TREASURY DEPARTMENT TECHNICAL EXPLANATION OF THE CONVENTION BETWEEN THE GOVERNMENT OF THE UNITED STATES OF AMERICA AND THE GOVERNMENT OF THE REPUBLIC OF CYPRUS FOR THE AVOIDANCE OF DOUBLE TAXATION AND THE PREVENTION OF FISCAL EVASION WITH RESPECT TO TAXES ON INCOME（二） 　　　　　　　　　　　　ARTICLE 6 Source of Income 　　This Article contains the source rules which are used in applying the rules of the Convention. For example, under Article 4 (General Rules of Taxation), one Contracting State may tax a resident of the other Contracting State only on income from sources within the firstmentioned Contracting State (provided, with certain exceptions, such resident is not a citizen of the first-mentioned State). 　　Paragraph (1) provides, as a general rule, that dividends will be treated as income from sources within a Contracting State only if paid by a corporation of that State. An exception to this general rule provides that a dividend will be deemed to be from United States sources if paid by a corporation other than a United States corporation (including a Cypriot corporation) which derives 50 percent or more of its total gross income from one or more permanent establishments which that corporation has in the United States. This rule is similar to that in Code section 861(a)(2)(B). It differs from the Code rule, however, in several respects. For example, it deals with income derived from a permanent establishment rather than a trade or business, and it does not specifically provide that only a pro rata portion of the dividend will be treated as income from sources within the United States. However, since Article 4 (General Rules of Taxation) provide, in effect, that the Convention cannot operate to increase a person's United States tax, the proration specified in the Code will be applied to determine the portion of the dividend paid by such non-United States corporation which will be treated as United States source income. In the case of a dividend which would be treated under the general rule as being from Cypriot sources (i.e., paid by a Cypriot corporation), but which, under the exception, would be treated as being from United States sources, the portion of the total dividend, after proration, to which the exception applies would be treated as United States source income, and any excess would be treated as Cypriot source income. 　　Paragraph (2) provides, as a general rule, that interest will be treated as income from sources within a Contracting State only if the interest is paid by the Contracting State itself, a political subdivision or local authority of that State or by a resident of that State. An exception to this general rule provides that if the person paying the interest (whether or not that person is a resident of a Contracting State) has a permanent establishment in a Contracting State, and the indebtedness on which the interest is paid was incurred in connection with that permanent establishment and the interest is borne by the permanent establishment (i.e., the interest is deducted in computing the income of the permanent establishment), then the interest will be deemed to be from sources in the Contracting State in which the permanent establishment is situated. Similarly, if a resident of a Contracting State has a permanent establishment in a State other than a Contracting State, then interest paid on indebtedness incurred in connection with that permanent establishment, which is borne by the permanent establishment, will be deemed to be from sources in the State in which the permanent establishment is situated. 　　A further exception provides that interest will be deemed to be from sources within the United States if paid by a Cypriot corporation which derives 50 percent or more of its total gross income from one or more permanent establishments which that Cypriot corporation has in the United States. This is similar to the rule in Code section 861(a)(l)(C) and (D). It differs from the Code rule, for example, in that the rule in the Convention does not provide for proration. As in the case of dividends, however, the ability of the United States to exercise its taxing rights under this provision is limited by its right to impose tax under the Code. Thus, the Code proration rules will apply. 　　Under paragraph (3), royalties, as defined in paragraph (2) of Article 14 (Royalties), are treated as income from sources within a Contracting State only to the extent that they are for the use of or the right to use in that Contracting State the property or rights giving rise to the royalties. 　　Paragraph (4) provides that income from real property, as described in Article 15 (Income from Real Property), has its source in the Contracting State in which the real property is situated. Under paragraph (5), income from the rental of tangible personal property has its source in a Contracting State only if the property is used in that Contracting State, or is held for use there. 　　Paragraph (6) provides the rule for the source of income from the performance of personal services. The general rule is that income received by an individual for the performance of labor or personal services, either as an employee or in an independent capacity, will be treated as income from sources in a Contracting State only to the extent that the services are performedin that State. Income from labor or personal services includes pensions (as defined in paragraph 　　(3) of Article 23 (Private Pensions and Annuities)) paid in respect of such services. There are several exceptions to the general rule, under which income from personal services may be sourced in a Contracting State other than the State where the services are performed: Income from personal services performed aboard ships or aircraft operated by a resident of a Contracting State in international traffic will be treated as income from sources only within that Contracting State if the services are rendered by a member of the regular complement of the ship or aircraft. Remuneration described in Article 22 (Governmental Functions) and payments described in Article 24 (Social Security Payments) are treated as income from sources within a Contracting State only if paid by or from the public funds of that State or a political subdivision or local authority of that State. In addition, Article 20 (Directors' Fees) provides that a portion of directors' fees paid by a corporation of a Contracting State may be taxed in that State; this paragraph treats that portion of the fees as income from sources within that State. 　　