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（九） ARTICLE 26 Exchange of Information and Administrative Assistance This Article provides for the exchange of information between the competent authorities of the Contracting States. The information to be exchanged is that necessary for carrying out the provisions of the Convention or the domestic laws of the United States or Germany concerning the taxes covered by the Convention. The taxes covered by the Convention are those referred to in Article 2 (Taxes Covered). This differs from the U.S. Model, which, for purposes of exchange of information, covers all taxes imposed by the two Contracting States. However, paragraph 6 of this Article provides that the Contracting States may agree through the exchange of diplomatic notes to broaden the coverage of this Article by exchanging information for the purpose of taxes imposed by a Contracting State which are not identified as covered taxes by Article 2. Exchange of information with respect to domestic law is authorized insofar as the taxation under those domestic laws is not contrary to the Convention. Thus, for example, information may be exchanged with respect to a covered tax, even if the transaction to which the information relates is a purely domestic transaction in the requesting State and, therefore, the exchange is not made for the purpose of carrying out the Convention. 　　Paragraph 1 states that information exchange is not restricted by Article 1 (General Scope). This means that information may be requested and provided under this Article with respect to persons who are not residents of either Contracting State. For example, if a thirdcountry resident has a permanent establishment in Germany which engages in transactions with a U.S. enterprise, the United States could request information with respect to that permanent establishment, even though it is not a resident of either Contracting State. Similarly, if a thirdcountry resident maintains a bank account in Germany, and the Internal Revenue Service has reason to believe that funds in that account should have been reported for U.S. tax purposes but have not been so reported, information can be requested from Germany with respect to that person's account. 　　Paragraph 1 also provides assurances that any information exchanged will be treated as secret, subject to the same disclosure constraints as information obtained under the laws of the requesting State. Information received may be disclosed only to persons, including courts and administrative bodies, concerned with the assessment, collection, enforcement or prosecution in respect of the taxes to which the information relates, or to persons concerned with the administration of these taxes. The information must be used by these persons in connection with these designated functions. Persons concerned with the administration of taxes, in the United States, include legislative bodies, such as the tax-writing committees of Congress and the General Accounting office. Information received by these bodies is for use in the performance of their role in overseeing the administration of U.S. tax laws. Information received may be disclosed in public court proceedings or in judicial decisions unless the State supplying the information objects to such use. It is United States policy not to object to such use. As a general matter, it is not anticipated that Germany will raise objections to such use of information. 　　Paragraph 25 of the Protocol relates to the disclosure provisions of Article 26 and to the arbitration provisions of paragraph 5 of Article 25 (Mutual Agreement Procedure). The Protocol provides that, when a case is referred to an arbitration board, confidential information necessary for carrying out the arbitration procedure may be released by the Contracting States to the board.The members of the board, and any staff, however, are subject to the disclosure rules of Article 26. 　　It is contemplated that the Contracting States will utilize Article 26 to exchange information on a routine basis, on request in relation to a specific case, or spontaneously. Paragraph 26 of the Protocol provides that Germany will exchange information with or without request to the extent provided for in its law of 19 December, 1985, as it may be amended from time to time without changing the law's general principle, i.e., that Germany will exchange information. 　　Paragraph 2 explains that the obligations undertaken in paragraph 1 to exchange information do not require a Contracting State to carry out administrative measures which are at variance with the laws or administrative practice of either State. Nor does that paragraph require a Contracting State to supply information not obtainable under the laws or administrative practice of either State, or to disclose trade secrets or other information, the disclosure of which would be contrary to public policy. Either Contracting State may, however, at its discretion, subject to the limitations of the paragraph and its internal law, provide information which it is not obligated to provide under the provisions of this paragraph. 　　Paragraph 3 provides that when information is requested by a Contracting State in accordance with this Article, the other Contracting State is obligated to obtain the requested information as if the tax in question were the tax of the requested State, even if that State has no direct tax interest in the case to which the request relates. The paragraph further provides that the requesting State may specify the form in which information is to be provided (e.g., depositions of witnesses and authenticated copies of original documents) so that the information can be usable in the judicial proceedings of the requesting State. The requested State should, if possible, provide the information in the form requested to the same extent that it can obtain information in that form under its own laws and administrative practices with respect to its own taxes. 　　