benefits test of paragraph 3 of Article 28. Thus, a 
German company that owns all of the stock of a U.S. corporation 
may qualify for the elimination of withholding tax if it is 
wholly-owned, for example, by a U.K., Dutch, Mexican or a 
Swedish publicly-traded company and the other requirements of 
the derivative benefits test are met. At this time, ownership 
by companies that are residents of other European Union, 
European Economic Area or North American Free Trade Agreement 
countries would not qualify the German company for benefits 
under this provision, as the United States does not have 
treaties that eliminate the withholding tax on inter-company 
dividends with any other of those countries. If the United 
States were to enter into such treaties with more of those 
countries, residents of those countries could then qualify as 
equivalent beneficiaries for purposes of this provision.
    The derivative benefits test may also provide benefits to 
U.S. companies receiving dividends from German subsidiaries, 
because of the effect of the Parent-Subsidiary Directive in the 
European Union. Under that directive, inter-company dividends 
paid within the European Union are free of withholding tax. 
Under subparagraph (f) of paragraph 8 of Article 28 that 
directive will also be taken into account in determining 
whether the owner of a U.S. company receiving dividends from a 
German company is an ``equivalent beneficiary.'' Thus, a 
company that is a resident of a member state of the European 
Union will, by definition, meet the requirements regarding 
equivalent benefits with respect to any dividends received by 
its U.S. subsidiary from a German company. For example, assume 
USCo is a wholly-owned subsidiary of ICo, an Italian publicly-
traded company. USCo owns all of the shares of GCo, a German 
company. If GCo were to pay dividends directly to ICo, those 
dividends would be exempt from withholding tax in the Federal 
Republic of Germany by reason of the Parent-Subsidiary 
Directive. If ICo meets the other conditions to be an 
equivalent beneficiary under subparagraph 8(e) of Article 28, 
it will be treated as an equivalent beneficiary by reason of 
subparagraph 8(f) of that article.
    A company also may qualify for the elimination of 
withholding tax pursuant to Article 10(3)(a)(cc) if it is owned 
by seven or fewer U.S. or German residents who qualify as an 
``equivalent beneficiary'' and meet the other requirements of 
the derivative benefits provision. This rule may apply, for 
example, to certain German corporate joint venture vehicles 
that are closely-held by a few German resident individuals.
    Article 28(e) contains a specific rule of application 
intended to ensure that for purposes of applying Article 10(3) 
certain joint ventures, not just wholly-owned subsidiaries, can 
qualify for benefits. For example, assume that the United 
States were to enter into a treaty with Country X, a member of 
the European Union, that includes a provision identical to 
Article 10(3). USCo is 100 percent owned by GCo, a German 
company, which in turn is owned 49 percent by PCo, a German 
publicly-traded company, and 51 percent by XCo, a publicly-
traded company that is resident in Country X. In the absence of 
a special rule for interpreting the derivative benefits 
provision, each of PCo and XCo would be treated as owning only 
their proportionate share of the shares held by GCo in USCo. If 
that rule were applied in this situation, neither PCo nor XCo 
would be an equivalent beneficiary, because neither would meet 
the 80 percent ownership test with respect to USCo. However, 
since both PCo and XCo are residents of countries that have 
treaties with the United States that provide for elimination of 
withholding tax on inter-company dividends, it is appropriate 
to provide benefits to GCo in this case.
    Accordingly, the definition of ``equivalent beneficiary'' 
includes a rule of application that is intended to ensure that 
such joint ventures qualify for the benefits of Article 10(3). 
Under that rule, each of the shareholders is treated as owning 
shares of USCo with the same percentage of voting power as the 
shares held by GCo 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 elimination of withholding tax on inter-
company dividends.
    If a company does not qualify for the elimination of 
withholding tax under any of the foregoing objective tests, it 
may request a determination from the relevant competent 
authority pursuant to paragraph 7 of Article 28. 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.
    Subparagraph (b) of paragraph 3 of Article 10 provides that 
dividends received by a pension fund may not be taxed in the 
Contracting State of which the company paying the dividend is a 
resident, unless such dividends are derived from the carrying 
on of a business, directly or indirectly, by the pension fund.
    The rule is necessary because pension funds normally do not 
pay tax (either through a general exemption or because reserves 
for future pension liabilities effectively offset all of the 
fund's income), and therefore cannot benefit from a foreign tax 
credit. Moreover, distributions from a pension fund generally 
do not maintain the character of the underlying income, so the 
beneficiaries of the pension are not in a position to claim a 
foreign tax credit when they finally receive the pension, in 
many cases years after the withholding tax has been paid. 
Accordingly, in the absence of this rule, the dividends would 
almost certainly be subject to unrelieved double taxation.
    Clause (b) of paragraph 8 of Article XVI of the Protocol 
provides that in the case of Germany, subparagraph (b) of 
paragraph 3 of Article 10 applies to the person treated as 
owning the assets of the pension fund under section 39 of the 
Fiscal Code, provided that the dividends may only be used for 
providing retirement benefits through such fund. This provision 
makes clear that in the case of Germany, the zero rate of 
withholding tax for dividends paid to pension funds is also 
available in the case of an employer that has not set up a 
pension fund, but commits to pay a certain level of retirement 
income to its employees as described in sec. 6a of the Income 
Tax Act and for which the employer has established a 
contractual trust arrangement so long as sec. 39 of the Fiscal 
Code provides that for tax purposes the assets are attributable 
to the employer that entered into the contractual trust 
arrangement. For these purposes, the term ``pension fund'' is 
defined in paragraph 11 of Article 10.
Paragraph 4
    Article 10 generally applies to distributions made by a RIC 
or a REIT. However, distributions made by a REIT or certain 
RICs that are attributable to gains derived from the alienation 
of U.S. real property interests and treated as gain recognized 
under section 897(h)(1) are taxable under paragraph 1 of 
Article 13 instead of Article 10. In the case of RIC or REIT 
distributions to which Article 10 applies, paragraph 4 imposes 
limitations on the rate reductions provided by paragraphs 2 and 
3 in the case of dividends paid by a RIC or a REIT.
    The first sentence of subparagraph 4 provides that 
dividends paid by a RIC or REIT or a German Investment Fund or 
a German Investmentaktiengesellschaft (collectively referred to 
as Investmentvermogen) are not eligible for the 5 percent rate 
of withholding tax of subparagraph 2(a) or the elimination of 
source-country withholding tax of subparagraph 3(a).
    The second sentence of subparagraph 4(a) provides that the 
15 percent maximum rate of withholding tax of subparagraph 2(b) 
applies to dividends paid by RICs and Investmentvermogen and 
that the elimination of source-country withholding tax of 
subparagraph 3(b) applies to dividends paid by such RICs and 
Investmentvermogen and beneficially owned by a pension fund.
    The third sentence of subparagraph 4(a) provides that the 
15 percent rate of withholding tax also applies to dividends 
paid by a REIT and that the elimination of source-country 
withholding tax of subparagraph 3(b) applies to dividends paid 
by REITs and beneficially owned by a pension fund, provided 
that one of the three following conditions is met. First, the 
beneficial owner of the dividend is an individual or a pension 
fund, in either case holding an interest of not more than 10 
percent in the REIT. Second, the dividend is paid with respect 
to a class of stock that is publicly traded and the beneficial 
owner of the dividend is a person holding an interest of not 
more than 5 percent of any class of the REIT's shares. Third, 
the beneficial owner of the dividend holds an interest in the 
REIT of not more than 10 percent and the REIT is 
``diversified.''
    Paragraph 4 provides a definition of the term 
``diversified'', which is necessary because the term is not 
defined in the Code. A REIT is diversified if the gross value 
of no single interest in real property held by the REIT exceeds 
10 percent of the gross value of the REIT's total interest in 
real property. Foreclosure property is not considered an 
interest in real property, and a REIT holding a partnership 
interest is treated as owning its proportionate share of any 
interest in real property held by the partnership.
    The restrictions set out above are intended to prevent the 
use of these entities to gain inappropriate U.S. tax benefits. 
For example, a company resident in the Federal Republic of 
Germany that wishes to hold a diversified portfolio of U.S. 
corporate shares could hold the portfolio directly and would 
bear a U.S. withholding tax of 15 percent on all of the 
dividends that it receives. Alternatively, it could hold the 
same diversified portfolio by purchasing 10 percent or more of 
the interests 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 maximum rate 
of withholding tax, into direct investment dividends taxable at 
a 5 percent maximum rate of withholding tax or eligible under 
paragraph 3(a) for the elimination of source-country 
withholding tax.
    Similarly, a resident of the Federal Republic of Germany 
directly holding U.S. real property would pay U.S. tax on 
rental income either at a 30 percent rate of withholding tax on 
the gross income or at graduated rates on the net income. As in 
the preceding example, by placing the real property in a REIT, 
the investor could, absent a special rule, transform rental 
income into dividend income from the REIT, taxable at the rates 
provided in Article 10, significantly reducing the U.S. tax 
that otherwise would be imposed. Paragraph 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 in which paragraph 4 allows 
a dividend from a REIT to be eligible for the 15 percent rate 
of withholding tax, the holding in the REIT is not considered 
the equivalent of a direct holding in the underlying real 
property.
    The same reasoning explains the treatment of U.S. REIT 
dividends to a pension fund. In the cases in which paragraph 4 
allows a dividend from a REIT paid to a pension fund to be 
eligible for the zero rate of withholding tax, the holding in 
the REIT is also not considered the equivalent of a direct 
holding in the underlying real property. Although the third 
sentence of subparagraph 4(a) of Article 10 with respect to the 
elimination of source-country withholding tax of dividends paid 
by REITs to pension funds is by its terms bilateral, the 
domestic law of the Federal Republic of Germany does not 
currently provide for the exemption from tax of REITs. In 
addition, paragraph 8 of Article XVI of the Protocol provides 
that in the event the Federal Republic of Germany enacts such 
legislation, subparagraph (b) of paragraph 3 of Article 10 will 
not apply to dividends paid by such a company that is a 
resident of the Federal Republic of Germany.
Paragraph 5
    Paragraph 5 defines the term dividends broadly and 
flexibly. The definition is intended to cover all arrangements 
that yield a return on an equity investment in a corporation as 
determined under the tax law of the state of source, as well as 
arrange*ments that might be developed in the future.
    The term includes income from shares, or other corporate 
rights that are not treated as debt under the law of the source 
State, that participate in the profits of the company. The term 
also includes income that is subjected to the same tax 
treatment as income from shares by the law of the State of 
source. Thus, a constructive dividend that results from a non-
arm's length transaction between a corporation and a related 
party is a dividend. In the case of the Federal Republic of 
Germany dividends also include income from sleeping 
partnerships, a participating loan, a ``Gewinnobligation'' as 
well as distributions on certificates of a German 
Investmentvermogen. In the case of the United States the term 
dividend includes amounts treated as a dividend under U.S. law 
upon the sale or redemption of shares or upon a transfer of 
shares in a reorganization. See, e.g., Rev. Rul. 92-85, 1992-2 
C.B. 69 (sale of foreign subsidiary's stock to U.S. sister 
company is a deemed dividend to extent of the subsidiary's and 
sister company's earnings and profits). Further, a distribution 
from a U.S. publicly traded limited partnership, which is taxed 
as a corporation under U.S. law, is a dividend for purposes of 
Article 10. However, a distribution by a limited liability 
company is not taxable by the United States under Article 10, 
provided the limited liability company is not characterized as 
an association taxable as a corporation under U.S. law.
    Finally, a payment denominated as interest that is made by 
a thinly capitalized corporation may be treated as a dividend 
to the extent that the debt is recharacterized as equity under 
the laws of the source State.
Paragraph 6
    Paragraph 6 provides that the income from arrangements that 
carry the right to participate in profits that are deductible 
in the determining the profits of the payor may be taxed by the 
source country according to its domestic law. In the United 
States, these amounts include contingent interest of a type 
that would not qualify as portfolio interest. In the Federal 
Republic of Germany, these amounts include income under a 
sleeping partnership, a participating loan or a 
``Gewinnobligation'' or ``jouissance'' shares or rights. This 
rule applies notwithstanding the provisions of paragraph 2 and 
3 of this Article and paragraph 1 of Article 11 (Interest).
Paragraph 7
    Paragraph 7 provides that the general source country 
limitations under paragraphs 2 through 4 on dividends do not 
apply if the beneficial owner of the dividends is a permanent 
establishment situated in the source country and the dividends 
are attributable to such permanent establishment. In such case, 
the rules of Article 7 (Business Profits) shall apply. 
Accordingly, such dividends will be taxed on a net basis using 
the rates and rules of taxation generally applicable to 
residents of the Contracting State in which the permanent 
establishment is located, as modified by the Convention. An 
example of dividends attributable to a permanent establishment 
would be dividends derived by a dealer in stock or securities 
from stock or securities that the dealer held for sale to 
customers.
Paragraph 8
    The right of a Contracting State to tax dividends paid by a 
company that is a resident of the other Contracting State is 
restricted by paragraph 8 to cases in which the dividends are 
paid to a resident of that Contracting State or are 
attributable to a permanent establishment in that Contracting 
State. Thus, a Contracting State may not impose a ``secondary'' 
withholding tax on dividends paid by a nonresident company out 
of earnings and profits from that Contracting State. In the 
case of the United States, the secondary withholding tax was 
eliminated for payments made after December 31, 2004, in the 
American Jobs Creation Act of 2004.
    The paragraph also restricts the right of a Contracting 
State to impose corporate level taxes on undistributed profits 
of a company that is a resident of the other Contracting State, 
other than a branch profits tax. The paragraph does not 
restrict a State's right to tax its resident shareholders on 
undistributed earnings of a corporation resident in the other 
State. Thus, the authority of the United States to impose taxes 
on subpart F income and on earnings deemed invested in U.S. 
property, and its tax on income of a passive foreign investment 
company that is a qualified electing fund is in no way 
restricted by this provision.
Paragraphs 9 and 10
    Paragraph 9 permits a Contracting State to impose a branch 
profits tax on a company resident in the other Contracting 
State. The tax is in addition to other taxes permitted by the 
Convention. The term ``company'' is defined in subparagraph 
1(e) of Article 3 (General Definitions) of the Convention.
    A Contracting State may impose a branch profits tax on a 
company if the company has income attributable to a permanent 
establishment in that Contracting State, derives income from 
real property in that Contracting State that is taxed on a net 
basis under Article 6 (Income from Immovable (Real) Property), 
or realizes gains taxable in that State under paragraph 1 of 
Article 13 (Gains). In the case of the United States, the 
imposition of such tax is limited, however, to the portion of 
the aforementioned items of income that represents the amount 
of such income that is the ``dividend equivalent amount.'' This 
is consistent with the relevant rules under the U.S. branch 
profits tax, and the term dividend equivalent amount is defined 
under U.S. law. Section 884 of the Code defines the dividend 
equivalent amount as an amount for a particular year that is 
equivalent to 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 Immovable (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. Paragraph 9 of Article XVI of the Protocol 
clarifies that the general principle of the ``dividend 
equivalent amount'' under U.S. law is to approximate that 
portion of the income described in paragraph 9 of Article 10 
(Dividends) that is comparable to the amount that would be 
distributed as a dividend if such income were earned by a 
locally incorporated subsidiary. Thus, the dividend equivalent 
amount for any year approximates the dividend that a U.S. 
branch office would have paid during the year if the branch had 
been operated as a separate U.S. subsidiary company.
    The Federal Republic of Germany currently does not impose a 
branch profits tax. If the Federal Republic of Germany were to 
impose such a tax, the base is limited to the portion of the 
income described in subparagraph 9(a) that is comparable to the 
amount that would be distributed as a dividend by a locally 
incorporated subsidiary.
    As discussed in the Technical Explanations to Articles 1(2) 
and Paragraph 4 of Article XVI of the Protocol, consistency 
principles require that a taxpayer may not mix and match the 
rules of the Code and the Convention in an inconsistent manner. 
In the context of the branch profits tax, the consistency 
requirement means that an enterprise that uses the principles 
of Article 7 to determine its net taxable income also must use 
those principles in determining the dividend equivalent amount. 
Similarly, an enterprise that uses U.S. domestic law to 
determine its net taxable income must also use U.S. domestic 
law in complying with the branch profits tax. As in the case of 
Article 7, if an enterprise switches between domestic law and 
treaty principles from year to year, it will need to make 
appropriate adjustments or recapture amounts that otherwise 
might go untaxed.
    Paragraph 10 limits the rate of the branch profits tax 
allowed under paragraph 9 to 5 percent. Paragraph 10 also 
provides that the branch profits tax shall 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., the elimination of 
source-country withholding tax). Accordingly, the branch 
profits tax may not be imposed in the case of a company that: 
(1) meets the ``publicly traded'' test of subparagraph 2(c) of 
Article 28 (Limitation on Benefits), (2) meets the ``ownership-
base erosion'' and ``active trade or business'' tests described 
in subparagraph 2(f) and paragraph 4 of Article 28 (Limitation 
on Benefits), (3) meets the ``derivative benefits'' test of 
paragraph 3 of Article 28 (Limitation on Benefits), or (4) is 
granted benefits with respect to the elimination of the branch 
profits tax by the competent authority pursuant to paragraph 7 
of Article 28 (Limitation on Benefits).
    Thus, for example, if a German 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 10 
may apply to eliminate the branch profits tax if the company 
either met the publicly traded test, met both the ownership-
base erosion and active trade or business tests, or met the 
derivative benefits test. If a German company did not meet any 
of those tests, but otherwise qualified for benefits under 
Article 28, then the branch profits tax would apply at a rate 
of 5 percent, unless the German company is granted benefits 
with respect to the elimination of the branch profits tax by 
the competent authority pursuant to paragraph 7 of Article 28.
Paragraph 11
    Paragraph 11 defines a pension fund to mean a person that 
is organized under the laws of a Contracting State and that is 
established and maintained in that State primarily to 
administer or provide pensions or other similar remuneration 
(including social security payments, disability pensions and 
widow's pensions) or to earn income for the benefit of one or 
more such persons, and in the case of the United States, is 
exempt from tax in the United States with respect to such 
activities, or in the case of the Federal Republic of Germany, 
is a plan the contributions to which are eligible for 
preferential treatment under the Income Tax Act.
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 5 of Article 
23 (Relief from Double Taxation), as if the Convention had not 
come into effect.
    The benefits of this Article are also subject to the 
provisions of Article 28 (Limitation on Benefits). Thus, if a 
resident of the Federal Republic of Germany is the beneficial 
owner of dividends paid by a U.S. corporation, the shareholder 
must qualify for treaty benefits under at least one of the 
tests of Article 28 in order to receive the benefits of this 
Article.