Paragraph (7) provides that income from the purchase and sale of property (including tangible and intangible personal property and real property) will be treated as income from sources in a Contracting State if either 　　(1) the property is sold in that Contracting State, or 　　(2) the property is of the type described in Paragraph (l)(a) or (b) of Article 16 (Gains) and the property is located or deemed to be located (under paragraph (3) of Article 16) in that Contracting State. 　　Thus, for example, if the property is shares in a United States corporation which is a United States real property holding corporation (i.e., a "United States real property interest"), the income from the sale of those shares will be income from sources in the United States even if the sale takes place outside the United States. 　　The source of gains described in paragraph (2)(b) of Article 14 (Royalties) will be determined under paragraph (3) of this Article, not under this paragraph. Paragraph (8) contains a general qualification to the preceding source rules. It provides that industrial and commercial profits attributable to a permanent establishment which the recipient, a resident of a Contracting State, has in the other Contracting State will be treated as income from sources within that other Contracting State. Industrial and commercial profits attributable to such permanent establishment may include any items of income described in the preceding paragraphs of this Article (except paragraph (6)) if the item of income is effectively connected with the permanent establishment. (See the explanation of paragraph (6)(b) of Article 8 (Business Profits) for a discussion of the "effectively connected" concept.) 　　Under paragraph (9), the source of any item of income not described in the preceding paragraphs of this Article will be determined by each Contracting State in accordance with its own law. If the source rules of the Contracting States with regard to a particular item of income differ, or if the source of an item of income is not readily determinable under the laws of a Contracting State, the competent authorities may establish a common source of that item of income for purposes of the Convention in order to prevent double taxation or further any other purpose of the Convention. 　　Several of the source rules set out in this Article may differ in some degree from those in the Code. Since as noted previously, paragraph 2 of Article 4 (General Rules of Taxation) provides, in effect, that the Convention will not increase a person's overall United States tax, a taxpayer is not required to apply the Convention rules in calculating his United States tax liability if the Code rules provide a more favorable result. A taxpayer may not, however, make inconsistent choices between Code and Convention rules. ARTICLE 7 Non-Discrimination 　　Paragraph (1) provides that a citizen of one Contracting State shall not be subject to more burdensome taxes in the other Contracting State than a citizen or that other Contracting State who is in similar circumstances. This paragraph would not apply in the case of a citizen of Cyprus who is not resident in the United States and a citizen of the United States who is not resident in the United States, to require that the Cyprus citizen not be subject to more burdensome United States taxation than the citizen of the United States. The citizen of the United States is subject to United States taxation on worldwide income, while the citizen of Cyprus is not, thus making their circumstances different. However, a citizen of Cyprus who is resident in the United States, and who otherwise meets the requirements of Code section 911, would, under this paragraph, be entitled to the benefits of section 911, even though not a citizen of the United States. 　　Paragraph (2) provides that a Contracting State may not impose more burdensome taxes on a permanent establishment of a resident of the other Contracting State than it imposes on its own residents carrying on similar activities. This provision, however, does not obligate a Contracting State to grant to individual residents of the other Contracting State any personal allowances, etc., on account of civil status or family responsibility, which it grants to its own individual residents. 　　Paragraph (3) prohibits discrimination in the allowance of deductions. Except where the provisions of paragraph (1) of Article 11 (Related Persons), paragraph (5) of Article 13 (Interest) and paragraph (4) of Article 14 (Royalties) apply (all of which permit denial of deductions in certain circumstances in transactions between related persons), interest, royalties and other disbursements paid by a resident of one Contracting State to a resident of the other shall be deductible in the first-mentioned Contracting State under the same conditions as if they had been paid to a resident of that first-mentioned Contracting State. The term "other disbursements" is defined to include a reasonable allocation of executive and general administrative expenses (other than expenses which constitute "stewardship" expenses undertaken for the benefit of the investor), research and development expenses and other expenses incurred for the benefit of a group of related persons which includes the person incurring the expense. This paragraph also requires that a debt of a resident of one Contracting State owed to a resident of the other be deductible for purposes of any capital taxation in the first-mentioned Contracting State under the same conditions as if the debt were owed to a resident of the first-mentioned State. Though the Convention does not generally cover capital taxes, under paragraph (3) of Article 1 (Taxes Covered), the non-discrimination provisions apply to taxes of all kinds, imposed at all levels of government in both Contracting States. 　　