TREASURY DEPARTMENT TECHNICAL EXPLANATION OF THE CONVENTION AND PROTOCOL 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（三） ARTICLE 6 Income from Immovable (Real) Property 　　Paragraph 1 provides that income of a resident of a Contracting State derived from real property situated in the other Contracting State may be taxed in the Contracting State in which the property is situated. The paragraph specifies that income from real property includes income from agriculture and forestry. This Article does not grant an exclusive taxing right to the situs State, but merely grants it the primary right to tax. The Article does not impose any limitation in terms of rate or form of tax on the situs State. As clarified in paragraph 3, the income referred to in paragraph 1 means income from any use of real property, including, but not limited to, income from direct use by the owner and rental income from the letting of real property. 　Paragraph 2 defines the term "immovable property", which, as is made clear by the use of the term "real" in the title to the Article and in paragraph 1, is to be understood, for U.S. purposes, to have the same meaning as the term "real property" in the United States. The term is to have the same meaning that it has under the law of the situs country. In addition, the paragraph specifies certain classes of property which, regardless of internal law definitions, are to be included within the meaning of the term for purposes of the Convention. 　　Paragraph 4 specifies that the basic rule of paragraph 1 (as elaborated in paragraph 3) applies to income from real property of an enterprise and to income from real property used for the performance of independent personal services. This clarifies that the situs country may tax the real property income of a resident of the other Contracting State in the absence of a permanent establishment or fixed base in the situs State, notwithstanding the requirements of Articles 7 (Business Profits) and 14 (Independent Personal Services) that in order to be taxable, income must be attributable to a permanent establishment or fixed base, respectively. 　　The provision in the U.S. Model for a binding election by the taxpayer to be taxed on real property income on a net basis was not included in the Convention. Both Contracting States provide for net basis taxation of such income under internal law, and, therefore, an election provision is not needed. ARTICLE 7 Business Profits 　　This Article provides the rules for the taxation by a Contracting State of the business profits of an enterprise of the other Contracting State. The general rule is found in paragraph 1, that business profits (as defined in paragraph 7) of an enterprise of one Contracting State may not be taxed by the other Contracting State unless the enterprise carries on business in that other Contracting State through a permanent establishment (as defined in Article 5 (Permanent Establishment)) situated there. Where that condition is met, the State in which the permanent establishment exists may tax the income of the enterprise, but only so much of the income as is attributable to the permanent establishment. This differs from the comparable rule in the 1954 Convention, which contained a limited force of attraction rule. That rule permitted the State in which the permanent establishment is located to tax income of the enterprise even if not attributable to the permanent establishment, if the income is derived from sources in that State from the sale of goods or merchandise of the same kind as that sold through the permanent establishment or from other transactions of the same kind as those effected through the permanent establishment. 　　Paragraph 2 provides rules for the proper attribution of business profits to a permanent establishment. It provides that the Contracting States will attribute to a permanent establishment the profits which it would have earned had it been an independent entity, engaged in the same or similar activities under the same or similar circumstances. The computation of the business profits attributable to a permanent establishment under this paragraph is subject to the rules of paragraph 3 for the allowance of expenses incurred for the purposes of earning the income. The profits attributable to a permanent establishment may be from sources within or without a Contracting State. Thus, certain items of foreign source income described in section 864(c)(4)(B) of the Code may be attributed to a U.S. permanent establishment of a German enterprise and subject to tax in the United States. The concept of "attributable to" in the Convention is narrower than the concept of "effectively connected" in section 864(c) of the Code. The limited "force of attraction" rule in Code section 864(c)(3), therefore, is not applicable under the Convention. 　　Paragraph 4 of the Protocol elaborates on paragraphs 1 and 2 of Article 7, and on paragraph 3 of Article 13 (Gains). This Protocol paragraph incorporates the rule of Code section 864(c)(6) into the Convention. Like the Code section on which it is based, Paragraph 4 of the Protocol provides that any income or gain attributable to a permanent establishment (or, in the context of Article 13, a fixed base as well) during its existence is taxable in the Contracting State where the permanent establishment (or fixed base) is situated even if the payments are deferred until after the permanent establishment (or fixed base) no longer exists. The Protocol provision goes beyond the Code section on which it is based by clarifying that expenses attributable to the permanent establishment (or fixed base) during its existence may be deducted from the deferred income at such time as that income is subject to tax. 　　