Paragraph 4 and 5 provide for assistance in collection of taxes to the extent necessary to ensure that treaty benefits are enjoyed only by persons entitled to those benefits under the terms of the Convention. Under paragraph 4, a Contracting State will endeavor to collect on behalf of the other State only those amounts necessary to ensure that any exemption or reduced rate of tax at source granted under the Convention by that other State is not enjoyed by persons not entitled to those benefits. Paragraph 5 makes clear that the Contracting State asked to collect the tax is not obligated, in the process, to carry out administrative measures that are different from those used in the collection of its own taxes, or that would be contrary to its sovereignty, security or public policy. ARTICLE 27 Exempt Organizations 　　Article 27 is essentially the same as Article XV A of the 1954 Convention. The Article provides that a company or organization in one Contracting State which is operated exclusively for religious, charitable, scientific, educational or public purposes will be exempt from tax in the other Contracting State in respect of items of income if two conditions are met. The two conditions are 　　(1) that the company or organization be exempt from tax in its State of residence, and 　　(2) that the company or organization would be exempt from tax on such items of income in the other Contracting State, under its laws, if the company or organization were organized in that other State and carried on all of its activities there. 　　None of the benefits of this Article can be denied by the application of the provisions of Article 28 (Limitation on Benefits). Paragraph 27 of the Protocol provides that the competent authorities will develop procedures to implement the Article. ARTICLE 28 Limitation on Benefits 　　Article 28 assures that source basis tax benefits granted by a Contracting State pursuant to the Convention are limited to the intended beneficiaries-residents of the other Contracting State -and are not extended to residents of third States not having a substantial business in, or business nexus with, the other Contracting State. For example, a resident of a third State might establish an entity resident in a Contracting State for the purpose of deriving income from the other Contracting State and claiming source State benefits with respect to that income. Absent Article 28, the entity would generally be entitled to benefits as a resident of a Contracting State, subject, however, to such limitations (e.g., business purpose, substance-over-form, step transaction or conduit principles) as may be applicable to the transaction or arrangement under the domestic law of the source State. 　　The structure of the Article is as follows: Paragraph 1 lists a series of attributes of a resident of a Contracting State, the presence of any one of which will entitle that person to benefits of the Convention in the other Contracting State. Several of these, which will be discussed first, are purely objective tests. One, in subparagraph (c), is more subjective, and requires some elaboration and interpretation. Paragraph 2 provides that benefits may be granted even to a person not entitled to benefits under the tests of paragraph 1, if the competent authority of the source State so determines. Paragraph 3 defines the term "recognized stock exchange" as used in paragraph 1. Paragraph 4 authorizes the competent authorities to develop agreed applications of the Article and to exchange information necessary for carrying out the provisions of the Article. 　　A memorandum of understanding was developed by the negotiators indicating how the provisions of the Article are to be understood both by the competent authorities and by taxpayers in the Contracting States. It is anticipated that as the competent authorities and taxpayers gain more experience with the concepts in this Article, some of which are relatively new, further guidance will be developed and made public. 　　Two categories of persons eligible for benefits from the other Contracting State under subparagraphs (a) and (b) of paragraph 1 are 　　(1) individual residents of a Contracting State and 　　(2) the Contracting States, political subdivisions or local authorities thereof. 　　It is most unlikely that persons falling into these two categories can be used to derive treatybenefited income, as the beneficial owner of the income, on behalf of a third-country person. If an individual is receiving income as a nominee on behalf of a third-country resident, benefits will be denied with respect to those items of income under the articles of the Convention which grant the benefit, because of the requirements in those articles that the beneficial owner of the income be a resident of a Contracting State. 　　Under subparagraph (d) a corporation which is a resident of a Contracting State is entitled to treaty benefits from the other Contracting State if there is substantial and regular trading in the corporation's principal class of shares on a recognized stock exchange. The term "recognized stock exchange" is defined in paragraph 3 of the Article to mean, in the United States, the NASDAQ System and any stock exchange which is registered as a national securities exchange with the Securities and Exchange Commission, and, in Germany, any German stock exchange on which registered dealings in shares take place. Paragraph 3 also provides that the competent authorities may, by mutual agreement, recognize additional exchanges for purposes of subparagraph 1(d). 　　Subparagraph (e) of paragraph 1 provides a two-part test, the so-called ownership and base erosion tests, both of which must be met for entitlement to benefits under this subparagraph. under these tests, benefits will be granted to a resident of a Contracting State other than an individual, if both 　　(1) more than 50 percent of the beneficial interest in the person (or, in the case of a corporation, more than 50 percent of each class of its shares) is owned, directly or indirectly, by persons who are themselves entitled to benefits under the other tests of paragraph 1 (other than subparagraph (c)), or by U.S. citizens, and 　　(2) more than 50 percent of the person's gross income is not used, directly or indirectly,　to make deductible payments to persons, other than persons who are themselves eligible for benefits under the other tests of paragraph 1 (other than subparagraph (c)), or to U.S. citizens. 　　