Paragraph (4) requires that a Contracting State not impose other or more burdensome　taxation (including connected requirements) on a corporation of that State which is owned or controlled, directly or indirectly, by residents of the other Contracting State than it imposes on other similar corporations of that Contracting State. Thus, a Cypriot subsidiary of a United States corporation must not be subject to more burdensome taxation in Cyprus than a Cypriot corporation owned by residents of Cyprus. 　　This Article is not subject to the saving clause of paragraph (3) of Article 4 (General Rules of Taxation). Thus, a resident of a Contracting State who is a citizen of the other Contracting State may claim the benefits of this Article in that other Contracting State. ARTICLE 8 Business Profits This Article provides rules for the taxation by a Contracting State of income from business activity carried on by a resident of the other Contracting State. Paragraph (1) sets forth the general rule that industrial or commercial profits (as defined in paragraph (6)(a)) of a resident of one Contracting State are exempt from tax in the other Contracting State unless that resident is engaged in industrial and commercial activity (as defined in paragraph (5)) through a permanent establishment in that other Contracting State. Permanent establishment is defined in Article 9 (Permanent Establishment). Where there is a permanent establishment, only the industrial and commercial profits attributable to the permanent establishment may be taxed. 　　The saving clause of paragraph (3) of Article 4 (General Rules of Taxation) applies to this Article, so that if, for example, a citizen of the United States who is a resident of Cyprus derives industrial and commercial profits from the United States, the United States may tax those profits even if the individual has no permanent establishment in the United States. 　　Under paragraph (8) of Article 6 (Source of Income), industrial or commercial profits which are attributable to a permanent establishment which a resident of one Contracting State has in the other Contracting State will be considered to be from sources within that other State. 　　Under this rule, items of income described in Code section 864(c)(4)(B) attributable to a permanent establishment situated in the United States will be subject to tax by the United States. 　　In determining the proper attribution of industrial or commercial profits to a permanent establishment under the Convention, paragraph (2) provides that both Contracting States will attribute to a permanent establishment the profits which the establishment would have earned had it been an independent entity engaged in the same or similar activities under the same or similar conditions. 　　Under paragraph (3), expenses which are reasonably connected with the profits of a permanent establishment, including executive and general administrative expenses, wherever incurred, will be allowed as deductions in determining the industrial or commercial profits of the permanent establishment. 　　Paragraph (4) provides that a Contracting State will not attribute profits to a permanent establishment of a resident of the other Contracting State merely because of the purchase of goods or merchandise by that permanent establishment, or by that resident for its own account. 　　Paragraph (2) does not override paragraph (4), so that where a permanent establishment purchases goods for its home office, the industrial and commercial profits will not include any notional figure representing profits from purchasing activities. 　　Paragraph (5) defines the term "industrial and commercial activity". The term includes the conduct of manufacturing, mercantile, banking, insurance, agricultural, fishing or mining activities, the operation of ships or aircraft, the furnishing of services and the rental of tangible personal property. The term does not include the performance of personal services by an individual, which is dealt with in Articles 17 and 25. The term "industrial and commercial profits" is defined in paragraph (6)(a) to mean income derived from industrial and commercial activity. The term also includes income from real property, dividends, interest, royalties and gains, but only if the property or rights giving rise to that income is effectively connected with a permanent establishment in a Contracting State. Such income need not be derived from industrial or commercial activity, but unless the recipient is engaged in industrial and commercial activity,under paragraph (1), the Contracting State in which the permanent establishment is situated may not tax that income under this Article. Paragraph (6)(b) provides criteria for determining when property or rights are effectively connected with a permanent establishment. The factors to be taken into account include whether rights or property are used or held for use in carrying on industrial or commercial activities through the permanent establishment and whether those activities were a material factor in the realization of the income derived from the property or rights. In making such a