                               ARTICLE V

    Paragraph (a) of Article V of the Protocol provides for a 
new paragraph 6 of Article 11 (Interest) of the Convention. 
Paragraph 6 provides an anti-abuse exception to paragraph 1 of 
Article 11 (Interest) for excess inclusions from U.S. real 
estate mortgage investment conduits (``REMICs'') that follows 
subparagraph (b) of paragraph 5 of the 1996 U.S. Model. 
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. Sec. 1.860G-3. Paragraph 6 also 
serves to indicate that excess inclusions from REMICs are not 
considered ``other income'' subject to Article 21 (Other 
Income) of the Convention.
    Paragraph (b) of Article V of the Protocol provides for an 
amended cross-reference in paragraph 5 of Article 11 (Interest) 
of the Convention.

                               ARTICLE VI

    Article VI of the Protocol replaces the existing paragraph 
6 of Article 13 (Gains) of the Convention. Paragraph 6 of 
Article 13 (Gains) provides special basis adjustment rules 
where an individual, who upon ceasing to be a resident of a 
Contracting State, is treated under the taxation laws of that 
State as having alienated property and is taxed in that State 
by reason thereof. Such an individual may elect to be treated 
for purposes of taxation in the other Contracting State as if 
the individual had, immediately before ceasing to be a resident 
of the first-mentioned Contracting State to have alienated and 
reacquired the property for amount equal to its fair market 
value. As a consequence of the election, the other Contracting 
State, for purposes of imposing tax on any subsequent sale of 
the property, will be limited to the gain (if any) accrued once 
the individual ceased to be a resident of the first-mentioned 
Contracting State.
    Notwithstanding the forgoing provisions, subparagraph (a) 
of paragraph 4 of the Article 1 (General Scope) permits the 
United States to tax its citizens and residents as if the 
Convention had not come into effect. The rules of paragraph 6 
of this Article, however, continue to apply to U.S. citizens 
and residents by virtue of the exceptions to the saving clause 
in subparagraph (a) of paragraph 5.

                              ARTICLE VII

    Article VII of the Protocol deletes the existing Article 14 
(Independent Personal Services) of the Convention. Accordingly, 
paragraph (b) of Article III of the Protocol amends Article 7 
(Business Profits) to provide that income from the performance 
of professional services and other activities of an independent 
character is included in the term business profits. This is 
consistent with recent U.S. tax treaty practice.

                              ARTICLE VIII

    Article VIII of the Protocol changes the name Article 18 
(Pensions, Annuities, Alimony, and Child Support) of the 
Convention to Article 18 (Pensions, Annuities, Alimony, Child 
Support, and Social Security).
    In addition, Article VIII of the Protocol adds a new 
paragraph 5 to Article 18, the substance of which was 
previously contained in Article 19 (Government Service; Social 
Security). Paragraph 5 provides for exclusive residence-country 
taxation of social security benefits and similar public 
pensions. Paragraph 5 provides that payments made by one of the 
Contracting States under the provisions of its social security 
law and other public pensions (not dealt with in new Article 19 
(Government Service)) to a resident of the other Contracting 
State will be taxable only in the other Contracting State. The 
phrase ``other public pensions'' is intended to refer to United 
States Tier 1 Railroad Retirement benefits. Paragraph 5 applies 
to social security beneficiaries, whether they have contributed 
to the system as private-sector or government employees. The 
treatment of social security benefits in the Convention differs 
from that in the U.S. Model which provides for exclusive source 
country taxation of social security benefits.
    In applying its tax, the residence country will treat the 
benefit as though it were a benefit paid to a resident under 
its own social security system. Thus, for example, if a U.S. 
resident receives a German social security benefit, he would 
include only one half of the benefit or such other portion as 
he would if the benefit had been a U.S. social security or 
railroad retirement benefit.
    With respect the Article 18, the Joint Declaration 
acknowledges that the Federal Republic of Germany has recently 
amended its domestic law regarding the taxation of retirement 
income and contributions to pension plans. However, these new 
rules are subject to a long phase-in period. Consequently, the 
Contracting States have agreed to enter into consultations no 
sooner than January 1, 2013 with a view to further amending 
this Article in light of this legislation.

