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（七） ARTICLE 21 Other Income 　　This Article provides the rules for the taxation of items of income not dealt within the other articles of the Convention. An item of income is "dealt with" in an article when an item in the same category is a subject of the article, whether or not any treaty benefit is granted to that item of income. This Article deals both with classes of income which are not dealt with elsewhere, such as, for example, lottery winnings, and with income of the same class as income dealt within another article of the Convention, but from sources in third States, and, therefore, not a subject of the other Article, if that article deals only with items of that class of income from sources within a Contracting State. Paragraph 1 contains the general rule that such items of income derived by a resident of a Contracting State will be taxable only in the State of residence. 　　This exclusive right of taxation applies irrespective of whether the residence State exercises its right to tax the income covered by the Article. 　　Paragraph 2 contains an exception to the general rule of paragraph 1 for income, other than income from real property, which is attributable to a permanent establishment or fixed base maintained in a Contracting State by a resident of the other Contracting State. The taxation of such income is governed by the provisions of Articles 7 (Business Profits) and 14 (Independent Personal Services). Thus, in general, third-country income which is attributable to a permanent establishment maintained in the United States by a resident of Germany would be taxable by the United States. There is an exception to this rule for income from real property, as defined in paragraph 2 of Article 6 (Income from Immovable (Real) Property). If a German resident derives income from real property located outside the United States which is attributable to the resident's permanent establishment or fixed base in the United States, only Germany and not the United States may tax that income. This special rule for foreign situs real property is consistent with the general rule, also reflected in Articles 6 (Income from Immovable (Real) Property) and 22 (Capital), that only the situs and residence States may tax real property and real property income; Even if such property is part of the property of a permanent establishment or fixed base in a Contracting State, that State may not tax if neither the situs of the property nor the residence of the owner is in that State. 　　Paragraph 19 of the Protocol relates to paragraph 2 of the Article. It provides a special rule for the case where a German corporation pays a dividend to a resident of Germany and the dividend is attributable to a permanent establishment or fixed base which the resident maintains in the United States. This dividend is an item of income which is not dealt within Article 10 (Dividends), because Article 10, by its terms, applies to dividends paid by a resident of one Contracting State to a resident of the other. In the case dealt within Paragraph 19, Germany will treat the dividend as if it were paid to a resident of the United States, i.e., it may impose tax, but must limit its tax to the rates provided for in paragraphs 2 and 3 of Article 10 (Dividends). The United States may tax the dividend as income attributable to the permanent establishment or fixed base, but must give credit in accordance with tile provisions of Article 23 (Relief from Double Taxation). 　　This Article is subject to the saving clause of subparagraph (a) of Paragraph 1 of the Protocol. Thus, the United States may tax the income of a German resident not dealt with elsewhere in the Convention, if that German resident is a citizen of the United States. ARTICLE 22 Capital 　　This Article specifies the circumstances in which a Contracting State may impose tax on capital owned by a resident of the other Contracting State. Since the United States does not impose taxes on capital, tile only capital taxes covered by the Convention are those imposed by Germany. Thus, although the Article is drafted in a reciprocal manner, its provisions are relevant only for the imposition of German tax. The explanation which follows will be from the perspective of Germany as the taxing State. The Article was included at Germany's request. It provides essentially the same rules as Article XIV A of the 1954 Convention. 　　The Article provides the general rule in paragraph 4 that capital owned by a resident of a Contracting State may be taxed only by that Contracting State. Thus, in general, Germany cannot tax a resident of the United States on capital owned by that resident. Exceptions to this general rule are provided in paragraphs 1, 2 and 3. 　　Paragraph 1 provides that capital represented by real property (as defined in Article 6 (Income from Immovable (Real) Property)) which is owned by a U.S. resident and located in Germany may be taxed by Germany. Under paragraph 2, capital which is represented by movable property which is part of the business property of a permanent establishment maintained by a U.S. resident in Germany or pertains to a fixed base maintained in Germany by a U.S. resident may be taxed by Germany. 　　