determination, due regard is to be given to whether or not the property, rights or income were accounted for through the permanent establishment. The concept of effective connection as used in this Convention is narrower that the concept in Code section 864(c)(3), which includes a limited "force of attraction" rule not present in the Convention. Under paragraph (7), where industrial or commercial profits include items of income which are dealt with separately in other articles of the Convention, the provisions of those articles, except where they specifically provide to the contrary, will take precedence over the provisions of this Article. Thus, for example, the taxation of interest will be determined under Article 13 (Interest) and not under this Article, except when, as provided in paragraph (4) of Article 13, the indebtedness giving rise to the interest is effectively connected with a permanent establishment. ARTICLE 9 Permanent Establishment 　　This Article defines the term "permanent establishment". The existence of a permanent establishment is relevant under Article S (Business Profits) to the taxation of industrial or commercial profits and in determining the applicability of other provisions of the Convention. 　　Under paragraph (1), the term "permanent establishment" means a fixed place of business through which a resident of a Contracting State engages in industrial or commercial activity. 　　Paragraph (2) gives an illustrative, non-exclusive, list of fixed places of business which will constitute a permanent establishment. This list includes a branch, an office, a factory, a workshop, a warehouse, and a store or other sales outlet. 　　The list also includes a mine, quarry or other place of extraction of natural resources, and a building site or construction or installation project or an installation or drilling rig or ship used to explore for natural resources, but only if that site, etc., exists or lasts for more than six months. 　　Under this rule, the six month period begins only when work physically commences in the other Contracting State; A series of con tracts or projects which are interdependent both commercially and geographically is to be treated as a single project for purposes of applying the six month test. If the six month test is exceeded, the site or project constitutes a permanent establishment from its first day. 　　Paragraph (3) lists a number of exceptions to the general rule that a fixed place of business through which industrial or commercial activity is carried on will constitute a permanent establishment. The activities listed in the paragraph are considered to be preparatory or auxiliary to industrial or commercial activity. The exceptions are cumulative, and a fixed place of business used only for one or more of the listed activities will not constitute a permanent establishment. 　　Paragraphs (4) and (5) deal with the use of agents. Under paragraph (4), a dependent agent of a resident of a Contracting State in the other Contracting State will be deemed to be a permanent establishment of that resident if the agent has and habitually exercises an authority to conclude contracts in the name of that resident, unless his activities are limited to those specified in paragraph (3), which would not constitute a permanent establishment if exercised through a fixed place of business. Under paragraph (5), a resident of a Contracting State will not be deemed to have a permanent establishment in the other Contracting State merely because it engages in industrial or commercial activity in that other Contracting State through an independent agent who is acting in the ordinary course of his business. 　　Paragraph (6) provides that, in determining whether a resident of a Contracting State has a permanent establishment in the other Contracting State, no account shall be taken of the fact that the first-mentioned resident may be related (within the meaning of Article II (Related Persons)) to a resident of the other Contracting State, or to any person who engages in industrial or commercial activity in that other Contracting State, whether or not through a permanent establishment. 　　Under paragraph (7), for purposes of the Convention, the provisions of this Article also apply in determining whether any person has a permanent establishment in any State. Thus, the principles of Article 9 would be used, in applying the Convention, to determine whether a resident of a third State has a permanent establishment in the United States or Cyprus, and whether a resident of the United States or Cyprus has a permanent establishment in a third State. ARTICLE 10 Shipping And Air Transport 　　Paragraph (1) provides that, notwithstanding Article 8 (Business Profits) and Article 16 (Gains), income derived by a resident of a Contracting State from the operation in international traffic of ships or aircraft shall be exempt from tax in the other Contracting State. The exemption also covers gains from the sale, exchange or other disposition of such ships or aircraft. The term "international traffic" is defined in paragraph (1)(h) of Article 2 (General Definitions). 　　Under paragraph (2), profits derived from the rental on a full or bareboat basis of ships or aircraft which are operated in international traffic by the lessee, or which rental profits are incidental to profits, described in paragraph (1), from the operation in international traffic of ships or aircraft, are included within profits from the operation of ships or aircraft in international traffic. Such profits, therefore, derived by a resident of one Contracting State are exempt from tax in the other Contracting State. Thus, if a resident of the United States leases an aircraft to a resident of Cyprus, the lease payments will be exempt from Cyprus tax if either the aircraft is used in international traffic by the resident of Cyprus, or if the United States lessor is engaged in the operation of aircraft in international traffic, and the rental profits are incidental to such operation, regardless of whether the aircraft is used internationally or domestically by the lessee. 　　