                               ARTICLE IX

    Article IX of the Protocol adds a new Article 18A (Pension 
Plans) to the Convention. Article 18A 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 and the taxation of a pension plan's earnings and 
accretions. 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. Similar discontinuities may arise where 
countries allow their residents to defer taxation on a pension 
plan's earnings and accretions, but do not allow such deferral 
for plans resident in another country.
    The 2006 U.S. Model includes a comparable set of rules in 
Article 18 (Pension Funds).
Paragraph 1
    Paragraph 1 provides that if a resident of a Contracting 
State participates in a pension plan established in the other 
Contracting State, the State of residence will not tax the 
income of the pension plan with respect to that resident until 
a distribution is made from the pension plan. 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 Federal Republic of Germany, paragraph 1 
prevents the Federal Republic of Germany from taxing currently 
the plan's earnings and accretions with respect to that 
individual. When the resident receives a distribution from the 
pension plan, that distribution may be subject to tax in the 
State of residence, subject to paragraph 1 of Article 18 
(Pensions, Annuities, Alimony, Child Support, and Social 
Security).
Paragraph 2
    Paragraph 2 provides certain benefits with respect to 
cross-border contributions to a pension plan, subject to the 
limitations of paragraph 3 and 5 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 plan 
established in the other Contracting State. Thus, for example, 
if a participant in a U.S. qualified plan goes to work in the 
Federal Republic of Germany, the participant may deduct or 
exclude from income in the Federal Republic of Germany 
contributions to the U.S. qualified plan made while the 
participant works in the Federal Republic of Germany. 
Subparagraph (a), however, applies only to the extent of the 
relief allowed by the host State (i.e., the Federal Republic of 
Germany in the example) to a resident of that State for 
contributions to a pension plan 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 
Federal Republic of Germany, the participant's employer may 
deduct from its business profits in the Federal Republic of 
Germany contributions to the U.S. qualified plan for the 
benefit of the employee while the employee renders services in 
the Federal Republic of Germany.
    As in the case of subparagraph (a), subparagraph (b) 
applies only to the extent of relief allowed by the host State 
to a resident of that State for contributions to, or benefits 
accrued under, a pension plan 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.
    The competent authorities shall determine the relief 
available under subparagraphs (a) and (b) of paragraph 2.
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 plan unless the 
participant already was contributing to the plan, or his 
employer already was contributing to the plan with respect to 
that individual, before the individual began exercising 
employment in the host State. This condition would be met if 
either the employee or the employer was contributing to a plan 
that was replaced by the plan to which he is contributing. The 
rule regarding successor plans would apply if, for example, the 
employer has been taken over by a company that replaces the 
existing plan with its own plan, rolling membership in the old 
plan over into the new plan.
    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. Pursuant to clause (b)(aa) of paragraph 16 of Article 
XVI, the U.S. pension plans eligible for the benefits of 
paragraph 2 include the following plans (and any identical or 
substantially similar plans established pursuant to legislation 
enacted after the date of signature of this Protocol): 
qualified plans under section 401(a) of the Internal Revenue 
Code, 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, and section 408(p) 
accounts), section 403(a) qualified annuity plans, section 
403(b) plans, and section 457(b) governmental plans. Clause 
(b)(bb) of paragraph 16 of Article XVI provides that it is 
understood for this purpose that German plans include 
arrangements under section 1 of the German law on employment-
related pensions (Betriebsrentengesetz).
Paragraph 4
    Paragraph 4 defines the term ``pension plan'' for purposes 
of Article 18A to mean an arrangement established in a 
Contracting State which is operated principally to administer 
or provide pension or retirement benefits or to earn income for 
the benefit of one or more such arrangements. Clause (a)(aa) of 
paragraph 16 of Article XVI of the Protocol provides that the 
term ``pension plan'' shall include the following U.S. plans 
and any identical or substantially similar plans established 
pursuant to legislation enacted after the date of signature of 
this Protocol: qualified plans under section 401(a) of the 
Code, 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, and section 408(p) 
accounts, and Roth IRAs under section 408A), section 403(a) 
qualified annuity plans, section 403(b) plans, and section 
457(b) governmental plans. In the case of the Federal Republic 
of Germany, clause (a)(bb) of paragraph 16 of Article XVI of 
the Protocol provides that the term ``pension plan'' shall 
include arrangements under section 1 of the German law on 
employment related pensions (Betriebsrentengesetz) and any 
identical or substantially similar plans established pursuant 
to legislation enacted after the date of signature of this 
Protocol.
Paragraph 5
    Paragraph 5 generally provides U.S. tax treatment for 
certain contributions by or on behalf of U.S. citizens resident 
in the Federal Republic of Germany to pension plans established 
in the Federal Republic of Germany that is comparable to the 
treatment that would be provided for contributions to U.S. 
plans. Under clause (aa) of subparagraph (a) of paragraph 5, a 
U.S. citizen resident in the Federal Republic of Germany may 
exclude or deduct for U.S. tax purposes certain contributions 
to a pension plan established in the Federal Republic of 
Germany. Qualifying contributions generally include 
contributions made during the period the U.S. citizen exercises 
an employment in the Federal Republic of Germany the income 
from which is taxable in the Federal Republic if expenses of 
the employment are borne by a German employer or German 
permanent establishment. Similarly, with respect to the U.S. 
citizen's participation in the German pension plan, accrued 
benefits and contributions during that period generally are not 
treated as taxable income in the United States under clause 
(bb) of subparagraph (a) of paragraph 5.
    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 plan established in 
the Federal Republic of Germany and, under subparagraph (b), 
the amount of relief that would be allowed for contributions 
and benefits under a generally corresponding pension plan 
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 plan 
established in the United States. Thus, for example, 
contributions to a German pension plan 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 plan 
established in the Federal Republic of Germany generally 
corresponds to a pension plan established in the United States. 
Paragraph 16 of Article XIV provides that certain pension plans 
have been determined to ``generally correspond'' to plans in 
the other country. Since paragraph 5 applies only with respect 
to persons employed by a German employer or German permanent 
establishment, however, the relevant German plans are those 
that correspond to employer plans in the United States. 
Accordingly, it applies with respect to retirement benefit 
plans under section 1 of the German law on employment related 
pensions (Betriebsrentengesetz).
Relation to other Articles
    Paragraphs 1 and 5 are 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. Thus, the United 
States will allow U.S. citizens and residents the benefits of 
paragraphs 1 and 5. Paragraph 2 is not subject to the saving 
clause by reason of subparagraph 5(b) of Article 1. 
Accordingly, a person who becomes a U.S. permanent resident or 
citizen will no longer receive a deduction for contributions to 
a pension fund established in the other Contracting State.

                               ARTICLE X

    Article X of the Protocol replaces Article 19 (Government 
Services) of the Convention. The amendments made by this 
Article X of the Protocol will not have effect with respect to 
individuals who, at the time of the signing of the Convention, 
August 29, 1989, were employed by the United States, a 
political subdivision or local authority thereof.
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 
salaries, wages and other similar remuneration paid to any 
individual who is rendering services to that State, political 
subdivision, local authority, or instrumentality is exempt from 
tax by the other State (i.e., the host State). Under 
subparagraph (b), such payments are, however, taxable 
exclusively in the host State if the services are rendered in 
the host 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.
Paragraph 2
    Paragraph 2 deals with the taxation of pensions and other 
similar remuneration paid by, or out of funds created by, one 
of the States, or a political subdivision, local authority, or 
instrumentality thereof, to an individual in respect of 
services rendered to that State, subdivision, authority or 
instrumentality. Subparagraph (a) provides that such pensions 
and other remuneration 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 or the 
pension is not subject to tax in the Contracting State for 
which the services were performed because the services were 
performed entirely in the other Contracting 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, authority, 
or instrumentality) are in the form of social security 
benefits, however, those payments are covered by paragraph 5 of 
Article 18 (Pensions, Annuities, Alimony, Child Support, and 
Social Security). The result will differ depending upon whether 
Article 18 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.
Paragraph 3
    Paragraph 3 contains a provision proposed by the Federal 
Republic of Germany. It is based on a provision in the 1954 
Convention. The subparagraph provides that pension, annuities, 
and other amounts paid by a Contracting State or by a juridical 
person organized under the public laws of that State that are 
compensation for injury or damage sustained as a result of 
hostilities or political persecution are exempt from tax in the 
other Contracting State. Although the subparagraph is drafted 
reciprocally, it is intended to provide an exemption from U.S. 
tax for German war reparation payments.
Paragraph 4
    Paragraph 4 specifies that paragraphs 1 and 2 do not apply 
to salaries, wages, or similar remuneration, and to pensions, 
paid for services performed in connection with a business 
carried on by a Contracting State, or a political subdivision, 
local authority or instrumentality thereof. In such cases, the 
remuneration and pensions are subject instead to the provisions 
of Articles 15 (Dependant Personal Services), 16 (Directors' 
Fees), or 17 (Artistes and Athletes) and 18 (Pensions, 
Annuities, Alimony, Child Support, and Social Security). This 
provision conforms to the OECD Model.
Paragraph 5
    For purposes of this Article, the term ``instrumentality'' 
means an agent or entity created or organized by a Contracting 
State, one of its states or a political subdivision or local 
authority thereof in order to carry out functions of a 
government nature which is specified and agreed to in letters 
exchanged between the competent authorities of the Contracting 
States.
Relation to other Articles
    Under subparagraph (b) of paragraph 5 of Article 1 (General 
Scope), the saving clause (paragraph 4 of Article 1) does not 
apply to the benefits conferred if the recipient of the 
benefits is neither a citizen of United States, nor a person 
who has been admitted for permanent residence there (i.e., a 
``green card'' holder). Thus, for example, a resident of the 
Federal Republic of Germany who, in the course of rendering 
services to the government of the Federal Republic of Germany, 
becomes a resident of the United States (but not a permanent 
resident) would be entitled to the exemption from taxation by 
the United States provided by paragraph 1. However, Article 19 
is subject to the saving clause with respect to benefits 
conferred by the United States to citizens and permanent 
residents of the United States.
    Paragraph 3 of this Article is an exception to the saving 
clause (paragraph 4 of Article 1) pursuant to subparagraph (a) 
of paragraph 5 of Article 1 (General Scope).
    Thus, a U.S. citizen or resident who receives German 
reparations payments would not be subject to any U.S. tax on 
that payment, regardless of whether he would be taxable under 
the Code.

                               ARTICLE XI

    Paragraph (a) of Article XI of the Protocol replaces 
paragraph 1 of Article 20 (Visiting Professors and Teachers; 
Students and Trainees). Paragraph 1 provides that a professor 
or teacher who is resident in one Contracting State and who is 
temporarily present in the other Contracting State for the 
primary purpose of carrying out advanced study or research, or 
for teaching at a recognized educational institution, or an 
institution engaged in research for the public benefit in that 
other State will be exempted from tax by that other State on 
any remuneration for such teaching or research for a period not 
exceeding two years from the date he first visits that other 
State for the purpose of advanced study, teaching, or research. 
Since this two year period is determined from the date he first 
visits the other State, periodic vacations outside the other 
State, or a brief return to the first-mentioned State will not 
toll the running of the two-year period. Unlike the existing 
Convention, if the two-year period beginning from the date of 
his arrival is exceeded, the exemption will apply, but only for 
the first two years and only if the visit is temporary. Thus, 
if a person comes to a Contracting State for the purpose of 
teaching and stays for a temporary period in excess of two 
years, the person will not retroactively lose the exemption 
with respect to the first two years. The professor or teacher 
will not be granted the benefits of this provision if, during 
the period immediately preceding his visit, he enjoyed the 
benefits of paragraph 2, 3, or 4 of this Article or he was not 
a resident of the first-mentioned State.
    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).

