TREASURY DEPARTMENT TECHNICAL EXPLANATION OF THE AGREEMENT BETWEEN THE GOVERNMENT OF THE UNITED STATES OF AMERICA AND THE GOVERNMENT OF THE PEOPLE'S REPUBLIC OF CHINA FOR THE AVOIDANCE OF DOUBLE TAXATION AND THE PREVENTION OF TAX EVASION WITH RESPECT TO TAXES ON INCOME（二） 　　　　　　　　　　　　ARTICLE 8 　　　　　　　　　　　Related Enterprises 　　This article provides that, where related persons engage in transactions which are not at arm's length, the Contracting States may make appropriate adjustments to their taxable income and tax liability. 　　Paragraph 1 states the general rule that, where an enterprise of one Contracting State and an enterprise of the other State are related through management, control, or capital and their commercial or financial relations differ from those which would prevail between independent enterprises, the profits of the enterprises may be adjusted to reflect the profits which would have accrued if the two enterprises were independent. 　　Paragraph 2 provides that, where one of the Contracting States increases the profits of an enterprise of that State to the amount that would have accrued to the enterprise had it been independent of an enterprise of the other Contracting State, the second State shall, to the extent it agrees that the redetermination accurately reflects arm's length conditions, make a correlative adjustment, decreasing the amount of tax which it has already imposed on those profits. In determining such adjustments, due regard is to be paid to the other provisions of the convention. 　　The competent authorities of the two States may consult each other in implementing this provision. 　　　It is understood that each Contracting State may apply its internal law in determining liability for its tax. For example, although paragraphs 1 and 2 refer to allocations of "profits" and "taxes," it is understood that such terms also include the components of the tax base and of the tax liability, such as income, deductions, credits, and allowances. The United States will apply its rules and procedures under Code section 482. ARTICLE 9 Dividends 　　This article limits the tax which a Contracting State may impose on dividends paid by a company which is a resident of that State to a resident of the other Contracting State. 　　Paragraph 1 confirms that such dividends may be taxed in the State of residence of the shareholder. 　　Paragraph 2 provides that the dividends may also be taxed in the Contracting State of which the paying company is a resident. However, the beneficial owner is a resident the other Contracting State, the tax may not exceed 10 percent of the gross dividend. Although the language used, which is taken from the OECD and U.N. Models, refers the recipient being the beneficial owner, it is understood (consistent with the OECD commentary) that the intended meaning is that the reduced rate will apply when the beneficial owner is a resident of the other Contracting State, even when the recipient of the dividend may be a nominee for such resident. 　　Paragraph 3 defines the term "dividends" for purposes of this article. The definition, which is the same as that in the U.S. Model, is relevant only for determining the appropriate taxation at source. It does not govern for purposes of the country of residence of the shareholder, which applies its own law to the extent that characterizing an item of income is relevant. 　　Paragraph 4 provides that, where a resident of a Contracting State derives dividends from the other Contracting State and the holding is effectively connected with (the dividends are attributable to) a permanent establishment or fixed base through which the owner of the dividends carries on business in that other State, the dividends are taxable in accordance with the provisions of Article 7 or Article 13 rather than under this article. This paragraph does not automatically attribute dividends derived by a company having a permanent establishment in the source country to that permanent establishment (the "force of attraction" rule found in some early tax treaties). 　　Paragraph 5 provides that a Contracting State may not tax dividends paid by a company which is not a resident of that State except to the extent permitted under paragraph 2 or 4, of this article, i.e., to the extent that the dividends are paid to a resident of that State (or, in the case of the United States, a U.S. citizen residing in a third State) or the dividends are attributable to a permanent establishment or fixed base in that State. Thus, the United States will not tax dividends which are considered to be from U.S. sources under Code section 861(a)(2)(B) if paid by a Chinese corporation. China does not impose a tax on distributions of a foreign corporation out of the profits of its Chinese permanent establishment or a supplementary tax on the profits of a Chinese branch of a foreign corporation. 　　In accordance with the "saving clause" of paragraph 2 of the Protocol, the United States may in any event tax dividends derived by U.S. citizens. ARTICLE 10 Interest 　　This article limits the tax which a Contracting State may impose on interest arising in that State and paid to a resident of the other Contracting State. 　　