Paragraph 3 deals with capital represented by ships, aircraft or containers operated in international traffic by an enterprise of the United States and with other movable property pertaining to the operation of such ships, aircraft or containers. Under the paragraph, such capital is taxable only in the Contracting State where the income of the U.S. enterprise owning such capital is taxable under the provisions of Article 8 (Shipping and Air Transport). Since a U.S. shipping, airline or container enterprise operating in international traffic is exempt from German income tax, such capital is also exempt from capital tax in Germany. ARTICLE 23 Relief from Double Taxation 　　This Article describes the manner in which each Contracting State undertakes to relieve double taxation. The United States uses the foreign tax credit method exclusively. Germany uses a combination of foreign tax credit and exemption methods, depending on the nature of the income involved. 　　In paragraph 1, the United States agrees to allow to its citizens and residents a credit against U.S. tax for income taxes paid or accrued to Germany. The credit under the Convention is 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 this Article, i.e., 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. 　　Paragraph 1 also 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 German corporation in which the U.S. corporation owns at least 10 percent of the voting shares. This credit is for the tax paid by the German corporation on the earnings out of which the dividends are considered paid. 　　As indicated, the U.S. credit under the Convention is subject to the limitations of U.S.law, which generally limit the credit against U.S. tax 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)). Nothing in the Convention prevents the limitation of the U.S. credit from being applied on a per-country or overall basis or on some variation thereof. In general, where source rules are provided in the Convention for purposes of determining the taxing rights of the Contracting States, these are consistent with the Code source rules for foreign tax credit and other purposes. Where, however, there is an inconsistency between Convention and Code source rules, the Code source rules (e.g., Code section 904(g)) will be used to determine the limits for the allowance of a credit under the Convention. (Paragraph 3 of the Article provides an exception to this general rule with respect to certain U.S. source income of U.S. citizens resident in Germany.) 　　Paragraph 1 also provides that the German income taxes specified in subparagraph 1(b) and paragraph 2 of Article 2 (Taxes Covered) are to be treated as income taxes for purposes of allowing a credit under the Convention. It is not U.S. policy to allow credit by treaty for taxes which are not creditable under the Code, and it was the understanding of the negotiators that each of the German income taxes specified in Article 2 for which credit is allowed under Article 23 are creditable taxes under the Code. If, however, it should prove that a credit is being allowed under the Convention for a German tax which is not a creditable income tax under the Code, paragraph I specifies that such credits shall be allowed only on a per-country basis, to the extent of U.S. tax, i.e., only on net German source income within the relevant foreign tax credit limitation category under Code section 904(a). 　　Paragraph 20 of the Protocol relates to paragraph 1 of Article 23. It elaborates on certain aspects of the U.S. credit under the Convention, describing the relationship between the Code and Convention credit and source rules. All of the issues dealt within Paragraph 20 of the Protocol have been discussed above in this explanation. 　　Paragraph 2 of the Article provides the rules by which Germany, in imposing tax on its residents, provides relief for U.S. taxes paid by those residents. Subparagraph 2(a) specifies the general rule that (except in cases where a foreign tax credit is provided for under the provisions of subparagraph 2(b)) in imposing tax on its residents, Germany will exempt from German tax any item of income from U.S. sources or capital situated in the United States which may be taxed in the United States in accordance with the Convention. Germany may compute the exemption with progression. That is, in determining the rate of tax applicable under a progressive rate structure to the income or capital which is not exempt, Germany may take the exempt income or capital into account. The principal types of U.S. source income covered in this subparagraph, for which exemption is allowed, are 　　(1) income derived by a German enterprise which is attributable to a permanent establishment in the United States, 　　(2) many kinds of capital gains, 　　(3) most classes of personal services income, and, 　　(4) as described below, dividends from direct investments in the United States. 　　Paragraph 3 of Article 23 provides special rules for the tax treatment of U.S. citizens resident in Germany. These rules are narrower, with respect to the scope of Germany's double taxation relief obligations to such persons, than the provisions of subparagraph (l)(b)(2) of Article XV of the 1954 Convention. It is understood that the exemption under ubparagraph 2(a)does not apply to items of income which may be taxed in the United States by solely reason only of Paragraph 1 of the Protocol (i.e., the saving clause). 　　