                              ARTICLE XII

    Article XII of the Protocol replaces Article 23 (Relief 
from Double Taxation) of the Convention. Article 23 of the 
Convention addresses the manner in which each Contracting State 
undertakes to relieve double taxation. The United States uses 
the foreign tax credit method under its internal law and by 
treaty. The Federal Republic of Germany uses a combination of 
the foreign tax credit and exemption methods, depending on the 
nature of the income involved.
Paragraph 1
    The United States agrees, in subparagraph (a) of paragraph 
1, to allow to its citizens and residents a credit against U.S. 
tax for income taxes paid or accrued to the Federal Republic of 
Germany. For this purpose, the taxes covered by subparagraph 
(b) of paragraph 1 and by paragraph 2 of Article 2 (Taxes 
Covered), other than the capital tax (Vermoegensteuer) are 
income taxes. Thus, the German income tax (Einkommensteurer), 
the corporate income tax (Koerperschaftsteuer), the trade tax 
(Gewerbesteuer), as well as any identical or substantially 
similar German taxes that are imposed after the date of 
signature of the Convention in addition to, or in place of, 
these existing taxes, are considered to be income taxes for 
purposes of paragraph 1. The granting of a foreign tax credit 
with respect to German taxes is based on the Treasury 
Department's review of the laws of the Federal Republic of 
Germany.
    Subparagraph (b) provides for a deemed-paid credit, 
consistent with section 902 of the Code to a U.S. corporation 
in respect of dividends received from a corporation resident in 
the Federal Republic of Germany of which the U.S. corporation 
owns at least 10 percent of the voting stock. This credit is 
for the tax paid by the German corporation on the profits out 
of which the dividends are considered paid.
    The credits allowed under paragraph 1 are allowed in 
accordance with the provisions and subject to the limitations 
of U.S. law, as that law may be amended over time, so long as 
the general principle of the Article, that is, the allowance of 
a credit, is retained. Thus, although the Convention provides 
for a foreign tax credit, the terms of the credit are 
determined by the provisions, at the time a credit is given, of 
the U.S. statutory credit.
    Therefore, the U.S. credit under the Convention is subject 
to the various limitations of U.S. law (see Code sections 901-
908). For example, the credit against U.S. tax generally is 
limited to the amount of U.S. tax due with respect to net 
foreign source income within the relevant foreign tax credit 
limitation category (see Code section 904 (a) and (d)), and the 
dollar amount of the credit is determined in accordance with 
U.S. currency translation rules (see, e.g., Code section 986). 
Similarly, U.S. law applies to determine carryover periods for 
excess credits and other inter-year adjustments.
Paragraph 2
    Paragraph 2 provides a re-sourcing rule for gross income 
covered by paragraph 1. Paragraph 2 is intended to ensure that 
a U.S. resident can obtain a U.S. foreign tax credit for German 
taxes paid when the Convention assigns to the Federal Republic 
of Germany primary taxing rights over an item of gross income.
    Paragraph 2 provides that, if the Convention allows the 
Federal Republic of Germany to tax an item of gross income (as 
defined under U.S. law) derived by a resident of the United 
States, the United States will treat that item of gross income 
as gross income from sources within the Federal Republic of 
Germany for U.S. foreign tax credit purposes. In the case of a 
U.S.-owned foreign corporation, however, section 904(h)(10) may 
apply for purposes of determining the U.S. foreign tax credit 
with respect to income subject to this re-sourcing rule. 
Section 904(h)(10) generally applies the foreign tax credit 
limitation separately to re-sourced income. Furthermore, the 
paragraph 2 re-sourcing rule applies to gross income, not net 
income. Accordingly, U.S. expense allocation and apportionment 
rules, see, e.g., Treas. Reg. section 1.861-9, continue to 
apply to income resourced under paragraph 2.
Paragraph 3
    Paragraph 3 provides that the Federal Republic of Germany 
will relieve double taxation on German residents through a dual 
method of exemption and credit. Subparagraph (a) of paragraph 3 
generally provides an exemption from the German tax base for 
income or capital that may be taxed in the United States under 
the Convention or that is exempt from U.S. tax under Article 
10(3) (except in cases where a foreign tax credit is provided 
for under subparagraph (b) of paragraph 3). However, the 
Federal Republic of Germany may take the excluded income and 
assets into account in determining the rate of tax on other 
items of income and capital (i.e., the Federal Republic of 
Germany may provide for exemption with progression).
    Subparagraph (a) of paragraph 3 also provides that in the 
case of German resident companies (not including partnerships) 
that own at least 10 percent of the voting shares of U.S. 
resident companies, the Federal Republic of Germany will only 
exempt distributions of profits on corporate rights subject to 
corporate income tax under U.S. law. In addition, the exemption 
shall not apply to dividends from a RIC or REIT and 
distributions that are deductible for U.S. income tax purposes 
by the distributing company. With respect to German capital 
taxes, the Federal Republic of Germany will exclude any 
shareholding the dividends on which would be exempt from German 
income tax under subparagraph (a) of paragraph 3.
    The principal types of income for which exemption is 
allowed under subparagraph (a) of paragraph 3 are generally: 
(i) income derived by a German enterprise which is attributable 
to a permanent establishment in the United States, (ii) many 
kinds of capital gains, (iii) most classes of personal services 
income, and (iv) dividends from direct investments in the 
United States.
    Subparagraph (b) of paragraph 2 indicates those items of 
income, which have been taxed in the United States in 
accordance with the provisions of U.S. law and the Convention, 
for which the Federal Republic of Germany will provide a 
foreign tax credit rather than exemption. These are: (i) income 
from dividends (as defined in Article 10 (Dividends)) for which 
the Federal Republic of Germany will not grant exemption under 
subparagraph (a) of paragraph 3 of this Article (e.g., 
portfolio dividends, RIC dividends and similar deductible or 
pass-through entity dividends); (ii) gains from the alienation 
of immovable property to which Article 13 (Gains) apply 
provided such gains are taxable in the United States by reason 
only of paragraph 2 of Article 13 (Gains); (iii) income to 
which Article 16 (Directors' Fees) applies received by German 
residents in respect of their services rendered in the United 
States as directors of U.S. corporations, (iv) income to which 
Article 17 (Artistes and Athletes) applies, (v) income which 
would be exempt from U.S. tax under the Convention (e.g., 
interest), but which is denied the benefits of the Convention 
and is subject to tax by virtue of Article 28 (Limitation on 
Benefits). With respect to (v) above, such income would be 
fully taxable in the Federal Republic of Germany with no credit 
for U.S. tax absent a special provision; the provision provides 
for a German foreign tax credit in cases where the United 
States taxes solely by virtue of the Limitation on Benefits 
provisions.
    As with the U.S. credit under paragraph 1, the foreign tax 
credit granted by the Federal Republic of Germany under the 
Convention is subject to the provisions of German law regarding 
a credit for foreign taxes. Income that may be taxed in the 
United States in accordance with the Convention is deemed, for 
purposes of the German foreign tax credit and exemption 
provided in paragraph 3, to be from U.S. sources.
Paragraph 4
    The Federal Republic of Germany will provide a foreign tax 
credit pursuant to subparagraph (b) of paragraph 3 (as opposed 
to exemption under subparagraph (a) of paragraph 3) in three 
additional instances. The change from the exemption method to 
credit method provided by this paragraph is designed to prevent 
unintended instances either of double taxation or of double 
non-taxation or inappropriately low taxation.
    First, the Federal Republic of Germany provides a foreign 
tax credit if income or capital would be subject to double 
taxation as a result of the placement of such income under 
different provisions of the Convention and this conflict cannot 
be resolved pursuant to Article 25 (Mutual Agreement 
Procedure).
    Second, the Federal Republic of Germany will provide a 
foreign tax credit on income or capital if the United States 
applies the provisions of the Convention to exempt such income 
or capital from tax, or applies paragraph 2 or 3 of Article 10 
(Dividends) to such income or capital or may under the 
provisions of the Convention tax such income or capital but is 
prevented from doing so under its domestic law.
    Third, the Federal Republic of Germany may switch from an 
exemption to a foreign tax credit for items of income or 
capital to the extent consistent with internal German law and, 
after due consultation with the United States and notification 
of the United States through diplomatic channels (switchover 
clause). In such a case, the provisions of subparagraph (b) of 
paragraph 3 shall apply for all taxable years following the 
year of such notification. Any changes in treatment or 
characterization that may be made pursuant to subparagraph (c) 
of paragraph 4 can be effective only from the beginning of the 
calendar year following the year in which the formal 
notification of the change was transmitted to the United States 
and only when any legal prerequisites for the change in the 
domestic law of the Federal Republic of Germany have been 
fulfilled.
    The so-called ``switchover clause'' is intended to deal 
with cases of double exemption of income (e.g., through the 
granting of a dividends paid deduction to the U.S. payor of a 
dividend and a correlative exemption of such dividend in 
Germany) or arrangements for improper use of the Convention. It 
was not intended to apply to cases where the profits out of 
which a distribution is made have been subject to the general 
U.S. corporate-level taxing regime. Thus, for example, the fact 
that a U.S. corporation pays a reduced level of U.S. corporate-
level tax because of the nature or source of its income (e.g., 
because it is entitled to a dividends received deduction, a net 
operating loss carry forward, or a foreign tax credit) will not 
entitle Germany to switch from exemption to credit.
Paragraph 5
    Paragraph 5 provides special rules for the tax treatment in 
both Contracting States of certain types of income derived from 
U.S. sources by U.S. citizens who are resident in the Federal 
Republic of Germany. Since U.S. citizens, regardless of 
residence, are subject to United States tax at ordinary 
progressive rates on their worldwide income, the U.S. tax on 
the U.S. source income of a U.S. citizen resident in the 
Federal Republic of Germany may exceed the U.S. tax that may be 
imposed under the Convention on an item of U.S. source income 
derived by a resident of the Federal Republic of Germany who is 
not a U.S. citizen. The provisions of paragraph 5 ensure that 
the Federal Republic of Germany does not bear the cost of U.S. 
taxation of its citizens who are German residents.
    Subparagraph (a) provides, with respect to items of income 
from sources within the United States, special German credit 
rules. These rules apply to items of U.S.-source income that 
would be either exempt from U.S. tax or subject to reduced 
rates of U.S. tax under the provisions of the Convention if 
they had been received by a German resident who is not a U.S. 
citizen. The tax credit allowed under paragraph 5 with respect 
to such items need not exceed the U.S. tax that may be imposed 
under the Convention, other than tax imposed solely by reason 
of the U.S. citizenship of the taxpayer under the provisions of 
the saving clause of paragraph 4 of Article 1 (General Scope).
    For example, if a U.S. citizen resident in Germany receives 
portfolio dividends from sources within the United States, the 
German foreign tax credit would be limited to 15 percent of the 
dividend--the U.S. tax that may be imposed under subparagraph 
2(b) of Article 10 (Dividends)--even if the shareholder is 
subject (before the special U.S. foreign tax credit and source 
rules provided for in subparagraphs 5(b) and 5(c)) to U.S. net 
income tax because of his U.S. citizenship as a result of the 
saving clause. With respect to royalty or interest income, 
Germany would allow no foreign tax credit, because German 
residents are exempt from U.S. tax on these classes of income 
under the provisions of Articles 11 (Interest) and 12 
(Royalties).
    Subparagraph 5(b) eliminates the potential for double 
taxation that can arise as a result of the absence of a full 
German foreign tax credit, because of subparagraph 5(a), for 
the U.S. tax imposed on its citizens who are German residents. 
The subparagraph provides that the United States will credit 
the German income tax paid or accrued, after the application of 
subparagraph 5(a). It further provides that in allowing the 
credit, the United States will not reduce its tax below the 
amount which is allowed as a creditable tax in Germany under 
subparagraph 5(a).
    Since the income described in paragraph 5(a) generally will 
be U.S. source income, special rules are required to resource 
some of the income as German source in order for the United 
States to be able to credit the German tax. This resourcing is 
provided for in subparagraph 5(c), which deems the items of 
income referred to in subparagraph 5(a) to be from German 
sources to the extent necessary to avoid double taxation under 
subparagraph 5(b). Subparagraph 3(c)(cc) of Article 25 (Mutual 
Agreement Procedure) provides a mechanism by which the 
competent authorities can resolve any disputes regarding 
whether income is from sources within the United States.
    The following two examples illustrate the application of 
paragraph 5 in the case of a U.S.-source portfolio dividend 
received by a U.S. citizen resident in the Federal Republic of 
Germany. In both examples, the U.S. rate of tax on residents of 
the Federal Republic of Germany, under subparagraph (b) of 
paragraph 2 of Article 10 (Dividends) of the Convention, is 15 
percent. In both examples, the U.S. income tax rate on the U.S. 
citizen is 35 percent. In example 1, the German income tax rate 
on its resident (the U.S. citizen) is 25 percent (below the 
U.S. rate), and in example 2, the German rate on its resident 
is 40 percent (above the U.S. rate).

------------------------------------------------------------------------
                                                    Example 1  Example 2
------------------------------------------------------------------------
Subparagraph (a):
  U.S. dividend declared..........................    $100.00    $100.00
  Notional U.S. withholding tax (Article 10(2)(b))      15.00      15.00
  German taxable income...........................     100.00     100.00
  German tax before credit........................      25.00      40.00
  German foreign tax credit for notional U.S.           15.00      15.00
   withholding tax................................
  Net post-credit German tax......................      10.00      25.00
Subparagraphs (b) and (c):
  U.S. pre-tax income.............................     100.00     100.00
  U.S. pre-credit citizenship tax.................      35.00      35.00
  Notional U.S. withholding tax...................      15.00      15.00
  U.S. tax available for credit...................      20.00      20.00
  Tax paid to other Contracting State.............      10.00      25.00
  Income re-sourced from U.S. to German (see            28.57      57.14
   below).........................................
  U.S. pre-credit tax on re-sourced income........      10.00      20.00
  U.S. credit for German tax......................      10.00      20.00
  Net post-credit U.S. tax........................      10.00       0.00
  Total U.S. tax..................................      25.00      15.00
------------------------------------------------------------------------

    In both examples, in the application of subparagraph (a), 
the Federal Republic of Germany credits a 15 percent U.S. tax 
against its residence tax on the U.S. citizen. In the first 
example, the net German tax after the German foreign tax credit 
is $10.00; in the second example, it is $25.00. In the 
application of subparagraphs (b) and (c), from the U.S. tax due 
before credit of $35.00, the United States subtracts the amount 
of the U.S. source tax of $15.00, against which no U.S. foreign 
tax credit is allowed. This subtraction ensures that the United 
States collects the tax that it is due under the Convention as 
the State of source.
    In both examples, given the 35 percent U.S. tax rate, the 
maximum amount of U.S. tax against which credit for the German 
tax may be claimed is $20 ($35 U.S. tax minus $15 U.S. 
withholding tax). Initially, all of the income in both examples 
was from sources within the United States. For a U.S. foreign 
tax credit to be allowed for the full amount of the German tax, 
an appropriate amount of the income must be re-sourced to the 
Federal Republic of Germany under subparagraph (c).
    The amount that must be re-sourced depends on the amount of 
German tax for which the U.S. citizen is claiming a U.S. 
foreign tax credit. In example 1, the German tax was $10. For 
this amount to be creditable against U.S. tax, $28.57 ($10 
German tax divided by 35 percent U.S. tax rate) must be 
resourced to the Federal Republic of Germany. When the German 
tax is credited against the $10 of U.S. tax on this resourced 
income, there is a net U.S. tax of $10 due after credit ($20 
U.S. tax minus $10 German tax). Thus, in example 1, there is a 
total of $25 in U.S. tax ($15 U.S. withholding tax plus $10 
residual U.S. tax).
    In example 2, the German tax was $25, but, because the 
United States subtracts the U.S. withholding tax of $15 from 
the total U.S. tax of $35, only $20 of U.S. taxes may be offset 
by German taxes. Accordingly, the amount that must be resourced 
to the Federal Republic of Germany is limited to the amount 
necessary to ensure a U.S. foreign tax credit for $20 of German 
tax, or $57.14 ($20 German tax divided by 35 percent U.S. tax 
rate). When the German tax is credited against the U.S. tax on 
this re-sourced income, there is no residual U.S. tax ($20 U.S. 
tax minus $25 German tax, subject to the U.S. limit of $20). 
Thus, in example 2, there is a total of $15 in U.S. tax ($15 
U.S. withholding tax plus $0 residual U.S. tax). Because the 
German tax was $25 and the U.S. tax available for credit was 
$20, there is $5 of excess U.S. tax credit available for 
carryover.
Relation to other articles
    By virtue of subparagraph (a) of paragraph 5 of Article 1 
(General Scope), Article 23 is not subject to the saving clause 
of paragraph 4 of Article 1. Thus, the United States will allow 
a credit to its citizens and residents in accordance with the 
Article, even if such credit were to provide a benefit not 
available under the Code (such as the re-sourcing provided by 
paragraph 2 and subparagraph 5(c)).