Paragraph 1 confirms that such interest may be taxed in the State of residence of the recipient. 　　Paragraph 2 provides that such interest may also be taxed in the Contracting State in which it arises. However, if the beneficial owner is a resident of the other Contracting State, the tax may not exceed 10 percent of the gross interest. (See also the discussion of the corresponding provision in Article 9.) 　　Paragraph 3 provides, as an exception to paragraph 2, that interest arising in a Contracting State which is derived by the government of the other Contracting State, a political subdivision or local authority thereof, or the Central Bank or any financial institution wholly owned by the government of that other State or by any resident of that other State with respect to debt indirectly financed by any of the above (e.g., loans indirectly financed by Eximbank) is exempt from tax in the State in which it arises. 　　Paragraph 4 defines "interest" for purposes of this article. It includes income from debtclaims of all kinds, including mortgage interest and original issue discount. The definition, which is relevant only for determining the appropriate taxation at source, permits the United States to apply its rules regarding the distinction between interest and dividends pursuant to section 385 of the Code. It is understood that penalties for late payment are not interest. 　　Paragraph 5 provides that, where a resident of one Contracting State derives interest which arises in the other Contracting State and the debt claim is effectively connected with (i.e., the interest is attributable to) a permanent establishment or fixed base through which the owner of the interest carries on business in that other State, that interest is taxable in accordance with the provisions of Article 7 or Article 13 rather than under this article. Thus, interest derived by a resident of China which arises in the United States and is attributable to a U.S. permanent establishment of that resident may be taxed by the United States in accordance with Article 7. 　　Paragraph 6 provides a source rule for interest payments. Generally, interest is deemed to arise in the state of residence of the payer. However, where the interest is attributable to debt incurred by or for a permanent establishment or fixed base in one of the Contracting States and is borne (deducted from taxable income) by that permanent establishment or fixed base, the interest is deemed to arise where the permanent establishment or fixed base is located. 　　Paragraph 7 states that this article does not apply to interest payments between related persons in excess of the amount which would have been agreed upon at arm's length. Such excess amount shall be taxable according to the laws of each Contracting State, with regard also to the other provisions of this Agreement. For example, if the excess amount is taxable as a dividend, the tax imposed will be subject to the provisions of Article 10 (Dividends). In accordance with the "saving clause" of paragraph 2 of the Protocol, the United States may in any event tax interest derived by U.S. citizens. ARTICLE 11 Royalties 　　This article limits the tax which a Contracting State may impose on royalties arising in that State and paid to a resident of the other Contracting State. 　　Paragraph 1 confirms that such royalties may be taxed in the State of residence of the recipient. 　　Paragraph 2 provides that such royalties may also be taxed in the Contracting State in which they arise. However, if the beneficial owner is a resident of the other Contracting State, the tax may not exceed 10 percent of the gross royalty. (See also the discussion of the corresponding provision in Article 9.) In recognition of the expenses associated with the leasing of industrial, commercial, and scientific equipment, paragraph 6 of the Protocol provides that in such cases the tax shall be imposed on 70 percent of the gross amount, i.e. the tax may not exceed 7 percent of the gross rental payment. 　　Paragraph 3 defines the term "royalties" for purposes of this article. The definition includes payments for the right to use a copyright, trademark, patent, design, models, secret formula or process, know-how, or similar property or rights. Payments for film rentals and for the leasing of equipment are also included, and it is understood that the definition includes royalties contingent on the sale or use of the property or right. 　　Paragraph 4 provides that, where a resident of one Contracting State derives royalties which arise in the other Contracting State and the right or property is effectively connected with (i.e. the royalties are attributable to) a permanent establishment or fixed base through which the owner of the royalties carries on business in that other State, the royalties are taxable in accordance with the provisions of Article 7 or Article 13 rather than under this article. 　　