It is understood that the term "gross income" is to be interpreted as in U.S. law. Thus, in general, the term should be understood to mean gross receipts less cost of goods sold. 　　The rationale for this two-part test is that since treaty benefits can be indirectly enjoyed not only by equity holders of an entity, but also by that entity's various classes of obligees, such as lenders, licensors, service providers, insurers and reinsurers, and others, it is not enough, in order to prevent such benefits from inuring substantially to third-country residents, merely to require substantial ownership of the entity by treaty country residents or their equivalent. It is also necessary to require that the entity's deductible payments be made in substantial part to such treaty country residents or their equivalents. For example, a third-country resident could lend funds to a German-owned German corporation to be reloaned to the United States. The U.S. source interest income of the German corporation would be exempt from U.S. withholding tax under Article 11 (Interest) of the Convention. While the German corporation would be subject to German corporation income tax, its taxable income could be reduced to near zero by the deductible interest paid to the third-country resident. If, under a Convention between Germany and the third country, that interest is exempt from German tax, the U.S. treaty benefit with respect to the U.S. source interest income will have flowed to the third-country resident. 　　Subparagraph (f) provides that a not-for-profit organization which is a resident of a Contracting State is entitled to benefits from the other Contracting State if it satisfies two conditions: 　　(1) It must be generally exempt from tax in its State of residence by virtue of its not-forprofit status, and 　　(2) more than half of the beneficiaries, members or participants, if any, in the organization must be persons entitled, under this Article, to the benefits of the Convention. 　　Paragraph 28 of the protocol clarifies that the not-for-profit organizations dealt within subparagraph l(f) include pension funds, pension trusts, private foundations, trade unions, trade associations and similar organizations. A pension fund or trust or similar entity created for the purpose of providing retirement, disability or other employment benefits is entitled to the benefits of the Convention if the organization sponsoring the fund, trust or entity is entitled to the Convention's benefits under Article 28. Thus, one need not determine that more than half of the beneficiaries of a German pension plan are residents of Germany in deciding whether the plan is entitled to U.S. treaty benefits in respect of its income so long as the German corporation sponsoring the fund is entitled to benefits under Article 28, because, for example, it is publicly traded on the Frankfurt stock exchange. If, however, the sponsoring organization is not entitled to benefits, the tests of subparagraph 10 must be met. Under the provision of Article 27 (Exempt Organizations), a not- for-profit organization, otherwise dealt within subparagraph 1(f) of Article 28, which is operated exclusively for religious, charitable, scientific, educational or other public purposes, is eligible for the source exemption provided by Article 27, notwithstanding any provisions of Article 28. Thus, a German charitable organization receiving dividend income from the United States is exempt from U.S. withholding tax under Article 27, even if all of the beneficiaries of the charity are residents of a third country. 　　Subparagraph 1(c) of Article 28 provides a test for eligibility for benefits which looks not solely at objective characteristics of the person deriving the income, but at the nature of the activity engaged in by that person and the connection between the income and that activity. Under the subparagraph, a resident of a Contracting State deriving income from the other Contracting State is entitled to benefits if the person Is engaged in an active trade or business in his State of residence, and the item of income in question is derived in connection with, or is incidental to, that trade or business. Income which is derived in connection with, or is incidental to, the business of making or managing investments will not qualify for benefits under this provision, unless the business is a bank or insurance company engaged in banking or insurance activities. 　　In general, it is expected that if a person qualifies for benefits under the other subparagraphs of paragraph 1, no inquiry will be made into qualification for benefits tinder subparagraph l(c). Upon satisfaction of any of the other tests of paragraph 1, any income derived by the beneficial owner from the other Contracting State is entitled to treaty benefits. Under subparagraph 1(c), however, the test is applied separately for each item of income. 　　It is intended that the provisions of subparagraph 1(c) will be self-executing. Unlike the provisions of paragraph 2, discussed below, claiming benefits under this subparagraph does not require advance competent authority ruling or approval. The tax authorities may, of course, on review, determine that the taxpayer has improperly interpreted the subparagraph and is not entitled to the benefits claimed. 　　