                              ARTICLE XIII

    Article XIII of the Protocol deletes paragraph 5 of Article 
25 (Mutual Agreement Procedure) of the Convention, providing 
for voluntary binding arbitration, and replaces it with new 
paragraphs 5 and 6, which introduce a mandatory binding 
arbitration procedure.
    A case shall be resolved through arbitration when the 
competent authorities have endeavored but are unable to reach a 
complete agreement regarding a case through negotiation and the 
following three conditions are satisfied. First, tax returns 
have been filed with at least one of the Contracting States 
with respect to the taxable years at issue in the case. Second, 
the case: (i) is a case that involves one or more enumerated 
articles of the Convention, and is not a case that the 
competent authorities agree before the date on which 
arbitration proceedings would otherwise have begun, is not 
suitable for determination by arbitration; or (ii) is a case 
that the competent authorities agree is suitable for 
determination by arbitration. Third, all concerned persons and 
their authorized representatives agree not to disclose to any 
other person any information received during the course of the 
arbitration proceeding from either the Contracting States or 
the arbitration board, other than the determination of the 
board (confidentiality agreement). The confidentiality 
agreement may also be executed by any concerned person that has 
the legal authority to bind any other concerned person on the 
matter. For example, a parent corporation with the legal 
authority to bind its subsidiary with respect to 
confidentiality may execute a comprehensive confidentiality 
agreement on its own behalf and that of its subsidiary.
    Paragraph 22 of Article XVI of the Protocol provides that 
cases regarding the application of one or more of the following 
articles may be the subject of mandatory binding arbitration, 
if the requirements of paragraphs 5 and 6 of Article 25 are 
otherwise satisfied: Article 4 (Residence) as its relates to 
residence of a natural person, Article 5 (Permanent 
Establishment), Article 7 (Business Profits), Article 9 
(Associated Enterprises), and Article 12 (Royalties). The 
application of one or more of the other provisions in the 
Convention to which Article 25 applies may be the subject of 
binding arbitration should the competent authorities agree.
    A concerned person means the person that brought the case 
to competent authority for consideration under Article 25 and 
includes all other persons, if any, whose tax liability to 
either Contracting State may be directly affected by a mutual 
agreement arising from that consideration. For example, a 
concerned person does not only include a U.S. corporation that 
brings a transfer pricing case with respect to a transaction 
entered into with its German subsidiary for resolution to the 
U.S. competent authority, but also the German subsidiary, which 
may have a correlative adjustment as a result of the resolution 
of the case.
    An arbitration proceeding begins on the later of two dates: 
two years from the commencement date of that case, unless both 
competent authorities have previously agreed to a different 
date, or the earliest date upon which the all concerned persons 
have entered into a confidentiality agreement and the 
agreements have been received by both competent authorities. 
The commencement date is the earliest date on which information 
necessary to undertake substantive consideration for mutual 
agreement has been received by both competent authorities. 
Clause (p) of paragraph 22 of Article XVI of the Protocol 
provides that each competent authority will confirm in writing 
to the other competent authority and to the concerned persons 
the date of its receipt of the information necessary to 
undertake substantive consideration for a mutual agreement. In 
the case of the United States, this information is (i) the 
information that must be submitted to the U.S. competent 
authority under Section 4.05 of Rev. Proc. 2002-52, 2002-2 C.B. 
242, as it might be amended from time to time, and (ii) for 
cases initially submitted as a request for an Advance Pricing 
Agreement, the information that must be submitted to the 
Internal Revenue Service under Section 4 Rev. Proc. 2006-9, 
2006-2 I.R.B. 278, as it might be amended from time to time. In 
the case of the Federal Republic of Germany, this information 
is the information that must be submitted to the German 
competent authority pursuant to the German Ministry of 
Finance's circular of July 1, 1997, IV C 5-S 1300-189/96. The 
information will not be considered received until both 
competent authorities receive copies of all materials submitted 
by concerned persons in connection with the mutual agreement 
procedure.
    Paragraph 22 of Article XVI of the Protocol provides for a 
several procedural rules once an arbitration proceeding under 
paragraph 5 of Article 25 (``Proceeding'') has commenced, but 
the competent authorities may modify or supplement these rules 
as necessary. In addition, the arbitration board may adopt any 
procedures necessary for the conduct of its business, provided 
the procedures are not inconsistent with any provision of 
Article 25 of the Convention.
    Subparagraph (e) of paragraph 22 of Article XVI of the 
Protocol provides that each Contracting State has 60 days from 
the date on which the Proceeding begins to send a written 
communication to the other Contracting State appointing one 
member of the arbitration board. Within 60 days of the date the 
second of such communications is sent, these two board members 
will appoint a third member to serve as the chair of the board. 
The chair may not be a citizen of either Contracting State. In 
the event that any members of the board are not appointed 
(including as a result of the failure of the two members 
appointed by the Contracting States to agree on a third member) 
by the requisite date, the remaining members are appointed by 
the highest ranking member of the Secretariat at the Centre for 
Tax Policy and Administration of the Organisation for Economic 
Co-operation and Development (OECD) who is not a citizen of 
either Contracting State, by written notice to both Contracting 
States within 60 days of the date of such failure.
    Clause (g) of paragraph 22 of Article XVI of the Protocol 
establishes deadlines for submission of materials by the 
Contracting States to the arbitration board. Each competent 
authority has 90 days from the date of appointment of the chair 
to submit a Proposed Resolution describing the proposed 
disposition of the specific monetary amounts of income, expense 
or taxation at issue in the case, and a supporting Position 
Paper. Copies of each State's submissions are to be provided by 
the board to the other Contracting State on the date the later 
of the submissions is submitted to the board. Each of the 
Contracting States may submit a Reply Submission to the board 
within 180 days of the appointment of the chair to address 
points raised in the other State's Proposed Resolution or 
Position Paper. If one Contracting State fails to submit a 
Proposed Resolution within the requisite time, the Proposed 
Resolution of the other Contracting State is deemed to be the 
determination of the arbitration board. No other information 
may be supplied to the arbitration board, unless it requests 
additional information. Copies of any such requested 
information, along with the board's request, must be provided 
to the other Contracting State on the date the request or 
response is submitted.
    All communication with the board is to be in writing 
between the chair of the board and the designated competent 
authorities with the exception of communication regarding 
logistical matters.
    In making its determination the arbitration board will 
apply the following authorities as necessary and in descending 
order of relevance: (i) the provisions of the Convention, (ii) 
any agreed commentaries or explanation of the Contracting 
States concerning the Convention, (iii) the laws of the 
Contracting States to the extent they are not inconsistent with 
each other, and (iv) any OECD Commentary, Guidelines or Reports 
regarding relevant analogous portions of the OECD Model Tax 
Convention.
    The arbitration board must deliver a determination in 
writing to the Contracting States within 9 months of the 
appointment of the chair. The determination must be one of the 
two Proposed Resolutions submitted by the Contracting States. 
The determination may only provide a determination regarding 
the amount of income, expense or tax reportable to the 
Contracting States. The determination has no precedential value 
and consequently the rationale behind a board's determination 
would not be beneficial and may not be provided by the board.
    Unless any concerned person does not accept the decision of 
the arbitration board, the determination of the board 
constitutes a resolution by mutual agreement under Article 25 
and, consequently, is binding on both Contracting States. 
Within 30 days of receiving the determination from the 
competent authority to which the case was first presented, each 
concerned person must advise that competent authority whether 
the person accepts the determination. The failure to advise the 
competent authority within the requisite time is considered a 
rejection of the determination. In addition, if the case is in 
litigation, the concerned persons must advise the relevant 
court of their acceptance of the arbitration determination, and 
withdraw from the litigation the issues resolved by the MAP 
arbitration. If a determination is rejected the case cannot be 
the subject of a subsequent Proceeding. After the commencement 
of the Proceeding but before a decision of the board has been 
accepted by all concerned persons, the competent authorities 
may reach a mutual agreement to resolve the case and terminate 
the Proceeding.
    For purposes of the arbitration proceeding, the members of 
the arbitration board and their staffs shall be considered 
``persons or authorities'' to whom information may be disclosed 
under Article 26 (Exchange of Information and Administrative 
Assistance). Paragraph 22 of Article XVI of the Protocol 
provides that all materials prepared in the course of, or 
relating to the Proceeding are considered information exchanged 
between the Contracting States. No information relating to the 
Proceeding or the board's determination may be disclosed by 
members of the arbitration board or their staffs or by either 
competent authority, except as permitted by the Convention and 
the domestic laws of the Contracting States. Members of the 
arbitration board and their staffs must agree in statements 
sent to each of the Contracting States in confirmation of their 
appointment to the arbitration board to abide by and be subject 
to the confidentiality and nondisclosure provisions of Article 
26 of the Convention and the applicable domestic laws of the 
Contracting States, with the most restrictive of the provisions 
applying.
    The applicable domestic law of the Contracting States 
determines the treatment of any interest or penalties 
associated with a competent authority agreement achieved 
through arbitration.
    Fees and expenses are borne equally by the Contracting 
States, including the cost of translation services. In general, 
the fees of members of the arbitration board will be set at the 
fixed amount of $2,000 per day (or the equivalent amount in 
Euro). The expenses of members of the board will be set in 
accordance with the International Centre for Settlement of 
Investment Disputes (ICSID) Schedule of Fees for arbitrators 
(in effect on the date on which the arbitration board 
proceedings begin). The competent authorities may amend the set 
fees and expenses of members of the board. Meeting facilities, 
related resources, financial management, other logistical 
support, and general and administrative coordination of the 
Proceeding will be provided, at its own cost, by the 
Contracting State whose competent authority initiated the 
mutual agreement proceedings. All other costs are to be borne 
by the Contracting State that incurs them.