Subparagraph 2(a) specifies which dividends received by German residents from U.S. sources are subject to the exemption provisions of the subparagraph. Only those dividends paid by a U.S. company to a German company which owns at least 10 percent of the voting shares of the paying company are exempt. The subparagraph clarifies that exempt dividends are those which are distributions of profits on corporate rights which are subject to tax in the United States. It also clarifies that the recipient company cannot be a partnership. Furthermore, the subparagraph specifies that, notwithstanding the general rule described above, dividends paid by a U.S. Regulated Investment Company ("RIC"), or other U.S. corporate distributions where the distribution itself is deductible in calculating the profits for tax purposes of the paying company (e.g., dividends from Real Estate Investment Trusts), are not exempt from German tax. An exchange of notes between competent authorities, subsequent to the signing of the treaty, but before its ratification, clarifies that the intent of the negotiators was as stated in the preceding sentence. When the treaty speaks of "distributions of amounts that have been deducted when calculating for United States tax purposes the profits of the company distributing them", the reference is to a dividends paid deduction, not to a dividends received deduction. For purposes of German capital tax, the exemption rules follow those for the exemption of dividends from income tax. Thus, German capital tax will not be imposed on any shareholding if any dividends which night arise from such shareholding would be exempt under the provisions of this subparagraph. 　　Subparagraph 2(b), which contains the exceptions to the general exemption rule of subparagraph 2(a), indicates those items of U.S. source income, which have been taxed in the United States in accordance with the provisions of U.S. law and the Convention, for which Germany will provide a foreign tax credit rather than exemption. Any income which is taxed in the United States in accordance with the Convention is deemed, for purposes of the German foreign tax credit (as well as for purposes of the exemption under subparagraph 2(a)), to be from U.S. sources. As with the U.S. credit under paragraph 1, the foreign tax credit granted by Germany under the Convention is subject to the provisions of German law regarding a credit for foreign taxes. 　　The items of income in respect of which a credit for U.S. tax is allowed under subparagraph 2(b) are specified in sub-sub-paragraphs as follows: 　　(aa) those U.S. source dividends, as defined in Article 10 (Dividends), for which exemption is not granted under subparagraph a) (e.g., portfolio dividends, RIC dividends and similar deductible or pass-through entity dividends); 　　(bb) gains from the alienation of immovable property described in subparagraph 2(b) of Article 13 (Gains), other than an interest in a real estate partnership (i.e., the types of assets, other than real property itself, which constitute a "U.S. real property interest", as the term is used in the Code); 　　(cc) directors' fees to which Article 16 (Directors' Fees) applies, received by German residents in respect of their services as directors of U.S. corporations; 　　(dd) income to which Article 17 (Artistes and Athletes) applies, including both the compensation of the artiste or athlete himself, dealt within paragraph 1 of Article 17, and any income, to which paragraph 2 of Article 17 applies, earned by persons　providing the services of artistes and athletes; 　　(ee) salaries and similar compensation, and pensions paid by the United States Government or by its states or political subdivisions, as described in subparagraph 1a) of Article 19 (Government Service; Social Security), when paid to a German national; 　　(ff) 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); and 　　(gg) income to which Paragraph 21 of the Protocol applies, as described below. In the absence of the rule in sub-subparagraph (ff), such income would be fully taxable in Germany with no credit for U.S. tax. This sub-subparagraph provides for a German foreign tax credit in cases where the United States taxes solely by virtue of the Limitation on Benefits provisions. 　　Paragraph 21 of the Protocol elaborates on paragraph 2 of the Article by specifying circumstances in which Germany may apply a foreign tax credit with respect to an item of U.S. source income, notwithstanding the fact that the provisions of subparagraph 2(a) of Article 23 provide for exemption for such item of income. The change from exemption to credit provided by this Paragraph of the Protocol is designed to prevent unintended instances either of double taxation (sub-subparagraph (a)(aa)) or of double non-taxation or inappropriately low taxation (sub-subparagraph (a)(bb)). 　　Subparagraph (a) of Paragraph 21 of the Protocol deals with a circumstance in which an item of income or capital is either considered to fall under one provision of the Convention in Germany and under another in the United States or attributed to one person in the United States and to a different person in Germany (other than cases where this different attribution arises under Article 9 (Associated Enterprises) of the Convention). This role of the Protocol would apply only in cases where such conflict cannot be resolved through competent authority procedures under Article 25 (Mutual Agreement Procedure). An item of income would be considered as falling under different provisions of the Convention, for example, if interest paid by a U.S. partnership to a German corporate partner on a loan from the partner to the partnership were in the first instance characterized for U.S. purposes as exempt interest under Article 11 (Interest) of the Convention, and for German purposes as business profits attributable to a U.S. permanent establishment, exempt from German tax under subparagraph 2(a) of Article 23 of the Convention. In this example, the application of different provisions of the Convention to the same item of income would result in an inappropriate double exemption from both U.S. and German tax, subparagraph (a) of Paragraph 21 of the Protocol would permit Germany to switch over from an exemption to a credit mechanism for relieving double taxation. In effect, the switch over would permit Germany to tax the interest income in the German corporate partner's hands notwithstanding the general rule of subparagraph 2(a) of Article 23. 　　