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（十） Example VI Facts: 　　A German corporation, a French corporation and a Belgian corporation create a joint venture in the form of a German resident corporation in which they take equal shareholdings. The joint venture corporation engages in an active manufacturing business in Germany. Income derived from that business that is retained as working capital is invested in U.S. Government securities and other U.S. debt instruments until needed for use in the business. Is interest paid on these instruments eligible for U.S.- German treaty benefits? Analysis: 　　The interest would be eligible for treaty benefits. Interest income earned from short-term investment of working capital is incidental to the business in Germany of the German joint venture corporation. 　　Paragraph 2 of Article 28 provides that a resident of a Contracting State that derives income from the other Contracting State and is not entitled to the benefits of the Convention under any of the provisions of paragraph 1, may, nevertheless, be granted benefits at the discretion of the competent authority of the Contracting State in which the income arises. 　　The paragraph itself provides no guidance to competent authorities or taxpayers as to how the discretionary authority is to be exercised. The memorandum of understanding does provide some discussion and guidance. Relevant portions of that memorandum are reproduced in the discussion which follows. 　　It is assumed that, for purposes of implementing paragraph 2, a taxpayer will be permitted to present his case to his competent authority for an advance determination based on the facts, and will not be required to wait until the tax authorities of one of the Contracting States have determined that benefits are denied. In these circumstances, it is also expected that if the competent authority determines that benefits are to be allowed, they will be allowed retroactively to the time of entry into force of the relevant treaty provision or the establishment of the structure in question, whichever is later. 　　In making determinations under paragraph 2, it is understood that the competent authorities will take into account all relevant facts and circumstances. The factual criteria which the competent authorities are expected to take into account include the existence of a clear business purpose for the structure and location of the income earning entity in question; the conduct of an active trade or business (as opposed to a mere investment activity) by such entity; and a valid business nexus between that entity and the activity giving rise to the income. The competent authorities will, furthermore, consider, for example, whether and to what extent a substantial headquarters operation conducted in a Contracting State by employees of a resident of that State contributes to such valid business nexus, and should not, therefore, be treated merely as the "making or managing [of] investments" within the meaning of subparagraph 1(c) of Article 28. 　　The discretionary authority granted to the competent authorities in paragraph 2 is thought to be particularly important in view of the developments in, and objectives of, international economic integration, such as that among the member countries of the European Communities and between the United States and Canada. It is expected that the authority will be exercised with particular cognizance of those factors. 　　The following example illustrates the application of these principles: Facts: 　　German, French and Belgian companies, each of which is engaged directly or through its affiliates in substantial active business operations in its country of residence, decide to cooperate in the development, production and marketing of an advanced passenger aircraft through a corporate joint venture with its statutory seat in Germany. The development, production and marketing aspects of the project are carried out by the individual joint ventures. The joint venture company, which is staffed with a significant number of managerial and financial personnel seconded by the joint ventures, acts as the general headquarters for the joint venture, responsible for the overall management of the project including coordination of the functions separately performed by the individual joint ventures on behalf of the joint venture company, the investment of working capital contributed by the joint ventures and the financing of the project's additional capital requirements through public and private borrowings. The joint venture company derives portfolio investment income from U.S. sources. Is this income eligible for benefits under the U.S.-German treaty? Analysis: 　　If the joint venture corporations' activities constitute an active business and the income is connected to that business, benefits would be allowed under subparagraph 1(c). If not, it is expected that the U.S. competent authority would determine that treaty benefits should be allowed in accordance with paragraph (2) under the facts presented, particularly in view of 　　(1) the clear business purpose for the formation and location of the joint venture company; 　　(2) the significant headquarters functions performed by that company in addition to financial functions; and 　　(3) the fact that all of the joint ventures are corporations resident in EEC member countries in which they are engaged directly or through their affiliates in substantial active business operations. ARTICLE 29 Refund of Withholding Tax 　　This Article establishes rules for the implementation by a Contracting State of reduced withholding at source, as provided in the Convention, on items of income, such as dividends, interest and royalties, derived by a resident of the other Contracting State. Paragraphs 1 through 4 of the Article provide for the imposition of tax at statutory rates and the payment of refunds, upon application, to the extent necessary to reduce the tax payment to the level prescribed in the Convention. Application for refund of tax with respect to an item of income must be made within four years from the end of the calendar year in which the item of income is received. The Contracting State in which the income arises may require certification by the State of residence of the income recipient that the recipient has fulfilled any applicable conditions for unlimited tax liability in that State. 　　