                              ARTICLE XIV

    Article XIV of the Protocol replaces Article 28 (Limitation 
on Benefits) of the Convention.
Structure of the Article
    Article 28 contains anti-treaty-shopping provisions that 
are intended to prevent residents of third countries from 
benefiting from what is intended to be a reciprocal agreement 
between two countries. In general, the provision does not rely 
on a determination of purpose or intention but instead sets 
forth a series of objective tests. A resident of a Contracting 
State that satisfies one of the tests will receive benefits 
regardless of its motivations in choosing its particular 
business structure.
    The structure of the Article is as follows: Paragraph 1 
states the general rule that a resident of a Contracting State 
is entitled to benefits otherwise accorded to residents only to 
the extent that the resident is a ``qualified person'' and 
satisfies any satisfies any other conditions specified in the 
Convention for the obtaining of 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 may be granted 
benefits with regard to certain types of income regardless of 
whether the person is a qualified person. Paragraph 5 provides 
special rules for so-called ``triangular cases'' 
notwithstanding the other provisions of Article 28. Paragraph 6 
provides a special rule for Investmentvermogen. Paragraph 7 
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 8 defines the terms used specifically in this 
Article.
Paragraph 1
    Paragraph 1 provides that, except as otherwise provided, a 
resident of a Contracting State is 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 28.
    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, and the protection afforded to residents of a 
Contracting State under Article 24 (Nondiscrimination). Some 
provisions do not require that a person be a resident in order 
to enjoy the benefits of those provisions. For example, Article 
25 (Mutual Agreement Procedure) is not limited to residents of 
the Contracting States, and Article 19 (Government Service) 
applies to government employees regardless of residence. 
Article 28 accordingly does not limit the availability of 
treaty benefits under such provisions.
    Article 28 and the anti-abuse provisions of domestic law 
complement each other, as Article 28 effectively determines 
whether an entity has a sufficient nexus to a Contracting State 
to be treated as a resident for treaty purposes, while domestic 
anti-abuse provisions (e.g., business purpose, substance-over-
form, step transaction or conduit principles) determine whether 
a particular transaction should be recast in accordance with 
its substance. Thus, internal law principles of the source 
Contracting State may be applied to identify the beneficial 
owner of an item of income, and Article 28 then will be applied 
to the beneficial owner to determine if that person is entitled 
to the benefits of the Convention with respect to such income.
Paragraph 2
    Paragraph 2 has six subparagraphs, each of which describes 
a category of residents that are entitled to all benefits of 
the Convention. It is intended that the provisions of paragraph 
2 will be self-executing. Claiming benefits under paragraph 2 
does not require an 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 the benefits of the Convention. If such an 
individual receives income as a nominee on behalf of a third 
country resident, benefits may be denied under the applicable 
articles of the Convention by the requirement that the 
beneficial owner of the income be a resident of a Contracting 
State.
    Governments--Subparagraph 2(b).--Subparagraph (b) provides 
that the Contracting States and any political subdivision or 
local authority thereof will be entitled to all the benefits of 
the Convention.
    Publicly-Traded Corporations--Subparagraph 2(c)(aa).--
Subparagraph (c) applies to two categories of companies: 
publicly traded companies and subsidiaries of publicly traded 
companies. A company resident in a Contracting State is 
entitled to all the benefits of the Convention under clause 
(aa) of subparagraph (c) if the principal class of its shares, 
and any disproportionate class of shares, is regularly traded 
on one or more recognized stock exchanges and the company 
satisfies at least one of the following additional tests. 
First, the company's principal class of shares is primarily 
traded on a recognized stock exchange located in a Contracting 
State of which the company is a resident. Second, the company's 
primary place of management and control is in its State of 
residence.
    The term ``recognized stock exchange'' is defined in 
subparagraph (a) of paragraph 8. It includes the NASDAQ System 
and any stock exchange registered with the Securities and 
Exchange Commission as a national securities exchange for 
purposes of the Securities Exchange Act of 1934 and any German 
stock exchange on which registered dealings in shares takes 
place. The term also includes any other stock exchange agreed 
upon by the competent authorities of the Contracting States.
    If a company has only one class of shares, it is only 
necessary to consider whether the shares of that class meet the 
relevant trading requirements. If the company has more than one 
class of shares, it is necessary as an initial matter to 
determine which class or classes constitute the ``principal 
class of shares.'' The term ``principal class of shares'' is 
defined in clause (b)(aa) of paragraph 8 to mean the ordinary 
or common shares of the company representing the majority of 
the aggregate voting power and value of the company. If the 
company does not have a class of ordinary or common shares 
representing the majority of the aggregate voting power and 
value of the company, then the ``principal class of shares'' is 
that class or any combination of classes of shares that 
represents, in the aggregate, a majority of the voting power 
and value of the company. Although in a particular case 
involving a company with several classes of shares it is 
conceivable that more than one group of classes could be 
identified that account for more than 50% of the shares, it is 
only necessary for one such group to satisfy the requirements 
of this subparagraph in order for the company to be entitled to 
benefits. Benefits would not be denied to the company even if a 
second, non-qualifying, group of shares with more than half of 
the company's voting power and value could be identified. 
Clause (c)(bb) of paragraph 8 defines the term ``shares'' to 
include depository receipts for shares or trust certificates 
for shares.
    A company whose principal class of shares is regularly 
traded on a recognized stock exchange will nevertheless not 
qualify for benefits under subparagraph (c) of paragraph 2 if 
it has a disproportionate class of shares that is not regularly 
traded on a recognized stock exchange. The term 
``disproportionate class of shares'' is defined in subparagraph 
(c) of paragraph 8. A company has a disproportionate class of 
shares if it has outstanding a class of shares that is subject 
to terms or other arrangements that entitle the holder to a 
larger portion of the company's income, profit, or gain in the 
other Contracting State than that to which the holder would be 
entitled in the absence of such terms or arrangements. Thus, 
for example, a company resident in the Federal Republic of 
Germany meets the test of subparagraph (c) of paragraph 8 if it 
has outstanding a class of ``tracking stock'' that pays 
dividends based upon a formula that approximates the company's 
return on its assets employed in the United States.
    The following example illustrates this result.
    Example. GCo is a corporation resident in the Federal 
Republic of Germany. GCo has two classes of shares: Common and 
Preferred. The Common shares are listed and regularly traded on 
the Frankfurt Stockholm Stock Exchange. The Preferred shares 
have no voting rights and are entitled to receive dividends 
equal in amount to interest payments that GCo 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 GCo 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 GCo, the Preferred shares are a 
disproportionate class of shares. Because the Preferred shares 
are not regularly traded on a recognized stock exchange, GCo 
will not qualify for benefits under subparagraph (c) of 
paragraph 2.
    The term ``regularly traded'' is not defined in the 
Convention. In accordance with paragraph 2 of Article 3 
(General Definitions), this term will be defined by reference 
to the domestic tax laws of the State from which treaty 
benefits are sought, generally the source State. In the case of 
the United States, this term is understood to have the meaning 
it has under Treas. Reg. section 1.884-5(d)(4)(i)(B), relating 
to the branch tax provisions of the Code. Under these 
regulations, a class of shares is considered to be ``regularly 
traded'' if two requirements are met: trades in the class of 
shares are made in more than de minim is quantities on at least 
60 days during the taxable year, and the aggregate number of 
shares in the class traded during the year is at least 10 
percent of the average number of shares outstanding during the 
year. Sections 1. 884-5(d)(4)(i)(A), (ii) and (iii) will not be 
taken into account for purposes of defining the term 
``regularly traded'' under the Convention.
    The regular trading requirement can be met by trading on 
any recognized exchange or exchanges. Trading on one or more 
recognized stock exchanges may be aggregated for purposes of 
this requirement. Thus, a U.S. company could satisfy the 
regularly traded requirement through trading, in whole or in 
part, on a recognized stock exchange located in the Federal 
Republic of Germany. Authorized but unis sued shares are not 
considered for purposes of this test.
    The term ``primarily traded'' is not defined in the 
Convention. In accordance with paragraph 2 of Article 3 
(General Definitions), this term will have the meaning it has 
under the laws of the State concerning the taxes to which the 
Convention applies, generally the source State. In the case of 
the United States, this term is understood to have the meaning 
it has under Treas. Reg. section 1.884-5(d)(3), relating to the 
branch tax provisions of the Code. Accordingly, stock of a 
corporation is ``primarily traded'' on a recognized stock 
exchange located in the State of residence if the number of 
shares in the company's principal class of shares that are 
traded during the taxable year on all recognized stock 
exchanges in the State of residence exceeds the number of 
shares in the company's principal class of shares that are 
traded during that year on established securities markets in 
any other single foreign country.
    A company whose principal class of shares is regularly 
traded on a recognized exchange but cannot meet the primarily 
traded test may claim treaty benefits if its primary place of 
management and control is in its country of residence. This 
test should be distinguished from the ``place of effective 
management'' test which is used in the OECD Model and by many 
other countries to establish residence. In some cases, the 
place of effective management test has been interpreted to mean 
the place where the board of directors meets. By contrast, the 
primary place of management and control test looks to where 
day-to-day responsibility for the management of the company 
(and its subsidiaries) is exercised. The company's primary 
place of management and control will be located in the State in 
which the company is a resident only if the executive officers 
and senior management employees exercise day-to-day 
responsibility for more of the strategic, financial and 
operational policy decision making for the company (including 
direct and indirect subsidiaries) in that State than in the 
other State or any third state, and the staff that support the 
management in making those decisions are also based in that 
State. Thus, the test looks to the overall activities of the 
relevant persons to see where those activities are conducted. 
In most cases, it will be a necessary, but not a sufficient, 
condition that the headquarters of the company (that is, the 
place at which the CEO and other top executives normally are 
based) be located in the Contracting State of which the company 
is a resident.
    To apply the test, it will be necessary to determine which 
persons are to be considered ``executive officers and senior 
management employees.'' In most cases, it will not be necessary 
to look beyond the executives who are members of the Board of 
Directors (the ``inside directors'') in the case of a U.S. 
company. That will not always be the case, however; in fact, 
the relevant persons may be employees of subsidiaries if those 
persons make the strategic, financial and operational policy 
decisions. Moreover, it would be necessary to take into account 
any special voting arrangements that result in certain board 
members making certain decisions without the participation of 
other board members.
    Subsidiaries of Publicly-Traded Corporations--Subparagraph 
2(c)(bb). A company resident in a Contracting State is entitled 
to all the benefits of the Convention under clause (bb) of 
subparagraph (c) of paragraph 2 if five or fewer publicly 
traded companies described in clause (i) are the direct or 
indirect owners of at least 50 percent of the aggregate vote 
and value of the company's shares (and at least 50 percent of 
any disproportionate class of shares). If the publicly-traded 
companies are indirect owners, however, each of the 
intermediate companies must be a resident of one of the 
Contracting States.
    Thus, for example, a German company, all the shares of 
which are owned by another German company, would qualify for 
benefits under the Convention if the principal class of shares 
(and any disproportionate classes of shares) of the German 
parent company are regularly and primarily traded on the London 
stock exchange. However, a German subsidiary would not qualify 
for benefits under clause (ii) if the publicly traded parent 
company were a resident of Ireland, for example, and not a 
resident of the United States or Germany. Furthermore, if a 
German parent company indirectly owned a German 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 Germany for the German subsidiary to meet the test in clause 
(bb).
    Tax-Exempt Organizations--Subparagraph 2(d). The 
Contracting States agreed that certain tax-exempt organizations 
should be entitled to all the benefits of the Convention, 
without regard to the residence of beneficiaries or members. 
Entities qualifying under this subparagraph are those that are 
organized under the laws of one of the Contracting States and 
established and maintained in that Contracting State 
exclusively for a religious, charitable, educational, 
scientific, or other similar purpose.
    Pension Funds--Subparagraph 2(e). An entity organized under 
the laws of one of the Contracting States and established and 
maintained in that Contracting State to provide, pursuant to a 
plan, pension or other similar benefits to employed and self-
employed persons, provided that more than 50 percent of the 
beneficiaries, members or participants of the entity are 
individuals resident in either Contracting State or if the 
organization sponsoring such person is entitled to all the 
benefits of the Convention under paragraph 2 of Article 28. For 
purposes of this provision, the term ``beneficiaries'' should 
be understood to refer to the persons receiving benefits from 
the entity.
    Ownership/Base Erosion--Subparagraph 2(f). Subparagraph 
2(f) provides an additional method to qualify for treaty 
benefits that applies to any form of legal entity that is a 
resident of a Contracting State. The test provided in 
subparagraph (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 treaty benefits 
under subparagraph 2(f).
    The ownership prong of the test, under clause (aa), 
requires that 50 percent or more of each class of shares or 
other beneficial interests in the person is owned, directly or 
indirectly, on at least half the days of the person's taxable 
year by persons who are residents of the Contracting State of 
which that person is a resident and that are themselves 
entitled to treaty benefits under certain parts of paragraph 
2--subparagraphs (a), (b), (d), (e), or clause (aa) of 
subparagraph (c). In the case of indirect owners, however, each 
of the intermediate owners must be a resident of that 
Contracting State.
    Trusts may be entitled to benefits under this provision if 
they are treated as residents under Article 4 (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 
the beneficiaries in a trust, the ownership test under clause 
(aa) cannot be satisfied, unless all possible beneficiaries are 
persons entitled to benefits under the specified subparagraphs 
of paragraph 2.
    The base erosion prong of clause (bb) of subparagraph (f) 
is satisfied with respect to a person if less than 50 percent 
of the person's gross income for the taxable year, as 
determined under the tax law in the person's State of 
residence, is paid or accrued, directly or indirectly, to 
persons who are not residents of either Contracting State 
entitled to treaty benefits under subparagraph (a), (b), (d), 
(e), or clause (aa) of subparagraph (c), in the form of 
payments deductible for tax purposes in the person's State of 
residence. To the extent they are deductible from the taxable 
base, trust distributions are deductible payments. However, 
depreciation and amortization deductions, which do not 
represent payments or accruals to other persons, are 
disregarded for this purpose.
Paragraph 3
    Paragraph 3 sets forth a derivative benefits test that is 
potentially applicable to all treaty benefits, although the 
test is applied to individual items of income. In general, a 
derivative benefits test entitles the resident of a Contracting 
State to treaty benefits if the owner of the resident would 
have been entitled to the same benefit had the income in 
question flowed directly to that owner. To qualify under this 
paragraph, the company must meet an ownership test and a base 
erosion test.
    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 and at least 50 percent of any 
disproportionate class of shares. Ownership may be direct or 
indirect. The term ``equivalent beneficiary'' is defined in 
subparagraph (e) of paragraph 8. 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 Union, a European Economic 
Area state, or a party to the North American Free Trade 
Agreement (collectively, ``qualifying States'').
    The second requirement of the first alternative 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 under provisions 
that are analogous to the rules in paragraph 2 of this Article 
regarding individuals, governments, publicly-traded companies, 
tax-exempt organizations, and pension funds. If the treaty in 
question does not have a comprehensive limitation on benefits 
article, this requirement is met only if the person would be 
entitled to treaty benefits under the tests in paragraph 2 of 
this Article applicable to individuals governments, publicly-
traded companies, tax-exempt organizations and pension funds. 
if the person were a resident of one of the Contracting States.
    In order to satisfy the second requirement of the first 
alternative with respect to insurance premiums, dividends, 
interest, royalties, or branch tax, paragraph 8(e)(aa)(B) 
provides that the person must be entitled to a rate of tax that 
is at least as low as the tax rate that would apply under the 
Convention to such income. Thus, the rates to be compared are: 
(1) the rate of tax that the source State would have imposed if 
a qualified resident of the other Contracting State was the 
beneficial owner of the income; and (2) the rate of tax that 
the source State would have imposed if the third State resident 
received the income directly from the source State. For 
example, USCo is a wholly owned subsidiary of GCo, a company 
resident in the Federal Republic of Germany. GCo is wholly 
owned by ICo, a corporation resident in Italy. Assuming GCo 
satisfies the requirements of paragraph 3 of Article 10 
(Dividends), GCo would be eligible for the elimination of 
dividend withholding tax. The dividend withholding tax rate in 
the treaty between the United States and Italy is 5 percent. 
Thus, if ICo received the dividend directly from USCo, ICo 
would have been subject to a 5 percent rate of withholding tax 
on the dividend. Because ICo 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), ICo is 
not an equivalent beneficiary within the meaning of paragraph 
8(g)(aa) of Article 28 with respect to the elimination of 
withholding tax on dividends.
    Subparagraph 8(f) provides a special rule to take account 
of the fact that withholding taxes on many inter-company 
dividends, interest and royalties are exempt within the 
European Union by reason of various EU directives, rather than 
by tax treaty. If a U.S. company receives such payments from a 
German company, and that U.S. company is owned by a company 
resident in a member state of the European Union that would 
have qualified for an exemption from withholding tax if it had 
received the income directly, the parent company will be 
treated as an equivalent beneficiary. This rule is necessary 
because many European Union member countries have not re-
negotiated their tax treaties to reflect the rates applicable 
under the directives.
    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 German 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 from a U.S. subsidiary of the German company 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 second alternative for satisfying the ``equivalent 
beneficiary'' test is available only to residents of one of the 
two Contracting States. U.S. or German residents who are 
eligible for treaty benefits by reason of subparagraphs (a), 
(b), (c)(aa), (d), or (e) of paragraph 2 are equivalent 
beneficiaries under the second alternative. Thus, a German 
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 qualify for treaty benefits under any of 