Paragraph 5 provides a source of rule for royalty payments. In general, a royalty is considered to arise in a Contracting State if paid by the government or a resident of that State.However, if a permanent establishment or fixed base of the payor in one of the States incurs the liability to pay the royalties and bears the payment (deducts it in arriving at taxable income) the royalty is considered to arise in the State where the permanent establishment or fixed base is located. Moreover, if under these rules a royalty is not considered to arise in either State, but it relates to the use of, or the right to use, property in a State, the royalty is considered to arise in the State where the property is used (or where there is a right to use it). Thus, for example, if a resident of China were to license a patent to a third country company, which in turn sub-licensed it for use in the United States, the United States would tax the license payment by the third country company to the resident of China, subject to the limitation in paragraph 2. The sublicense payment by the U.S. user to the third country resident would not be covered by the Agreement and would be subject to U.S. tax under U.S. law or the provisions of a U.S. tax treaty with that third country, if applicable. 　　Paragraph 6 states that this article does not apply to royalties paid between related persons in excess of the amount which would have been agreed upon at arm's length. Such excess amount shall be taxable according to the law of each Contracting State, with regard also to the other provisions of this Agreement. For example, if the excess royalty is taxable as a dividend, it will be subject to the provisions of Article 9. In accordance with the ''saving clause" of paragraph 2 of the Protocol, the United States may in any event tax royalties derived by U.S. citizens. ARTICLE 12 Gains 　　This article specifies the situations in which a Contracting State may tax gains derived by a resident of the other Contracting State. The term "gains" includes amounts treated as capital gains and as ordinary income. 　　Paragraph 1 provides that gains derived by a resident of a Contracting State from the alienation of real property situated in the other Contracting State may be taxed by the State where the property is located. 　　Paragraph 2 provides that gains derived by a resident of a Contracting State with respect　to movable property forming part of a permanent establishment or a fixed base maintained by　that resident in the other Contracting State and gains from the alienation of such a permanent establishment or fixed base may be taxed where the permanent establishment or fixed base is located. 　　Paragraph 3 reserves to the State of residence the exclusive right to tax gains of a resident of a Contracting State from the alienation of ships, aircraft, operated in international traffic, and related personal property, such as containers. 　　Paragraph 4 provides that gains derived from the alienation of shares of a company the assets of which directly or indirectly consist principally of real property situated in a Contracting State may be taxed in the State where the real property is situated. 　　Paragraph 5 provides that gains derived from the alienation of shares, other than those covered by paragraph 4, which represent a participating of 25 percent or more in a company which is a resident of a Contracting State may be taxed in that State. For example, China may tax the gain derived by a U.S. company from the alienation of its 25 percent or greater participation in a Chinese corporate joint venture. 　　Paragraph 6 provides that gains from the alienation of any property not referred to in paragraphs 1 through 5 may be taxed in the State in which they arise. Thus, gains on the disposition of a U.S. real property interest, to the extent not taxable under the preceding paragraphs, are taxable under this paragraph in accordance with the provisions of the Foreign Investment in Real Property Tax Act, as amended. 　　The gains covered in this article may also be taxed in the State of residence of the alienator, subject to the provisions of Article 22 concerning the avoidance of double taxation. In accordance with paragraph 2 of the Protocol, the United States may also tax its citizens. ARTICLE 13 Independent Personal Services 　　This article provides that income derived by an individual resident of a Contracting State from performing independent personal services may be taxed in the other Contracting State only if the individual is present in that other State for more than 183 days in the calendar year or has a fixed base regularly available to him in that other State. In such a case, that other State may tax the income attributable to the services performed there or to that fixed base, as the case may be. The concept of a "fixed base" is analogous to that of a "permanent establishment" as defined in Article 5. Thus, a fixed base means a fixed place of business used with some continuity for performing independent services. It would not include a hotel room unless used as an office or work site on a continuing basis. The rules of Article 7 should also be applied in taxing the profits attributable to a fixed base, e.g., taxation on a net basis using arm's-length principles. Independent personal services are in general, services performed by an individual for his own account where he receives the income and bears the losses arising from such services. They include services of professional persons, such as doctors and lawyers, but also other services performed by sole proprietors or partners. 　　