Paragraph 5 of the Protocol incorporates into Articles 7 and 13 of the Convention a rule similar to that of Code section 864(c)(7). Under the Code rule, if an asset which had been part of the business property of a U.S. trade or business (or, in a treaty context, of a permanent e stablishment or fixed base in the United States) is alienated within ten years of its removal from the U.S. trade or business (or permanent establishment/fixed base), the gain realized on such alienation is subject to U.S. tax. Under Paragraph 5 of the Protocol, a right of the Contracting State in which the permanent establishment (or fixed base) exists or existed to tax such gains is confirmed, but the taxable gain is limited to that portion which accrued during the time that the asset formed part of the business property of the permanent establishment (or fixed base). The tax may be imposed under the Convention if the alienation occurs within ten years of the date on which the property ceased to be part of the business property of the permanent establishment (or fixed base). If, however, the laws of either Contracting State provide for a look-back period shorter than ten years, that shorter period will al)ply with respect to the tax of both Contracting States under the Convention. This rule in Paragraph 5 of the Protocol combines certain features of the laws of both the United States and Germany. It limits German law by imposing the ten year limit of U.S. law on either Contracting State's right to tax such gains, and it restricts U.S. law by limiting the taxable gain, as under German law, to the gain which accrued while the property formed part of the business property of the permanent establishment (or fixed base). 　　Paragraph 3 provides that in determining the business profits of a permanent establishment, deductions shall be allowed for expenses incurred for the purposes of the permanent establishment. Deductions are to be allowed regardless of where the expenses are incurred. The paragraph specifies that among the expenses referred to which are incurred for the purposes of the permanent establishment are expenses for research and development, interest and other similar expenses. Also included is a reasonable amount of executive and general administrative expenses. The language of this paragraph differs in minor respect from that in the U.S. Model. The U.S. Model refers to a "reasonable allocation" of the enumerated expenses; this paragraph in the Convention omits this reference. During the negotiations, the German delegation observed that the U.S. Model language seems to require both Contracting States to apply the sorts of expense allocations that are found in U.S. law, as, for example, in regulation sections 1.861-8 and 1.882-5. Leaving out the reference to "reasonable allocation" is understood to make clear that each State may use its own rules, whether tracing or allocation rules, for attributing expenses to a permanent establishment. 　　Paragraph 6 of the Protocol refers to paragraph 3 of Article 7 of the Convention. The Protocol Paragraph provides that the competent authorities may by mutual agreement determine common procedures for allocating expenses to a permanent establishment which may differ from the procedures used under the laws of the Contracting States. The language of this Paragraph of the Protocol reinforces the point made in the preceding paragraph of this explanation, that (in the absence of a mutual agreement to the contrary) the Contracting States may under the Convention use their own internal law rules for determining the expenses which are to be allowed as deductions in calculating the income of a permanent establishment. 　　Paragraph 4 provides that no business profits will be attributed to a permanent establishment merely because it purchases goods or merchandise for the enterprise of which it is a permanent establishment. This rule refers to a permanent establishment which performs more than one function for the enterprise, including purchasing. For example, the permanent establishment may purchase raw materials for the enterprise's manufacturing operation and sell the manufactured output, while business profits may be attributable to the permanent establishment with respect to its sales activities, no profits are attributable with respect to its purchasing activities. If the sole activity were the purchasing of goods or merchandise for the enterprise the issue of the attribution of income would not arise, because, under subparagraph 4(d) of Article 5 (Permanent Establishment), there would be no permanent establishment. 　　Paragraph 5 states that the business profits attributed to a permanent establishment are only those derived from its assets or activities. This clarifies the fact, as noted in connection with paragraph 2 of the Article, that the Code concept of effective connection, with its limited "force of attraction", is not incorporated into the Convention. 　　Paragraph 6 explains the relationship between the provisions of Article 7 and other provisions of the Convention. Under paragraph 6, where business profits include items of income that are dealt with separately under other articles of the Convention, the provisions of those articles will, except where they specifically provide to the contrary, take precedence over the provisions of Article 7. Thus, for example, the taxation of interest will be determined by the rules of Article 11 (Interest), and not by Article 7, except where, as provided in paragraph 3 of Article 11, the interest is attributable to a permanent establishment, in which case the provisions of Article 7 apply. 　　