those subparagraphs or any other rule of the treaty, and 
therefore would not qualify as an equivalent beneficiary under 
this alternative. Thus, a 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.
    The second alternative was included in order to clarify 
that ownership by certain residents of a Contracting State 
would not disqualify a U.S. or German company under this 
paragraph. Thus, for example, if 90 percent of a German company 
is owned by five companies that are resident in member states 
of the European Union who satisfy the requirements of clause 
(aa), and 10 percent of the German company is owned by a U.S. 
or German individual, then the German company still can satisfy 
the requirements of subparagraph (a) of paragraph 3.
    Subparagraph (b) of paragraph 3 sets forth the base erosion 
test. A company meets this base erosion test if less than 50 
percent of its gross income, as determined under the tax law in 
the company's State of residence, for the taxable period is 
paid or accrued, directly or indirectly, to a person or persons 
who are not equivalent beneficiaries in the form of payments 
deductible for tax purposes in company's State of residence. 
This test is the same as the base erosion test in clause (bb) 
of subparagraph (f) of paragraph 2, except that the test in 
subparagraph 3(b) focuses on base-eroding payments to persons 
who are not equivalent beneficiaries.
Paragraph 4
    Paragraph 4 sets forth an alternative test under which a 
resident of a Contracting State may receive treaty benefits 
with respect to certain items of income that are connected to 
an active trade or business conducted in its State of 
residence. A resident of a Contracting State may qualify for 
benefits under paragraph 4 whether or not it also qualifies 
under paragraphs 2 or 3.
    Subparagraph (a) sets forth the general rule that a 
resident of a Contracting State engaged in the active conduct 
of a trade or business in that State may obtain the benefits of 
the Convention with respect to an item of income, profit, or 
gain derived from the other Contracting State. The item of 
income, profit, or gain, however, must be derived in connection 
with or incidental to that trade or business.
    The term ``trade or business'' is not defined in the 
Convention. Pursuant to paragraph 2 of Article 3 (General 
Definitions), when determining whether a resident of the 
Federal Republic of Germany is entitled to the benefits of the 
Convention under paragraph 4 of this Article with respect to an 
item of income derived from sources within the United States, 
the United States will ascribe to this term the meaning that it 
has under the law of the United States. Accordingly, the U.S. 
competent authority will refer to the regulations issued under 
section 367(a) for the definition of the term ``trade or 
business.'' In general, therefore, a trade or business will be 
considered to be a specific unified group of activities that 
constitute or could constitute an independent economic 
enterprise carried on for profit. Furthermore, a corporation 
generally will be considered to carry on a trade or business 
only if the officers and employees of the corporation conduct 
substantial managerial and operational activities.
    The business of making or managing investments for the 
resident's own account will be considered to be a trade or 
business only when part of banking, insurance or securities 
activities conducted by a bank, an insurance company, or a 
registered securities dealer. Such activities conducted by a 
person other than a bank, insurance company or registered 
securities dealer will not be considered to be the conduct of 
an active trade or business, nor would they be considered to be 
the conduct of an active trade or business if conducted by a 
bank, insurance company or registered securities dealer but not 
as part of the company's banking, insurance or dealer business. 
Because a headquarters operation is in the business of managing 
investments, a company that functions solely as a headquarters 
company will not be considered to be engaged in an active trade 
or business for purposes of paragraph 4.
    An item of income is derived in connection with a trade or 
business if the income-producing activity in the State of 
source is a line of business that ``forms a part of'' or is 
``complementary'' to the trade or business conducted in the 
State of residence by the income recipient.
    A business activity generally will be considered to form 
part of a business activity conducted in the State of source if 
the two activities involve the design, manufacture or sale of 
the same products or type of products, or the provision of 
similar services. The line of business in the State of 
residence may be upstream, downstream, or parallel to the 
activity conducted in the State of source. Thus, the line of 
business may provide inputs for a manufacturing process that 
occurs in the State of source, may sell the output of that 
manufacturing process, or simply may sell the same sorts of 
products that are being sold by the trade or business carried 
on in the State of source.
    Example 1. USCo is a corporation resident in the United 
States. USCo is engaged in an active manufacturing business in 
the United States. USCo owns 100 percent of the shares of GCo, 
a company resident in the Federal Republic of Germany. GCo 
distributes USCo products in Germany. Because the business 
activities conducted by the two corporations involve the same 
products, GCo's distribution business is considered to form a 
part of USCo's manufacturing business.
    Example 2. The facts are the same as in Example 1, except 
that USCo does not manufacture. Rather, USCo operates a large 
research and development facility in the United States that 
licenses intellectual property to affiliates worldwide, 
including GCo. GCo and other USCo affiliates then manufacture 
and market the USCo-designed products in their respective 
markets. Because the activities conducted by GCo and USCo 
involve the same product lines, these activities are considered 
to form a part of the same trade or business.
    For two activities to be considered to be 
``complementary,'' the activities need not relate to the same 
types of products or services, but they should be part of the 
same overall industry and be related in the sense that the 
success or failure of one activity will tend to result in 
success or failure for the other. Where more than one trade or 
business is conducted in the State of source and only one of 
the trades or businesses forms a part of or is complementary to 
a trade or business conducted in the State of residence, it is 
necessary to identify the trade or business to which an item of 
income is attributable. Royalties generally will be considered 
to be derived in connection with the trade or business to which 
the underlying intangible property is attributable. Dividends 
will be deemed to be derived first out of earnings and profits 
of the treaty-benefited trade or business, and then out of 
other earnings and profits. Interest income may be allocated 
under any reasonable method consistently applied. A method that 
conforms to U.S. principles for expense allocation will be 
considered a reasonable method.
    Example 3. Americair is a corporation resident in the 
United States that operates an international airline. GSub is a 
wholly-owned subsidiary of Americair resident in the Federal 
Republic of Germany. SSub operates a chain of hotels in the 
Federal Republic of Germany that are located near airports 
served by Americair flights. Americair frequently sells tour 
packages that include air travel to the Federal Republic of 
Germany and lodging at GSub hotels. Although both companies are 
engaged in the active conduct of a trade or business, the 
businesses of operating a chain of hotels and operating an 
airline are distinct trades or businesses. Therefore GSub's 
business does not form a part of Americair's business. However, 
GSub's business is considered to be complementary to 
Americair's business because they are part of the same overall 
industry (travel), and the links between their operations tend 
to make them interdependent.
    Example 4. The facts are the same as in Example 3, except 
that GSub owns an office building in the Federal Republic of 
Germany instead of a hotel chain. No part of Americair's 
business is conducted through the office building. GSub's 
business is not considered to form a part of or to be 
complementary to Americair's business. They are engaged in 
distinct trades or businesses in separate industries, and there 
is no economic dependence between the two operations.
    Example 5. USFlower is a company resident in the United 
States. USFlower produces and sells flowers in the United 
States and other countries. USFlower owns all the shares of 
GHolding, a corporation resident in the Federal Republic of 
Germany. GHolding is a holding company that is not engaged in a 
trade or business. GHolding owns all the shares of three 
corporations that are resident in the Federal Republic of 
Germany: GFlower, GLawn, and GFish. GFlower distributes 
USFlower flowers under the USFlower trademark in the Federal 
Republic of Germany. GLawn markets a line of lawn care products 
in the Federal Republic of Germany under the USFlower 
trademark. In addition to being sold under the same trademark, 
GLawn and GFlower products are sold in the same stores and 
sales of each company's products tend to generate increased 
sales of the other's products. GFish imports fish from the 
United States and distributes it to fish wholesalers in the 
Federal Republic of Germany. For purposes of paragraph 4, the 
business of GFlower forms a part of the business of USFlower, 
the business of GLawn is complementary to the business of 
USFlower, and the business of GFish is neither part of nor 
complementary to that of USFlower.
    An item of income derived from the State of source is 
``incidental to'' the trade or business carried on in the State 
of residence if production of the item facilitates the conduct 
of the trade or business in the State of residence. An example 
of incidental income is the temporary investment of working 
capital of a person in the State of residence in securities 
issued by persons in the State of source.
    Subparagraph (b) of paragraph 4 states a further condition 
to the general rule in subparagraph (a) in cases where the 
trade or business generating the item of income in question is 
carried on either by the person deriving the income or by any 
associated enterprises. Subparagraph (b) states that the trade 
or business carried on in the State of residence, under these 
circumstances, must be substantial in relation to the activity 
in the State of source. The substantiality requirement is 
intended to prevent a narrow case of treaty-shopping abuses in 
which a company attempts to qualify for benefits by engaging in 
de minimis connected business activities in the treaty country 
in which it is resident (i.e., activities that have little 
economic cost or effect with respect to the company business as 
a whole).
    The determination of substantiality is made based upon all 
the facts and circumstances and takes into account the 
comparative sizes of the trades or businesses in each 
Contracting State , the nature of the activities performed in 
each Contracting State, and the relative contributions made to 
that trade or business in each Contracting State. In any case, 
in making each determination or comparison, due regard will be 
given to the relative sizes of the U.S. and German economies.
    The determination in subparagraph (b) also is made 
separately for each item of income derived from the State of 
source. It therefore is possible that a person would be 
entitled to the benefits of the Convention with respect to one 
item of income but not with respect to another. If a resident 
of a Contracting State is entitled to treaty benefits with 
respect to a particular item of income under paragraph 4, the 
resident is entitled to all benefits of the Convention insofar 
as they affect the taxation of that item of income in the State 
of source.
    The application of the substantiality requirement only to 
income from related parties focuses only on potential abuse 
cases, and does not hamper certain other kinds of non-abusive 
activities, even though the income recipient resident in a 
Contracting State may be very small in relation to the entity 
generating income in the other Contracting State. For example, 
if a small U.S. research firm develops a process that it 
licenses to a very large, unrelated, German pharmaceutical 
manufacturer, the size of the U.S. research firm would not have 
to be tested against the size of the German manufacturer. 
Similarly, a small U.S. bank that makes a loan to a very large 
unrelated German business would not have to pass a 
substantiality test to receive treaty benefits under paragraph 
4.
    Subparagraph (c) of paragraph 4 provides special 
attribution rules for purposes of applying the substantive 
rules of subparagraphs (a) and (b). Thus, these rules apply for 
purposes of determining whether a person meets the requirement 
in subparagraph (a) that it be engaged in the active conduct of 
a trade or business and that the item of income is derived in 
connection with that active trade or business, and for making 
the comparison required by the ``substantiality'' requirement 
in subparagraph (b). Subparagraph (c) attributes the activities 
of a partnership to each of its partners. Subparagraph (c) also 
attributes to a person activities conducted by persons 
``connected'' to such person. A person (``X'') is connected to 
another person (``Y'') if X possesses 50 percent or more of the 
beneficial interest in Y (or if Y possesses 50 percent or more 
of the beneficial interest in X). For this purpose, X is 
connected to a company if X owns shares representing fifty 
percent or more of the aggregate voting power and value of the 
company or fifty percent or more of the beneficial equity 
interest in the company. X also is connected to Y if a third 
person possesses fifty percent or more of the beneficial 
interest in both X and Y. For this purpose, if X or Y is a 
company, the threshold relationship with respect to such 
company or companies is fifty percent or more of the aggregate 
voting power and value or fifty percent or more of the 
beneficial equity interest. Finally, X is connected to Y if, 
based upon all the facts and circumstances, X controls Y, Y 
controls X, or X and Y are controlled by the same person or 
persons.
Paragraph 5
    Paragraph 5 deals with the treatment of income in the 
context of a so-called ``triangular case.''
    The term ``triangular case'' refers to the use of the 
following structure by a resident of the Federal Republic of 
Germany to earn, in the example, interest income from the 
United States. The German resident, who is assumed to qualify 
for benefits under one or more of the provisions of Article 28 
(Limitation on Benefits), sets up a permanent establishment in 
a third jurisdiction that imposes only a low rate of tax on the 
income of the permanent establishment. The German resident 
lends funds into the United States through the permanent 
establishment. The permanent establishment, despite its third-
jurisdiction location, is an integral part of a German 
resident. Therefore the income that it earns on those loans, 
absent the provisions of paragraph 5, is entitled to exemption 
from U.S. withholding tax under the Convention. Under a German 
tax treaty with the host jurisdiction of the permanent 
establishment, the income of the permanent establishment is 
exempt from German tax. Thus, the interest income is exempt 
from U.S. tax, is subject to little tax in the host 
jurisdiction of the permanent establishment, and is exempt from 
German tax.
    Paragraph 5 replaces the otherwise applicable rules in the 
Convention for dividends, interest and royalties with a 15 
percent withholding tax for these amounts and the domestic law 
rules of the source country for any other income, if the actual 
tax paid on the income in the country of residence of the 
enterprise and in the third jurisdiction is less than 60 
percent of the tax that would have been payable in the country 
of residence of the enterprise if the income were earned in 
such country by the enterprise and were not attributable to the 
permanent establishment in the third state.
    In general, the principles employed under Code section 
954(b)(4) will be employed to determine whether the profits are 
subject to an effective rate of taxation that is above the 
specified threshold.
    Notwithstanding the level of tax on income of the permanent 
establishment, paragraph 5 does not apply under certain 
circumstances. In the case of royalties, paragraph 5 does not 
apply if the royalties are received as compensation for the use 
of, or the right to use, intangible property produced or 
developed by the permanent establishment itself. In the case of 
other income, paragraph 5 does not apply if the income is 
derived in connection with, or is incidental to, the active 
conduct of a trade or business carried on by the permanent 
establishment in the third state. The business of making, 
managing or simply holding investments for the person's own 
account is not considered to be an active trade or business, 
unless these are banking or securities activities carried on by 
a bank or registered securities dealer.
Paragraph 6
    Paragraph 6 provides that German Investment Funds or German 
Investmentaktiengesellschaft (collectively referred to as 
Investmentvermogen) may only be granted the benefits of the 
Convention if at least 90 percent of the shares or other 
beneficial interests in the German Investmentvermogen are owned 
directly or indirectly by German residents that are entitled to 
the benefits of this Convention under certain subparagraphs of 
paragraph 2 of this Article (i.e., subparagraphs (a), (b), (d) 
or (e) and clause (aa) of paragraph (c)) or by persons that are 
equivalent beneficiaries with respect to the income derived by 
the German Investmentvermogen for which benefits are being 
claimed. For purposes of this paragraph, beneficiaries of 
entities that are subject to numbers 3 and 5 of paragraph 1 of 
section 1 of the German Corporate Tax Act shall be treated as 
indirectly owning shares of a German Investmentvermogen. 
Foundations referred to in number 5 of paragraph 1 of section 1 
of the German Corporate Tax Act, other than those referred to 
in subparagraph (d) of paragraph 2 of this Article shall not be 
take into account in determining whether a German 
Investmentvermogen meets the 90 percent threshold. Paragraph 24 
of Article XVI of the Protocol provides that the competent 
authorities will establish procedures for determining indirect 
ownership for purposes of determining whether the 90 percent 
ownership threshold of paragraph 6 is met and that it is 
anticipated that such procedures may include statistically 
valid sampling techniques.
Paragraph 7
    Paragraph 7 provides that a resident of one of the 
Contracting States that is not entitled to the benefits of the 
Convention as a result of paragraphs 1 through 6 still may be 
granted benefits under the Convention at the discretion of the 
competent authority of the State from which benefits are 
claimed. In making determinations under paragraph 7, that 
competent authority will take into account as its guideline 
whether the establishment, acquisition, or maintenance of the 
person seeking benefits under the Convention, or the conduct of 
such person's operations, has or had as one of its principal 
purposes the obtaining of benefits under the Convention. 
Benefits will not be granted, however, solely because a company 
was established prior to the effective date of a treaty or 
protocol. In that case a company would still be required to 
establish to the satisfaction of the Competent Authority clear 
non-tax business reasons for its formation in a Contracting 
State, or that the allowance of benefits would not otherwise be 
contrary to the purposes of the treaty. Thus, persons that 
establish operations in one of the States with a principal 
purpose of obtaining the benefits of the Convention ordinarily 
will not be granted relief under paragraph 7.
    The competent authority's discretion is quite broad. It may 
grant all of the benefits of the Convention to the taxpayer 
making the request, or it may grant only certain benefits. For 
instance, it may grant benefits only with respect to a 
particular item of income in a manner similar to paragraph 4. 
Further, the competent authority may establish conditions, such 
as setting time limits on the duration of any relief granted.
    For purposes of implementing paragraph 7, a taxpayer will 
be permitted to present his case to the relevant competent 
authority for an advance determination based on the facts. In 
these circumstances, it is also expected that, if the competent 
authority determines that benefits are to be allowed, they will 
be allowed retroactively to the time of entry into force of the 
relevant treaty provision or the establishment of the structure 
in question, whichever is later. Before denying benefits of the 
Convention under this paragraph, the competent authority will 
consult with the competent authority of the other Contracting 
State.
    Finally, there may be cases in which a resident of a 
Contracting State may apply for discretionary relief to the 
competent authority of his State of residence. This would 
arise, for example, if the benefit it is claiming is provided 
by the residence country, and not by the source country. So, 
for example, if a company that is a resident of the United 
States would like to claim the benefit of the re-sourcing rule 
of paragraph 2 of Article 23, but it does not meet any of the 
objective tests of this Article, it may apply to the U.S. 
competent authority for discretionary relief.
Paragraph 8
    Paragraph 8 defines several key terms for purposes of 
Article 28. Each of the defined terms is discussed in the 
context in which it is used.

