ARTICLE 4

Source of Income

This Article contains the source rules which are to be used in applying the provisions of the Convention. For example, under Article 6 (General Rules of Taxation), one Contracting State may tax a resident of the other Contracting State only on income from sources within the firstmentioned Contracting State (provided, with certain exceptions, such resident is not a citizen of the first-mentioned Contracting State).

Paragraph (1) provides that, as a general rule, dividends will be treated as income from sources within a Contracting State only if paid by a corporation of the Contracting State. This general rule will not apply in two cases. First, dividends paid by a United States corporation will be treated as income from sources within Egypt if such corporation's activities lie solely or mainly in Egypt and the dividend is taxed in Egypt in the manner prescribed in paragraphs (3) and (5) of Article 11 (Dividends). This rule is similar to that of Code sections 861(a)(2)(A) and 862(a)(1). See the explanation of paragraph (5) of Article 11 (Dividends) for a discussion of the effects of this rule. Second, dividends paid by a corporation other than a United States corporation will be treated as income from sources within the United States if at least 50 percent of such corporation's gross income from all sources for the 3-year period (or such part of that period as the corporation has been in existence) ending with the close of its taxable year preceding the declaration of the dividend was industrial or commercial profits attributable to a permanent establishment which such corporation had in the United States. The rule in the second case, though similar, differs from that of Code section 861(a)(2)(B) in that, for example, it does not specifically provide that only a pro rata portion of the dividend will be treated as income from sources within the United States. However, since Article 6 (General Rules of Taxation) provides, in effect, that the Convention will not increase a person's United States tax, the pro ration specified in Code section 861(a)(2)(B) will be applied to determine the portion of the dividend paid by such non-United States corporation which will be treated as United States source income.

Under paragraph (2), interest will be treated as income from sources within a Contracting State only if paid by the Contracting State, a political subdivision or a local authority thereof, or by a resident of the Contracting State. However, if interest is paid on an indebtedness incurred in connection with a permanent establishment which bears such interest, (i.e., deducts the interest in computing the income of the permanent establishment) then such interest shall be deemed to be from sources within the State (whether or not a Contracting State) in which the permanent establishment is situated. This exception permits a Contracting State, under the proper

circumstances, to impose a tax on interest paid by a permanent establishment of a resident of a State other than a Contracting State. For example, if a resident of France has a permanent establishment in Egypt which borrows money from a resident of the United States and bears the interest, the interest will be deemed to be from Egyptian sources. Thus, Egypt may tax such interest, subject to the limitation of Article 12 (Interest). As provided in paragraph (8) of Article 5 (Permanent Establishment) the principles of Article 5 will be applied to determine whether the resident of France has a permanent establishment in Egypt. The United States will not, because of sections 86l(a)(1)(C) and (D) of the Code, impose a tax on interest received by nonresident alien individuals or foreign corporations from a foreign corporation having a permanent establishment in the United States unless 50 percent or more of the gross income of such corporation from all sources for the three year period ending with the close of its taxable year preceding the payment of the interest (or such part of such period as the corporation has been in existence) was effectively connected with the conduct of a trade or business within the United States. If it is, the U.S. will impose a tax on a pro rata portion of the interest.

In addition, the exception to the general rule of paragraph (2) of this Article will exempt interest from tax in the Contracting State in which the payor resides if the payor has a permanent establishment in a State other than a Contracting State in connection with which the indebtedness on which the interest is paid was incurred, such interest is borne by the permanent establishment and such interest is paid to a resident of the other Contracting State. This results from the restriction in Article 6 (General Rules of Taxation) that a resident of one Contracting State, not a citizen of the other Contracting State, may be taxed by the other Contracting State only on income from sources within that other Contracting State.

Paragraph (3) provides that royalties for the use of, or the right to use, property or rights described in paragraph (2) of Article 13 (Royalties) will be treated as income from sources within a Contracting State only to the extent that such royalties are for the use of, or the right to use, such property or rights within that Contracting State.

Paragraph (4) provides that income and gains (including royalties) to which Article 7 (Income from Real Property) applies will be treated as income from sources within a Contracting State only if the real property is situated in that Contracting State. As noted in Article 7, paragraph (4) determines not only the source of a gain from the alienation of real property itself, but also of gains from the alienation of shares of a corporation, or of an interest in a partnership, estate, or trust the property of which consists principally of real property situated in a Contracting State.

Paragraph (5) provides that income from the rental of tangible personal (movable) property will be treated as income from sources within a Contracting State only if such property is situated in that Contracting State.

Under paragraph (6) income from the purchase and sale, exchange, or other disposition of intangible or tangible personal property (other than gains described in paragraph (2) of Article 13 (Royalties)) will be treated as income from sources within a Contracting State only if such sale, exchange, or other disposition is within that Contracting State.

Under paragraph (7), income received by an individual for his performance of labor or personal services, whether as an employee or in an independent capacity, will be treated as income from sources within a Contracting State only to the extent that such services are performed in that Contracting State. Income from personal services performed aboard ships or aircraft operated by a resident of a Contracting State in international traffic will be treated as income from sources within that Contracting State if rendered by a member of the regular complement of the ship or aircraft. However, remuneration described in Article 21 (Governmental Functions), and payments described in Article 20 (Social Security Payments) paid from the public funds of a Contracting State or political subdivision or local authority thereof will be treated as income from sources within that Contracting State only.

Paragraph (8) contains a general qualification to the preceding source rules, It provides that industrial or commercial profits attributable to a permanent establishment which the recipient, a resident of one Contracting State, has in the other Contracting State will be treated as income from sources within that other Contracting State. Industrial or commercial profits attributable to such permanent establishment may include any item of income described in paragraphs (1) through (6) if the item of income is "effectively connected" with the permanent establishment, See the discussion of paragraph (6) of Article 8 (Business Profits) for a discussion of the effectively connected concept.

Under paragraph (9), the source of any item of income not described in the preceding paragraphs of Article 4 will be determined by each Contracting State in accordance with its own law. However, if the source of any item of income under the laws or one Contracting State is different from its source under the laws of the other Contracting State or if its source is not readily determinable under the laws of one of the Contracting States, the competent authorities of the Contracting State may, in order to prevent double taxation or further any other purpose of the Convention, establish a common source of the item of income for purposes of the Convention. (See paragraph (2)(C) of Article 27 (Mutual Agreement Procedure)).

Several of the source rules set out in this Article differ to some degree from those provided in the Code. Since Article 6 (General Rules of Taxation) provides, in effect, that the Convention will not increase a person's overall United States tax, a taxpayer is not required to apply the Convention rules in calculating his United States tax liability. However, a taxpayer may not make inconsistent choices between Code and Convention rules.