Paragraph (3) provides that the State from the use, maintenance or profits of a resident of a Contracting rental of containers (including equipment for their transport) which are used for the transport of goods or merchandise in international traffic will be exempt from tax in the other Contracting State. 　　This Article is subject to the saving clause of paragraph (3) of Article 4 (General Rules of Taxation). Therefore, a Contracting State may tax the income of a resident of the other Contracting State without regard to this Article, if such resident is a citizen of the first-mentioned Contracting State. ARTICLE 11 Related Persons 　　This Article complements section 482 of the Code. It provides that where related persons engage in transactions that are not at arm's length, the Contracting States may make appropriate adjustments to the taxable income and tax liability of such related persons.Under paragraph (1), where a person subject to the taxing jurisdiction of a Contracting State and any other person are related, and where those related persons make arrangements or impose conditions between themselves which are different from those that would be made between independent persons, then the Contracting States may, in computing the income (or loss) of such person, take into account any income, deductions, credits, etc., which would have been taken into account in the absence of such a relationship. 　　Paragraph (2) defines the concept of relate4 persons. Under this paragraph, a person is related to another person if either owns or controls the other, directly or indirectly, or if any third person or persons own or control both, directly or indirectly. The term ''control" includes any kind of control, whether or not legally enforceable and however exercised or exercisable. 　　Paragraph (3) provides that where a Contracting State has made an adjustment under paragraph (1), and the other Contracting State agrees that the adjustment was appropriate under that paragraph, that other Contracting State is obligated to make a corresponding adjustment to the income, loss or tax of the related person in that other Contracting State. ARTICLE 12 Dividends 　　Paragraph (1) provides that dividends derived from sources within Cyprus and beneficially owned by a resident of the United States will not be subject to any tax in Cyprus in excess of the tax imposed on the profits or earnings out of which the dividends are paid. This rule reflects the imputation system under which Cyprus taxes its corporations and their shareholders. Under Cyprus law, when a Cypriot corporation pays a dividend, there is no tax imposed in Cyprus on the dividend itself. The shareholder includes the dividend in income for Cyprus income tax purposes, grossed-up by the amount of Cypriot corporate tax paid on the income out of which the dividend is paid. The shareholder is then granted a refundable credit for the amount of the gross-up. Under the Convention, a United States individual resident shareholder may compute Cyprus tax on his dividend income and, if the corporate tax paid exceeds his liability for Cyprus tax on his dividend, he may apply to the Cyprus authorities for a refund. In no case will any United States shareholder be liable to any additional tax on Cyprus on his Cypriot source dividends. 　　Paragraph (2) provides the rules for determining United States tax on dividends paid to residents of Cyprus. The general rate of United States tax on dividends derived from sources within the United States and beneficially owned by a resident of Cyprus is limited to 15 percent of the gross dividend. The rate is limited to 5 percent if (1) at least 10 percent of the outstanding voting stock of the United States corporation was owned by the Cyprus corporation during the portion of the taxable year of the United States corporation prior to the payment of the dividend and all of the preceding taxable year, and (2) not more than 25 percent of the gross income of the United States corporation for the prior taxable year (if any) consists of certain passive income. 　　Paragraph (3) provides that the limitations on source country tax in paragraphs (1) and (2) do not apply if the beneficial owner of a dividend who is a resident of a Contracting State has a permanent establishment in the other Contracting State, and the dividend is paid with respect to shares which are effectively connected with the permanent establishment. In that case the taxation of the dividend income is determined under Article 8 (Business Profits) and not under this Article. 　　Paragraph (4) provides, in general, that a Contracting State may not tax the dividends paid by a corporation of the other Contracting State. However, such dividends may be taxed by that other Contracting State if the recipient has a permanent establishment in that other Contracting State, and the shares in respect of which the dividends are paid are effectively connected with such permanent establishment. In addition, if dividends are paid by a corporation of Cyprus which derives 50 percent or more of its total gross income from one or more permanent establishments which that corporation has in the United States, the United States may tax those dividends, and the limitations of paragraph (2) do not apply. This Article is subject to the saving clause of paragraph (3) of Article 4 (General Rules of Taxation). Thus, the United States may tax a dividend received by a resident of Cyprus without regard to the limitations of this Article if that Cyprus resident is a citizen of the United States.