                               ARTICLE XV

    Article XV of the Protocol updates several references in 
the Convention that have become outdated since the Euro has 
replaced the German mark as the currency of the Federal 
Republic of Germany.

                              ARTICLE XVI

    Article XVI of the Protocol restates and updates the 
Protocol to the Convention. The following description of 
Article XVI only discusses the aspect of Article XVI that 
amends the Protocol to the Convention and that has not been 
described elsewhere in the technical explanation. Consequently, 
only paragraphs 21 and 23 of the Article are described below.
Paragraph 21
    Paragraph 21 makes clear that paragraph 4 of Article 24 
does not obligate a Contracting State to permit cross-border 
consolidation of income or similar benefits between 
enterprises.
Paragraph 23
    Paragraph 23 makes clear that Article 26 (Exchange of 
Information and Administrative Assistance) provides the 
competent authority of each Contracting State the power to 
obtain and provide information held by financial institutions, 
nominees, or persons acting in an agency or fiduciary capacity 
(not including information that would reveal confidential 
communications between a client and an attorney, solicitor, or 
other legal representative, where the client seeks legal 
advice), or respecting interests in a person, including bearer 
shares, regardless of any laws or practices of the requested 
State that might otherwise preclude the obtaining of such 
information. Thus, such information must be provided to the 
requesting State notwithstanding the fact that disclosure of 
the information is precluded by bank secrecy or similar 
legislation relating to disclosure of financial information by 
financial institutions or intermediaries.

                              ARTICLE XVII

    Article XVII of the Protocol contains the rules for 
bringing the Protocol into force and giving effect to its 
provisions.
Paragraph 1
    Paragraph 1 provides for the ratification of the Convention 
by both Contracting States according to their constitutional 
and statutory requirements. Instruments of ratification shall 
be exchanged as soon as possible.
    In the United States, the process leading to ratification 
and entry into force is as follows: Once a treaty has been 
signed by authorized representatives of the two Contracting 
States, the Department of State sends the treaty to the 
President who formally transmits it to the Senate for its 
advice and consent to ratification, which requires approval by 
two-thirds of the Senators present and voting. Prior to this 
vote, however, it generally has been the practice for the 
Senate Committee on Foreign Relations to hold hearings on the 
treaty and make a recommendation regarding its approval to the 
full Senate. Both Government and private sector witnesses may 
testify at these hearings. After the Senate gives its advice 
and consent to ratification of the protocol or treaty, an 
instrument of ratification is drafted for the President's 
signature. The President's signature completes the process in 
the United States.
Paragraph 2
    Paragraph 2 provides that the Protocol will enter into 
force upon the exchange of instruments of ratification. The 
date on which a Protocol enters into force is not necessarily 
the date on which its provisions take effect. Paragraph 2, 
therefore, also contains rules that determine when the 
provisions of the Protocol will have effect.
    Under subparagraph 2(a), the Protocol will have effect with 
respect to taxes withheld at source (principally dividends and 
interest) for amounts paid or credited on or after the first 
day of January of the year in which the Protocol enters into 
force. For example, if instruments of ratification are 
exchanged on April 25 of a given year, the withholding rates 
specified in paragraph 2 and 3 of Article 10 (Dividends) would 
be applicable to any dividends paid or credited on or after 
January 1 of that year. This rule allows the benefits of the 
withholding reductions to be put into effect for the entire 
year the Protocol enters into force. If a withholding agent 
withholds at a higher rate than that provided by the Protocol 
(e.g., for payments made before April 25 in the example above), 
a beneficial owner of the income that is a resident of the 
Federal Republic of Germany may make a claim for refund 
pursuant to section 1464 of the Code.
    Under subparagraph 2(b), the Protocol will have effect with 
respect to taxes other than those withheld at source for any 
taxable period beginning on or after January 1 of the year next 
following entry into force of the Protocol. With respect to 
taxes on capital, the Convention will have effect for taxes 
levied on items of capital owned on or after January 1 next 
following the entry into force of the Protocol.
Paragraph 3
    Paragraph 3 provides two exceptions to the effective date 
rules of paragraph 2. The provisions of paragraphs 2 and 3 of 
Article 1 (General Scope) will have effect after the entry into 
force of the Protocol and apply in respect of any tax claim 
irrespective of whether the tax claim pre-dates the entry into 
force of the Protocol (or the effective date of any of its 
provisions). In addition, paragraph 3 provides that the 
amendments made to Article 19 (Government Service) by Article X 
of the Protocol do not have effect with respect to individuals 
who at the time of the signing of the Convention on August 29, 
1989 were employed by the United States, a political 
subdivision or local authority thereof.
Paragraph 4
    Paragraph 4 provides a specific effective date for purposes 
of the binding arbitration provisions of Article 25 (Mutual 
Agreement Procedure) (Article XIII of the Protocol). Paragraph 
4 provides that Article XIII of the Protocol is effective for 
cases (i) that are under consideration by the competent 
authorities as of the date on which the Protocol enters into 
force and (ii) cases that come under such consideration after 
the Protocol enters into force. In addition, paragraph 4 
provides that the commencement date for cases that are under 
consideration by the competent authorities as of the date on 
which the Protocol enters into force is the date the Protocol 
enters into force. As a result, cases that are unresolved as of 
the entry into force of the Protocol will go into binding 
arbitration no later than two years after the entry into force 
of the Protocol, if the cases are not otherwise resolved 
through the competent authority procedure. Pursuant to clause 
(c)(aa) of paragraph 6 of Article 25, the competent authorities 
may agree to any earlier date.
Paragraph 5
    As in many recent U.S. treaties, however, paragraph 5 also 
provides an additional exception to paragraph 2. Under 
paragraph 5, if the Convention as unmodified by the Protocol 
would have afforded any person that was entitled to benefits 
under the unmodified Convention greater relief from tax than 
under the Convention as modified by the Protocol, the 
unmodified Convention shall, at the election of such person, 
continue to have effect in its entirety for a 12-month period 
from the date on which the provisions of the Protocol would 
have otherwise had effect with respect to such person.
    Thus, a taxpayer who was entitled to benefits may elect to 
extend the benefits of the unmodified Convention for one year 
from the date on which the relevant provision of the modified 
Convention would first take effect. During the period in which 
the election is in effect, the provisions of the unmodified 
Convention will continue to apply only insofar as they applied 
before the entry into force of the Protocol. If the grace 
period is elected, all of the provisions of the unmodified 
Convention must be applied for that additional year. The 
taxpayer may not apply certain, more favorable provisions of 
the unmodified Convention and, at the same time, apply other, 
more favorable provisions of the modified Convention. The 
taxpayer must choose one regime or the other.
    For example, suppose the instruments of ratification are 
exchanged on April 1, 2007 and the Protocol thus enters into 
force on that date. The Protocol would take effect with respect 
to taxes withheld at source for amounts paid or credited on or 
after January 1, 2007. With respect to other income taxes, the 
Protocol would be applicable for taxable years beginning on or 
after January 1, 2008. If the election is made, the provisions 
of the unmodified Convention would continue to have effect (i) 
regarding withholding, for amounts paid or credited at any time 
prior to January 1, 2008, and (ii) regarding other income 
taxes, for fiscal periods beginning before January 1, 2009; the 
provisions of the Protocol (including the rules of Article 28 
(Limitation on Benefits)) would have effect (i) regarding 
withholding, for amounts paid or credited on or after January 
1, 2008, and (ii) regarding other income taxes, for fiscal 
periods beginning on or after January 1, 2009.
Paragraph 6
    Paragraph 6 provides that the following notes exchanged 
with respect to the current Convention will cease to have 
effect when the provisions of the Protocol take effect in 
accord with this Article: (i) the notes exchanged on August 29, 
1989 and (ii) the German note of November 3, 1989.
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