ARTICLE 11

Interest

The existing Convention provides that interest derived from sources within one State by a resident of the other State not having a permanent establishment in the former State will be subject to tax in the former State at a rate not in excess of 15 percent.

The proposed Convention retains the 15 percent rate on interest replacing the "force of attraction" principle by the effectively connected approach. In four important cases, however, the proposed Convention provides for exemption in the State of source. First, interest is exempt at source if it arises out of commercial credit - including credit which is represented by commercial paper - resulting from deferred payments for goods or merchandise or services supplied by a resident of one of the States to a resident of the other State. This exception would apply to interest derived by a bank or other financial institution which purchases paper which arose out of commercial credit which the seller of goods or services discounted at such bank or financial institution. It would also apply to interest derived by a finance company which is a subsidiary of a selling company and which is used by the parent to finance its sales. Second, interest paid between banks is exempt except on loans represented by bearer instruments. Under this provision, interest on advances between banks would be exempt as would interest on a loan from a United States bank to a Belgian bank, assuming that there was not a bearer instrument representing the indebtedness. Third, an exception is provided for interest arising from deposits, not represented by bearer instruments made in banks or other financial institutions. Fourth, interest beneficially derived by one of the States, or by an instrumentality of that State, not subject to tax by that State on its income, would be exempt from tax by the other State. Under this rule, interest income derived by the Export-Import Bank of the United States on loans made to Belgian residents would be exempt from tax in Belgium. This would still be the case if the Export-Import Bank sold interest-participation certificates on such a loan. On the other hand, this rule would not apply if the Export-Import Bank discounted or sell the instrument representing the loan. However, in such a case the exception for interest arising out of commercial credit may be applicable.

As noted above, the proposed Convention abandons the "force of attraction" principle. Thus, the reduced rates of tax applicable to interest apply unless the recipient has a permanent establishment in the State of source and the indebtedness giving rise to the interest is effectively connected with such permanent establishment. In such a case, the interest may be taxed as industrial or commercial profits.

Interest is defined generally as income from any kind of debt-claim or any income treated as interest under the tax law of the State of source. In cases in which excessive interest is paid by reason of a special relationships between the payor and the recipient, the provisions of the interest Article do not apply to the excess part of the payments. Excess interest payments may be taxed according to the law of the State from which the interest is derived. In the case of excess interest derived from the United States, the excess interest may be taxed as dividend. Under Belgian law, the excess interest is disallowed as a deduction, but, in the hands of the recipient, continues to retain its character as interest. However, the recipient is not entitled to the benefits of this Article with respect to such excess.

Thus, for example, in the case of the United States the rules provided in section 482 of the Internal Revenue Code would be applicable if excess interest is paid between related persons. On the other hand, if a Belgian resident pays excess interest to a United States related person, the Belgian tax authorities would disallow such excess as a deduction to the Belgian resident. and would continue to treat such excess as interest, and subject such excess to the 20-percent rate of withholding, as provided under Belgian domestic law. since such excess is not entitled to treaty benefits.

The term "interest" does not include amounts which are considered as dividends as discussed above in connection with Article 10 (Dividends). In the case of Belgium, the term "interest" includes prizes on lottery bonds.

Interest is from sources within a State when the payer is that State, a political subdivision, a local authority thereof or a resident of that State. However, if the payor has a permanent establishment in one of the States and the indebtedness on which the interest is paid is effectively connected with such permanent establishment and the interest is borne by such permanent establishment, such interest shall be deemed to be sourced within the State in which the permanent establishment is located. In addition, if a permanent establishment which a resident of one of the Contracting States has in a third State borrows money from a resident of the other Contracting State, for purposes of the treaty, the interest paid by the permanent establishment will be treated as from sources within the third State if the loan is effectively connected with, and interest is borne by, such permanent establishment.

In other cases, interest paid by a resident of one of the States to a person other than a resident of the other State is exempt from tax by the other State unless the interest is effectively connected with a permanent establishment of the recipient maintained in the other State or the interest is paid by a United States corporation and is received within Belgium by a person other than a citizen or resident of the United States.

As in the case of dividends, the interest Article also contains a special rule dealing with interest from sources within the United States which is received within Belgium by a resident of the United States or a citizen of the United States who is not a resident of Belgium. In such a case Belgium has agreed to waive its withholding tax.