The procedures described above will be implemented by competent authority agreement pursuant to Article 25 (Mutual Agreement Procedure). The competent authorities may also establish by mutual agreement other procedures for the implementation of tax benefits provided for in the Convention. 　　This Article was included at the request of Germany. The U.S. Model does not spell out procedures for the implementation of reduced withholding at source. Such procedures, however, including the types of requirements and conditions provided for in Article 29 are considered by the United States to be implicitly authorized by treaties. The United States does not presently intend, on the basis of this Article, to modify its current procedures with respect to U.S. withholding of tax on income payments to residents of Germany. Any changes which may be made in U.S. procedures will be generally applicable under U.S. treaties. ARTICLE 30 Members of Diplomatic Missions and Consular Posts 　　Paragraph 1 provides that any fiscal privileges to which diplomatic or consular officials are entitled under general provisions of international law or under special agreements will apply notwithstanding any provisions to the contrary in the Convention. If, however, because of such privileges, income or capital is not taxed in the receiving State, paragraph 2 grants to the sending State the right to tax the income or capital. 　　Under paragraph 3, an individual who is a member of a diplomatic mission or consular post of a Contracting State, whether situated in the other Contracting State or in a third State, will be deemed to be a resident of the sending State if two conditions are met: 　　(1) in accordance with international law, the individual is not subject to tax in the receiving State in respect of income from sources outside that State or in respect of capital situated outside that State, and 　　(2) the individual is liable to tax in the sending State on worldwide income and capital in the same manner as residents of that State. Residence as determined under this paragraph will apply notwithstanding any result to the contrary from the application to such individual of the rules of Article 4 (Residence). 　　The saving clause of subparagraph (a) of Paragraph I of the Protocol does not apply to override any benefits of this Article available to an individual who is neither a citizen of the United States nor has immigrant status there. 　　Paragraph 4 clarifies that the Convention does not apply to international organizations or to organs or officials of such organizations, or to members of diplomatic missions or consular posts of third States present in a Contracting State if such persons are not liable to the income or capital tax obligations of residents in either Contracting State. ARTICLE 31 Berlin Clause 　　Article 31 provides that the Convention will apply in Land Berlin (i.e., Berlin (West)) so long as the German Government has not notified the Government of the United States to the contrary within three months of the date of entry into force of the Convention. Similar rules applied under the 1954 Convention and the 1965 Protocol thereto. ARTICLE 32 Entry into Force 　　This Article provides the rules for bringing the Convention into force and giving effect to its provisions. Paragraph 1 provides for the ratification of the Convention by both Contracting States and the prompt exchange of instruments of ratification at Washington. 　　Paragraph 2 provides that the Convention will enter into force on the date on which instruments of ratification are exchanged. It further provides the general rules for the effective dates of the provisions of the Convention. Paragraphs 3 through 6 provide exceptions to these general effective date rules for particular classes of income. Under subparagraph 2(a) the Convention will have effect with respect to taxes withheld at source on dividends, interest and royalties, and to excise taxes imposed on insurance premiums, for amounts paid or credited on or after January 1, 1990. For all other income taxes, the Convention will have effect for any taxable year or assessment period beginning on or after January 1, 1990. This does not include income for any fiscal year beginning before January 1, 1990. This latter exception is necessary to assure that the Convention does not apply to a German assessment period which begins after January 1, 1990, but which includes income from a fiscal year which began prior to that date. With respect to taxes on capital, the Convention will have effect for taxes levied on items of capital owned on or after January 1, 1990. 　　