Paragraph 7 specifies that the term "business profits" as used in the Convention includes two classes of income which, in some countries, are subject to gross basis taxation at source and in the OECD Model Convention are treated as royalties under Article 12. These are income from the rental of tangible personal property and income from the rental or licensing of motion picture films or works on film, tape or other means of reproduction for use in radio or television broadcasting. The inclusion of these classes of income in business profits means that such income earned by a resident of a Contracting State can be taxed by the other Contracting State only if the income is attributable to a permanent establishment maintained by the resident in that other State, and, if the income is taxable, it can be taxed only on a net basis. The comparable provision in the U.S. Model also provides a general definition which says that the term "business profits" means income derived from any trade or business. The absence of this definition from the Convention does not indicate any difference in the meaning to be attributed to the term. 　　This Article is subject to the saving clause of subparagraph (a) of Paragraph 1 of the Protocol. Thus, if, for example, a citizen of the United States who is a resident of Germany derives business profits from the United States which are not attributable to a permanent establishment in the United States, the United States may, subject to the special foreign tax credit rules of paragraph 3 of Article 23 (Relief from Double Taxation), tax those profits as part of the worldwide income of the citizen, notwithstanding the provisions of this Article under which such income derived by a resident of Germany is exempt from U.S. tax. ARTICLE 8 Shipping and Air Transport 　　This Article provides the rules which govern the taxation of profits from the operation of ships and aircraft in international traffic. The term "international traffic" is defined in subparagraph 1(g) of Article 3 (General Definitions). Paragraph 1 provides that profits derived by an enterprise of a Contracting State from the operation in international traffic of ships or aircraft shall be taxable only in that Contracting State. By virtue of paragraph 6 of Article 7 (Business Profits), profits of an enterprise of a Contracting State that are exempt in the other Contracting State under this paragraph remain exempt even if the enterprise has a permanent establishment in that other Contracting State. 　　Income of an enterprise of a Contracting State from the rental of ships or aircraft on a full basis (i.e., with crew) is considered to be income from the operation of ships and aircraft and is, therefore, exempt from tax in the other Contracting State under paragraph 1. Unlike the U.S. Model, income from bareboat rentals of ships or aircraft is not included within the definition of profits from the operation of ships or aircraft in international traffic in the Convention. Such income is treated, consistent with paragraph 7 of Article 7 (Business Profits), as business profits. Only the rental income that is attributable to a permanent establishment which the lessor, a resident of one Contracting State, has in the other Contracting State can be taxed in that other State. It is understood that if, for example, a bank is a resident of one Contracting State and has a permanent establishment in the other Contracting State, and that bank leases an aircraft to an airline in the other Contracting State, if the permanent establishment was not involved in negotiating or concluding the lease agreement, the rental income will not be attributable to the permanent establishment and, therefore, will not be subject to tax by that other State. 　　Paragraph 2 provides that the profits of an enterprise of a Contracting State from the use or rental of containers (including equipment for their transport) which are used for the transport of goods in international traffic will be exempt from tax in the other Contracting State. This result obtains regardless of whether the recipient of the income is engaged in the operation of ships or aircraft in international traffic, and regardless of whether the enterprise has a permanent establishment in the other Contracting State. The comparable provision in the U.S. Model (Article 8, paragraph 3) speaks of profits from the "use, maintenance, or rental of containers". The absence of the word "maintenance" in the Convention is not intended to lead to a different result. The word was deleted at the request of the German delegation to avoid giving the mistaken impression that income derived from a business of providing maintenance services for containers owned and used by other enterprises would be exempt from tax. It is understood, however, that if a shipping company or container leasing company which is a resident of one Contracting State operates a facility for maintaining its own containers in the other Contracting State, the company will be exempt from tax in that other Contracting State even if the facility constitutes a permanent establishment. The shipping and air transport provisions of the 1954 Convention do not deal with income from the use or rental of containers. Such income, therefore, is treated under that Convention as royalty income or business profits, depending upon the circumstances. 　　Paragraph 3 clarifies that the provisions of the preceding paragraphs apply equally to profits derived by an enterprise of a Contracting State from participation in a pool, joint business or international operating agency. As with any benefit of the Convention, the enterprise claiming the benefit must be entitled to the benefit under the provisions of Article 28 (Limitation on Benefits). 　　The taxation of gains from the alienation of ships, aircraft or containers is not dealt within this Article, but in paragraph 4 of Article 13 (Gains). 　　