In accordance with paragraph 2 of the Protocol, the United States may in any event tax its citizens. ARTICLE 14 Dependent Personal Services This article specifies when personal service income earned by an employee who is a resident of a Contracting State may be taxed by the other Contracting State. 　　Paragraph 1 provides the basic rule that such employment income may be taxed only in　the employee's State of residence, unless the services are preformed in the other Contracting State. 　　Paragraph 2 provides that, even where the services are performed in the other Contracting State, the income derived may not be taxed by that other State if three conditions are met: (1) the recipient is present in that other State for not more than 183 days in the calendar year; (2) the remuneration is paid by or on behalf of an employer who is not a resident of that other State; and (3) the remuneration is not borne by (deducted from the taxable income of) a permanent establishment or a fixed base of that employer in that other State. If any one of the three conditions is not met, e.g., if the remuneration is borne by a permanent establishment of the employer in the State where the services are performed, the income may be taxed by that State. 　　In any such case, the right of the source State to tax is limited to the income attributable to services performed in that State. In accordance with paragraph 2 of the Protocol, the United States may in any event tax its citizens. ARTICLE 15 Directors' Fees 　　This article provides that a Contracting State may tax a resident of other Contracting State with respect to payments for his services as a director of a company which is a resident of the first-mentioned State. Payments for services as an officer or employee of such a company are covered under Article 13 or 14. In accordance with paragraph 2 of the Protocol, the United States may in any event tax its citizens. ARTICLE 16 Artistes and Athletes 　　This article specifies when a Contracting State may tax the remuneration of entertainers and athletes who are residents of the other Contracting State. It provides certain exceptions to the provisions of Articles 13 and 14. However, income from services rendered by producers, directors, technicians and others who are not artistes and athletes is taxable in accordance with Article 13 or 14, as the case may be. 　　Paragraph 1 provides that a Contracting State may tax income derived by a resident of the other Contracting State from the performance of services in the first State as an entertainer or athlete, unless the activities are exercised in accordance with a cultural exchange program agreed upon by the two Governments, in which case the host State agrees to exempt such income from tax. The exception for cultural exchange programs is expected to cover most, if not all, such exchanges at the present time. 　　Paragraph 2 provides that, where income for services performed by an entertainer or athlete accrues to another person, it may be taxed in the State where the activities are performed, without regard to the other provisions of the Agreement. Although this provision is drafted broadly, it is understood that it will be interpreted in accordance with the policy of the U.S. model and the commentary to the OECD model provision; i.e. the intent is to prevent abuse of the Convention by diverting income to a person, other than the individual performing the services (for example, by having the remuneration paid to a corporation which does not have a permanent establishment in the State where the services are performed). The paragraph is not intended to impose tax in cases where there is no tax avoidance motive, for example, when a payment is made to an orchestra on behalf of its members who performed in a concert. 　　In accordance with paragraph 2 of the Protocol, the United States may in any event tax its citizens. ARTICLE 17 Pensions and Annuities 　　This article deals with the taxation of private pensions and social security benefits. Pensions in consideration of government employment are covered under Article 18. Paragraph 1 provides that pensions in respect of private employment derived by a resident of a Contracting State may be taxed only in that State. On the other hand, public payments, such as social security benefits or public welfare payments, paid by a Contracting State may be taxed only in the paying State. This provision is excepted from the "saving" clause of paragraph 2 of the Protocol, so the United States will not tax its residents on social security benefits paid to them by the People's Republic of China.