Paragraph 3 provides a general exception to the effective date rules of paragraph 2. Under this paragraph, if the 1954 Convention would have afforded greater relief from tax to a person entitled to its benefits than would be the case under this Convention, that person may elect to remain subject to all of the provisions of the 1954 Convention for the first assessment period or taxable year with respect to which this Convention would have had effect under the provisions of paragraph 2(b) of this Article. Where, however, a provision has an effective date which is delayed beyond that provided in paragraph 2, under the provisions of paragraph 4, 5 or 6, the general exception in paragraph 3 does not apply. Under the general rule, for example, a resident performing independent personal services in Germany through a German fixed base for 30 days in 1990 would be subject to German tax under Article 14 (Independent Personal Services) of the Convention. Under Article X of the 1954 Convention, however, he would not be subject to German tax if he is under contract to a person who is not a German resident. Under paragraph 3 of Article 32, that individual may elect to be subject to the 1954 Convention for one additional year. If he makes such an election, he will not be subject to German tax on his personal services income. However, if, for example, he also derives portfolio dividend income from Germany which would be entitled to additional relief under the provisions of paragraph 3 of Article 10 (Dividends) of the Convention with respect to dividends paid after January 1, 1990, the election would postpone the effect of that benefit for one additional year as well. 　　An example of the exception to the general one-year grace period rule might involve the branch tax. The 1954 Convention has been interpreted as preventing the United States, subject to certain statutory limitations, from imposing the branch tax on income attributable to a U.S. permanent establishment of a German enterprise. This Convention permits the application of the branch tax, but its effective date is delayed one year under the provisions of paragraph 5 to assessment periods or taxable years beginning on or after January 1, 1991. A German enterprise with a permanent establishment in the United States may not elect to retain the benefits of the 1954 Convention for one additional year, and thus prevent application of the branch tax until 1992, because the effective date of the branch tax is provided under a special rule of subparagraph 5(a) rather than under the general rule of paragraph 2. 　　Paragraph 4 provides a special effective date rule for direct investment dividends which arc subject to the provisions of subparagraph 2(a) of Article 10 (Dividends). That subparagraph provides that the rate of tax at source on such dividends may not exceed 5 percent. Paragraph 4 provides that the maximum rate of 5 percent will apply to dividends distributed on or after January 1, 1992. Direct investment dividends paid or credited on or after January 1, 1990 but before January 1, 1992 will be subject to tax at source at a maximum rate of 10 percent. This rate applies regardless of whether the taxpayer has elected to claim the benefits of the grace period provided in paragraph 3. 　　Subparagraph 5(a) provides the effective date for the application of the branch tax under paragraph 8 of Article 10 (Dividends). Subparagraph 5(a) provides that the branch tax may first be imposed in respect of dividend equivalent amounts for assessment periods or taxable years beginning on or after January 1, 1991, but excluding fiscal years beginning before that date. For this purpose, the dividend equivalent amount is treated as paid on the last clay of the company's fiscal year. The rate of the tax will be 5 percent from the time the tax may first be imposed, in 1991, even though the rate of withholding at source on direct investment dividends will be 10 percent through December 31, 1991. 　　Subparagraph 5(b) deals with the effective dates for the rules for relief from double taxation in Germany with respect to dividends paid by U.S. Regulated Investment Companies ("RICs"). Paragraph 2(a) of Article' 23 (Relief from Double Taxation) provides that the exemption otherwise allowable from German tax with respect to direct investment dividends will not apply to dividends paid by RICs and to other distributions which have been deducted by the company making the distribution in calculating its U.S. income tax. Subparagraph 5(b) of Article 32 delays that exemption denial to RIC dividends paid on or after January 1, 1991, by RICs which were in existence on October 1, 1988. Thus, dividends paid prior to January 1, 1991 by a RIC which existed on October 1, 1988 to a German company which owns at least 10 percent of the voting shares of the RIC will be exempt from German tax, provided that the dividend is taxable in the United States. U.S. tax on such RIC dividends paid after December 31, 1990 will be subject to a foreign tax credit in Germany. 　　Paragraph 6 provides special rules for items of income described in Article 11 (Interest) and in paragraphs 4 and 5 of Article 10 (Dividends). Which of these rules applies generally depends upon the treatment by the Contracting States of certain payments carrying the right to participate in profits of the payor. If a Contracting State denies deductibility of such payments by the payor, then such payments are subject to one set of rules. If a Contracting State does not deny deductibility, such payments are subject to a second set of rules. In addition, the treatment provided by the 1954 Convention is extended for a limited period with respect to certain payments. 　　