An example of attribution of an item of income to different persons would be the following: German resident A makes a loan to a U.S. resident, but German resident B is the usufructuary, i.e., he has the right to use the "fruit" of the loan, that is, the interest. B uses the interest income in connection with his permanent establishment in the United States. The United States would recognize A as the beneficial owner of the income, and would treat the interest as an exempt payment of U.S. source interest to a German resident under Article 11 (Interest).Germany would recognize B as the beneficial owner of the income and would treat the interest as attributable to B's permanent establishment in the United States. As such, the income would be exempt from German tax under subparagraph 2(a) of Article 23 (Relief from Double Taxation). Thus would be an inappropriate double exemption, and Germany could, under subparagraph (a) of Paragraph 21 of the Protocol, switch from exemption to credit. 　　Under subparagraph (b) of Paragraph 21 of the Protocol, Germany may, to the extent consistent with internal German law and after consultation with the U.S. competent authority, switch from an exemption to a credit for a particular item or items of income not covered under subparagraph (a) if it considers such a switch necessary to prevent double exemption or other arrangements for improper use of the Convention. The United States must be notified through diplomatic channels of any change in double taxation relief in Germany made pursuant to this subparagraph. If there is a notification under subparagraph (b), the United States may characterize the income which was subject to the notification in a manner consistent with the characterization by Germany. The United States must notify Germany through diplomatic channels if there is such a change in characterization. 　　Subparagraph (b) was intended to deal with circumstances similar, for example, to those which arose under the 1954 Convention in connection with the treatment of dividends paid by U.S. Regulated Investment Companies ("RIC"s) to 10 percent or more German corporate shareholders in the RIC. Under that Convention, what was essentially portfolio interest could be transformed into direct investment dividends in the hands of such shareholders without the payment, directly or indirectly, of any corporate level U.S. tax by having the RIC hold the debt instrument. Dividends paid by the RIC were exempt from German tax as direct investment dividends, although as portfolio interest such amounts would have been taxable in Germany with a foreign tax credit. For U.S. tax purposes, the RIC was generally entitled to a dividend paid deduction. Had there been a differential rate of withholding tax for direct and portfolio dividends in the 1954 Convention (as in this Convention), the dividend would also have received the benefit of lower source country withholding, although the corporation paying the dividend was not subject to the generally applicable U.S. tax regime for corporations (i.e., it was entitled to a dividends paid deduction with respect to amounts distributed, regardless of whether such amounts had been previously subject to U.S. tax). Although this was identified and corrected in the Convention, the negotiators thought it wise to provide for the resolution of similar, though unforeseen, circumstances which might arise in the future. Subparagraph (b) would have permitted Germany to give a foreign tax credit rather than exempt the dividend and the United States to respond by taxing the dividends at the portfolio dividend withholding rate. 　　Diplomatic notes have been exchanged pursuant to the provisions of subparagraph (b) of Paragraph 21 of the Protocol to clarify that RIC and REIT dividends will be subject to credit and not exemption in Germany. A possible reading of paragraph 2 of Article 23 of the Convention might lead to the opposite conclusion. Although the negotiators did not believe that such an interpretation would be correct, the conclusion was reached that it would be prudent to exercise the authority of subparagraph (b) of Paragraph 21 to assure the correct result. 　　It should be emphasized that subparagraph (b) was 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 other 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. 　　Any changes in treatment or characterization which may be made pursuant to subparagraph (b) 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 other Contracting State and only when any legal prerequisites for the change in the domestic law of the Contracting State giving the notification have been fulfilled. The change in the method of double taxation relief in Germany and any change in characterization in the United States in response need not be effective in the same year. 　　Paragraph 3 of the Article modifies the rules in paragraphs 1 and 2 for certain types of income derived from U.S. sources by U.S. citizens who are resident in Germany. Since U.S. citizens 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 Germany will often exceed the U.S. tax allowable under the Convention on an item of U.S. source income derived by a resident of Germany who is not a U.S. citizen. 　　