This Article is subject to the saving clause of subparagraph (a) of Paragraph 1 of the Protocol. The United States, therefore, may, subject to the special foreign tax credit rules of paragraph 3 of Article 23 (Relief from Double Taxation), tax the shipping or air transport profits　of a resident of Germany if that German resident is a citizen of the United States. 　　　　　　　　　　　　　　　ARTICLE 9 　　　　　　　　　　　　　Associated Enterprises 　　This Article incorporates into the Convention the general principles of section 482 of the Code. It provides that when 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 to reflect what the income or tax of these persons with respect to such transactions would have been had there been an arm's length relationship between the persons. 　　Paragraph 1 deals with the circumstance where an enterprise of a Contracting State is related to an enterprise of the other Contracting State, and those related persons make arrangements or impose conditions between themselves in their commercial or financial relations which are different from those that would be made between independent persons. Paragraph 1 provides that, under those circumstances, the Contracting States may adjust the income (or loss) of the enterprise to reflect the income which would have been taken into account in the absence of such a relationship. The paragraph specifies what the term "related persons" means in this context. An enterprise of one Contracting State is related to an enterprise of the other Contracting State if either participates directly or indirectly in the management, control, or capital of the other. The two enterprises are also related if any third person or persons participate directly or indirectly in the management, control, or capital of both. The term "control" includes any kind of control, whether or not legally enforceable and however exercised or exercisable. 　　Paragraph 2 provides that where a Contracting State has made an adjustment that is consistent with the provisions of paragraph 1, and the other Contracting State agrees that the adjustment was appropriate to reflect arm's length conditions, that other Contracting State is obligated to make a corresponding adjustment to the tax liability of the related person in that other Contracting State. The Contracting State making such an adjustment will take the other provisions of the Convention, where relevant, into account. For example, if the effect of a correlative adjustment is to treat a German corporation as having made a distribution of profits to its U.S. parent corporation, the provisions of Article 10 (Dividends) will apply, and Germany may impose a 5 percent withholding tax on the dividend. The competent authorities are authorized, if necessary, to consult to resolve any differences in the application of these provisions. For example, there may be a disagreement over whether an adjustment made by a Contracting State under paragraph 1 was appropriate. 　　If a correlative adjustment is made under paragraph 2, it is to be implemented, pursuant to paragraph 2 of Article 25 (Mutual Agreement Procedure), notwithstanding any time limits or other procedural limitations in the law of the Contracting State making the adjustment. The saving clause of subparagraph (a) of Paragraph 1 of the Protocol does not apply to paragraph 2 of Article 9 (see the exceptions to the saving clause in sub-subparagraph (b)(aa) of Paragraph 1 of the Protocol). Thus, even if the statute of limitations has run, or there is a closing agreement between the Internal Revenue Service and the taxpayer, a refund of tax can be made in order to implement a correlative adjustment. Statutory or procedural limitations, however, cannot be overridden to impose additional tax, because, under subparagraph (c) of Paragraph 1 of the Protocol, the Convention cannot restrict any statutory benefit. 　　Paragraph 7 of the Protocol relates to Article 9 of the Convention. It has the same purpose as paragraph 3 of Article 9 of the U.S. Model. That paragraph of the U.S. Model is not in the Convention. The paragraph preserves the rights of the Contracting States to apply internal law provisions relating to adjustments between related parties. Such adjustments - the distribution, apportionment, or allocation of income, deductions, credits or allowances - are permitted even if they are different from, or go beyond, those authorized by paragraph 1 of the Article, so long as they accord with the general principles of paragraph 1, i.e., that the adjustment reflects what would have transpired had the related parties been acting at arm's length. Paragraph 7 of the Protocol also makes clear that Article 9 does not limit the rights of the Contracting States to allocate income between related persons in cases where the relationship is different from that described in paragraph 1 of the Article. This rule would apply, for example, if a commercial or contractual relationship results in the ability of one party to exercise a controlling influence over another. Any adjustments made pursuant to this provision of the Protocol must accord with the general principles of paragraph 1 of Article 9. 　　It is understood that the "commensurate with income" standard for determining appropriate transfer prices for intangibles, added to Code section 482 by the Tax Reform Act of 1986, was designed to operate in such a way that it does not represent a departure in U.S. practice or policy from the arm's length standard. It merely suggests alternative approaches, beyond those spelled out in current regulations, for achieving appropriate transfer prices. It is anticipated, therefore, that the application of this standard by the Internal Revenue Service will be in accordance with the general principles of paragraph 1 of Article 9 of the Convention, and of Paragraph 7 of the Protocol.