[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.
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\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'').
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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.