Subparagraph (a) of paragraph 3 provides special German credit rules with respect to items of income for which Germany allows a foreign tax credit rather than an exemption under paragraph 2 and which are either exempt from U.S. tax or subject to reduced rates of U.S. tax when received by German residents who are not U.S. citizens. The German foreign tax credit allowed under these circumstances, to the extent consistent with German law, need not exceed the U.S. tax which may be imposed under the provisions of 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 1 of the Protocol. Thus, for example, if a U.S. citizen resident in Germany receives U.S. source dividends, the German foreign tax credit would be limited to 15 percent of the dividend, the U.S. tax which 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 3(b) and 3(c)) to a U.S. rate of tax of 28 percent because of his U.S. citizenship under Paragraph 1 of the Protocol. 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 3(b) deals with the potential for double taxation which can arise as a result of the absence of a full German foreign tax credit, because of subparagraph 3(a), for the U.S. tax imposed on its citizens resident in Germany. The subparagraph provides that the United States will credit the German income tax paid, after allowance of the credit provided for in subparagraph 3(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 3(a). Since the income which is dealt within this paragraph is 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 3(c), which deems the items of income referred to in subparagraph 3(a) to be from German sources to the extent necessary to avoid double taxation under subparagraph 3(b). 　　Two examples will illustrate the application of paragraph 3 in the case of a U.S. source dividend received by a U.S. citizen resident in Germany. In both examples, the U.S. rate of tax on the German resident under Article 10 (Dividends) of the Convention is 15 percent. This is the tax which Germany must credit under subparagraph 3(a). Also in both examples the U.S. income tax rate on the U.S. citizen is 28 percent. In example I the German income tax rate on its resident (the U.S. citizen) is 25 percent, and in example II the German rate on its resident is 35 percent. Subparagraph 3(a) Example I Example II U.S. dividend declared 100.00 100.00 Notional U.S. withholding tax per Article10 15.00 15.00 German taxable income 100.00 100.00 German tax before credit 25.00 35.00 German foreign tax credit 15.00 15.00 Net German tax after credit 10.00 20.00 Subparagraph 3(b) and 3(c) U.S. Income of U.S. citizen before tax 100.00 100.00 U.S. citizenship tax before credit 28.00 28.00 Notional U.S. withholding tax per Article10 15.00 15.00 U.S. tax available for credit 13.00 13.00 Income resourced from U.S. to Germany 46.43 46.43 U.S. tax on resourced German income 13.00 13.00 U.S. credit for German tax 10.00 13.00 Subparagraph 3(a) Net U.S. tax after credit 3.00 0.00 　　In both examples, in the application of subparagraph 3(a) Germany credits a 15 percent U.S. tax against its residence tax on the U.S. citizen. In example I the net German tax after foreign tax credit is 10.00; in the second example it is 20.00. In the application of subparagraphs 3(b) and 3(c), from the U.S. tax due before credit of 28.00, the United States subtracts the amount of the U.S. source tax of 15.00, against which no foreign tax credit is to be allowed. This assures that, at a minimum, the United States will collect the tax which it is due under the Convention as the source country. This leaves, in both examples, an amount of U.S. tax against which credit for German tax may be claimed of 13.00. Initially, all of the income in these examples was U.S. source. In order for a U.S. credit to be allowed against 13.00 of U.S. tax on this income, the amount of income which, at a tax rate of 28 percent, generates a tax of 13.00 must be resourced as German source. Thus, 46.43 of income (13.00 divided by .28) is resourced.In example I, the German tax was 10.00. When this is credited against the U.S. tax on resourced German income, there is a net U.S. tax of 3.00 due after credit. In example II, the German tax was 20.00, but, because of the resourcing, only 13.00 is eligible for credit, since, under subparagraph 3(c), the amount of resourcing is limited to that necessary to avoid double taxation. Thus, even though the German tax was 20.00 and the U.S. tax available for credit was 13.00, there is no excess credit available for carryover. 　　Paragraph 4 provides that when a German company makes a distribution out of income derived from U.S. sources, Germany may, if appropriate in accordance with German law, impose a compensatory corporate tax on the distribution. Under German law, a German resident individual shareholder is entitled to a credit against his individual income tax for the 36 percent corporate tax imposed with respect to profits distributed to him as a dividend by a German corporation. If the profits out of which the dividend is paid have not borne a full 36 percent German tax, because, for example, of double taxation relief, Germany imposes a compensatory tax on the corporation at the time of distribution to fund the 36 percent credit at the shareholder level. This paragraph preserves Germany's right to impose this tax even when German tax on the underlying income at the corporate level has been reduced below 36 percent by a foreign tax credit for U.S. tax. 　　This Article is not subject to the saving clause of subparagraph (a) of Paragraph 1 of the Protocol. 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.