Paragraph 6(a) provides that the 1954 Convention and not this Convention shall apply to　interest, as that term is used in the 1954 Convention, that is paid or credited before January 1,　1991. Thus, interest payments made with respect to debt instruments carrying the right to participate in profits that are treated as interest for purposes of the 1954 Convention and otherwise meet the requirements of that Convention will continue to be exempt from source country taxation until 1991. Beginning in 1991, payments made with respect to such hybrid debt instruments (including, in the case of the United States "equity kicker" loans) will depend on the treatment of such payments under the national law of the Contracting States. Under current law, such payments would generally be subject to a 25 percent withholding tax when paid by a resident of Germany and a 30 percent withholding tax when paid by a resident of the United States (unless treated as portfolio interest). 　　Paragraph 6(b) provides that income from debt obligations to which paragraph 4 of Article 10 (Dividends) applies (i.e., income that is subjected to the same taxation treatment as income from shares by the source state), as well as in the case of the German income from a partiarisehes Darlehen or a Gewinnobligation to which paragraph 5 of Article 10 does not apply (i.e., income that, in the event of a change in German law, is no longer deductible in determining the profits of the payor) that is paid or credited after January 1, 1991 shall be taxable in the source country at the rates provided for in paragraphs 2 and 3 of Article 10. Thus, if Germany or the United States amends its law to deny the deductibility of payments made with respect to hybrid debt instruments in order to assimilate such payments to dividends, payments treated as dividends under national law could be entitled to the 5 percent withholding rate on direct dividends as early as 1991, provided such payments otherwise meet the conditions of Article 10. 　　Paragraph 6(c) provides that in the case of Germany income derived under a Stille Gesellsehaft and income derived from jouissance shares or rights to which paragraph 5 of Article 10 applies (i.e., income that remains deductible under German law in determining the profits of the payor) that is paid or credited before January 1, 1991 shall not be taxable in Germany at a rate exceeding 15 percent. Thus, if the Federal Republic of Germany does not amend its law to deny deductibility of payments made with respect to a Stille Gesellschaft or jouissance shares or rights, payments made with respect to such rights will remain subject to the 15 percent dividend rate of the 1954 Convention until 1991. Thereafter, paragraph 5 of Article 10 permits Germany to apply its national law to such payments. Under current German law such payments would generally be subject to a withholding tax of 25 percent. 　　Paragraph 6(d) provides that in the case of Germany income derived under a Stille Gesellschaft and income derived from jouissance shares or rights to which paragraph 5 of Article 10 does not apply (i.e., income that, in the event of a change in German law, is no longer deductible in determining the profits of the payor) that is paid or credited on or after January 1, 1990 shall be taxable in Germany at the rates provided for in paragraphs 2 and 3 of Article 10. Thus, if Germany amends its law to deny the deductibility of payments made with respect to a Stille Gesellschaft or jouissance shares or rights, such payments could be entitled to the 5 percent withholding rate on direct dividends as early as 1990, provided such payments otherwise meet the conditions of Article 10. 　　Paragraph 6(e) makes clear that the special transition rules of paragraph 6 do not apply to dividends or interest attributable to a permanent establishment or fixed base situated in the source country. 　　The special effective date rules provided for in paragraphs 4, 5, and 6 of Article 32 are summarized in the following table indicating the level of source country taxation for different classes of income in each of the years 1989-1992: 　　Paragraph 7 provides that the 1954 Convention will cease to have effect at the time this Convention takes effect under the provisions of this Article. Thus, with respect to items of income and taxes to which this Convention applies, the 1954 Convention will cease to have effect at the latest on January 1, 1992. ARTICLE 33 Termination 　　The Convention is to remain in effect indefinitely, unless terminated by one of the Contracting States in accordance with the provisions of Article 33. The Convention may be terminated at any time after 5 years from the date of its entry into force, provided that at least six months' prior written notice has been given through diplomatic channels. Thus, if notice is given on or before June 30 of any calendar year after 1994, the termination will have effect as follows: 　　(1) with respect to taxes on income, the Convention will cease to have effect for taxable years or assessment periods beginning on or after January 1 of the calendar year following the year in which notice is given (but not including fiscal years beginning before that date); 　　(2) with respect to taxes on capital, the Convention will cease to have effect for items of capital existing on or after January 1 of the calendar year following that in which the notice of termination is given; and 　　(3) with respect to taxes withheld at source on dividends, interest, and royalties and to excise taxes imposed on insurance premiums, the Convention will cease to have effect for amounts paid or credited on or after January 1 of the calendar year following the year in which the notice is given. 　　Nothing in Article 33, which relates to unilateral termination by a Contracting State of the Convention, should be construed as preventing the Contracting States from entering into a new bilateral agreement that supersedes, amends or terminates provisions of the Convention either prior to the expiration of the five year period or without the six month notification period.