A memorandum was exchanged at the time of the signing of the Convention which suggests, by means of examples, the understandings reached by the negotiators as to the intended scope of subparagraph 1(c). The examples, structured for purposes of exposition in terms of a German entity claiming U.S. treaty benefits, are reproduced in the following paragraphs. They are not intended to be exhaustive, but are merely illustrative of the kinds of considerations which are relevant in making a determination as to whether a particular case falls within the scope of the subparagraph 1(c). Example I Facts: 　　A German resident company is owned by three persons, each resident in a different third country. The company is engaged in an active manufacturing business in Germany. It has a wholly-owned subsidiary in the United States which has been capitalized with debt and equity. The subsidiary is engaged in selling the output of the German parent. The active manufacturing business in Germany is substantial in relation to the activities of the U.S. subsidiary. Are the subsidiary's interest and dividend payments to its German parent eligible for treaty benefits in the United States? Analysis: 　　Treaty benefits would be allowed because the treaty requirement that the U.S. income is "derived in connection with or is incidental to" the German active business is satisfied. This conclusion is based on two elements in the fact pattern presented: 　　(1) the income is connected with the active German business in this example in the form of a "downstream" connection; and 　　(2) the active German business is substantial in relation to the business of the U.S. subsidiary. Example II Facts: 　　The facts are the same as Example I except that while the income is derived by the German parent of the U.S. subsidiary, the relevant business activity in Germany is carried on by a German subsidiary corporation. The German subsidiary's activities meet the business relationship and substantiality tests of the business connection provision, as described in the preceding example. Are the U.S. subsidiary's dividends and interest payments to the German parent eligible for U.S. treaty benefits? Analysis: 　　Benefits are allowed because the two German entities (i.e., the one deriving the income and the one carrying on the substantial active business in Germany) are related. Benefits are not denied merely because the income is earned by a German holding company and the relevant activity is carried on in Germany by a German subsidiary. The existence of a similar holding company structure in the United States would not affect the right of the German parent to treaty benefits. Thus, if the German parent owns a subsidiary in the United States which is, itself, a holding company for the group's U.S. activities, which are related to the business activity in Germany, dividends paid by the U.S. holding company to the German parent holding company would be tested for eligibility for benefits in the same way as described above, ignoring the fact that the activities are carried on by one entity and the income in respect of which benefits are claimed is paid by another, related, entity. Example III Facts: 　　A German resident company is owned by three persons, each resident in a different third country. The company is the worldwide headquarters and parent of an integrated international business carried on through subsidiaries in many countries. The company's wholly-owned U.S. and German subsidiaries manufacture, in their countries of residence, products which are part of the group's product line. The United States subsidiary has been capitalized with debt and equity. The active manufacturing business of the German subsidiary is substantial in relation to the activities of the U.S. subsidiary. The German parent manages the worldwide group and also performs research and development to improve the manufacture of the group's product line. Are the U.S. subsidiary's dividend and interest payments to its German parent eligible for treaty benefits in the United States? Analysis: 　　Treaty benefits would be allowed because the treaty requirement that the United States income is "derived in connection with or is incidental to" the German active business is satisfied. This conclusion is based on two elements in the fact pattern presented: 　　(1) the income is connected with the German active business because the United States subsidiary and the German subsidiary manufacture products which are part of the group's product line, the German parent manages the worldwide group, and the parent performs research and development that benefits both subsidiaries; and 　　(2) the active German business is substantial in relation to the business of the U.S. subsidiary. Example IV Facts: 　　A third-country resident establishes a German corporation for the purpose of acquiring a large U.S. manufacturing company. The sole business activity of the German corporation (other than holding the stock of the U.S. corporation) is the operation of a small retailing outlet which sells products manufactured by the U.S. company. Is the German corporation entitled to treaty benefits under subparagraph 1(c) with respect to dividends it receives from the U.S. manufacturer? Analysis: 　　The dividends would not be entitled to benefits. Although there is, arguably, a business connection between the U.S. and the German businesses, the "substantiality" test described in the preceding examples is not met. Example V Facts: 　　German, French and Belgian corporations create a joint venture in the form of a partnership organized in Germany to manufacture a product in a developing country. The joint venture owns a U.S. sales corporation, which pays dividends to the joint venture. Are these dividends eligible for U.S.-German treaty benefits? Analysis: 　　Under Article 4, only the German partner is a resident of Germany for purposes of the treaty. The question arises under this treaty, therefore, only with respect to the German partner's share of the dividends. If the German partner meets the ownership and base erosion or the public trading tests of subparagraph 1(d) or (e), it is entitled to benefits without reference to subparagraph 1(c). If not, the analysis of the previous examples would be applied to determine eligibility for benefits under 1(c). The determination of treaty benefits available to the French and Belgian partners will be made under the United States treaties with France and Belgium.