Article 1 provides that — U.S. Income Tax Treaty

the Federal Republic of Germany ("Germany") except where the terms of the Convention provide otherwise. Under Article 4 (Residence) a person is treated as a resident of a Contracting State if that person is under the laws of that State liable to tax therein by reason of his domicile or other similar criteria, subject to certain limitations, as described in Article 4. If, however, a person is, under those criteria, a resident of both Contracting States, a single state of residence (or no state of residence) is assigned under Article 4. This definition governs for all provisions of the Convention. Certain provisions are applicable to persons who may not be residents of either Contracting State. For example, Article 19 (Government Service; Social Security) may apply to a citizen of a Contracting State who is resident in neither. Paragraph 1 of Article 24 (Nondiscrimination) applies to nationals of the Contracting States. Under Article 26 (Exchange of Information and Administrative Assistance), information may be exchanged with respect to residents of third states.

The provisions of paragraph 2 of Article 1 of the U.S. Model, describing the relationship between the rules of the Convention, on the one hand, and the laws of the Contracting States and other agreements between the Contracting States, on the other, and the provisions of paragraphs 3 and 4 of Article 1, preserving certain taxing rights of the Contracting States under the "saving clause", are found in Paragraph 1 of the Protocol. Although Paragraph 1 of the Protocol does not relate specifically to Article 1, its provisions are discussed here for ease of reference.

Subparagraphs (a) and (b) of Paragraph 1 of the Protocol contain the traditional saving clause. Unlike the similar provision in the U.S. Model, the saving clause in the Protocol is

unilateral, applying only for United States tax purposes. Under subparagraph (a), the United States reserves its right, except as provided in paragraph (b), to tax U.S. resident’s and citizens as provided in the Internal Revenue Code ("Code"), notwithstanding any Convention provisions to the contrary. If, for example, a German resident performs independent personal services in the United States and the income from the services is not attributable to a fixed base in the United States, Article 14 (Independent Personal Services) would normally prevent the United States from taxing the income. If, however, the German resident is also a citizen of the United States, the saving clause permits the United States to include the remuneration in the worldwide income of the citizen and subject it to tax under the normal Code rules. (For special foreign tax credit rules applicable to the U.S. taxation of certain U.S. income of its citizens resident in Germany, see paragraph 3 of Article 23 (Relief from Double Taxation).) "Residence", for the purpose of the saving clause, is determined under Article 4 (Residence). Thus; for example, if an individual who is not a U.S. citizen is a resident of the United States under the Code, and is also a resident of Germany under German law, and that individual has a permanent home available to him in Germany and not in the United States, he would be treated as a resident of Germany under Article 4 and for purposes of the saving clause. The United States would not be permitted to apply its statutory rules to that person if they are inconsistent with the treaty. Under paragraph (a), the United States also reserves its right to tax former U.S. citizens whose loss of citizenship had as one of its principal purposes the avoidance of U.S. income tax. Such a former citizen is taxable in accordance with the provisions of section 877 of the Code for 10 years following the loss of citizenship.

Subparagraph (b) sets forth certain exceptions to the saving clause in cases where its application would contravene policies reflected in the treaty which are intended to extend U.S. benefits to U.S. citizens and residents. Sub-subparagraph (b)(aa) lists certain provisions of the Convention which will be applicable to all U.S. citizens and residents despite the general saving clause rule of subparagraph (a):

(1) Paragraph 2 of Article 9 (Associated Enterprises) grants the right to a correlative adjustment, and, particularly, permits the override of the statute of limitations for the purpose of refunding tax under such a correlative adjustment.

(2) Paragraph 6 of Article 13 (Gains) provides special basis adjustment rules for U.S. taxation of gains derived by certain U.S. residents on the alienation of shares which represent a substantial holding in a German corporation. The rule coordinates U.S. and German taxation, and is intended to apply to U.S. citizens.

(3) Paragraphs 3 and 4 of Article 18 (Pensions, Annuities, Alimony and Child Support) deal with alimony and child support payments. Their inclusion in the exceptions to the saving clause means that alimony paid by a U.S. resident to a German resident who is a U.S. citizen will not be taxed by the United States as income of the U.S. citizen. Similarly, if a resident of Germany pays child support to a resident of the United States, the United States may not tax the recipient.

(4) Subparagraph 1(c) of Article 19 (Government Service; Social Security) provides that only the paying State may tax payments to a resident of the other which are compensation for injury or damage suffered as a result of hostility or persecution. This refers to German war reparations payments. The exception to the saving clause prohibits the United States from taxing such payments received by its residents and citizens even if they would otherwise be taxable under the Code.

(5) Paragraph 2 of Article 19 provides for the taxation of social security benefits only in the State of residence of the beneficiary. Excepting this rule from the saving clause means that the United States may not apply the Code rules to tax its citizens resident in Germany on U.S. social security benefits.

(6) Article 23 (Relief from Double Taxation) confers the benefit of a foreign tax credit on U.S. citizens and residents. To apply the saving clause to this Article would render the Article meaningless.

(7) Article 25 (Mutual Agreement Procedure) may confer benefits on U.S. citizens and residents. The statute of limitations may be waived for refunds, the competent authorities are permitted to use a definition of a term which differs from the Code definition, or they may refer an issue to an arbitration panel. As with the foreign tax credit, these benefits are intended to be granted by a Contracting State to its citizens and residents.

Sub-subparagraph (b)(bb) provides a different set of exceptions to the saving clause. The benefits referred to are all intended to be granted to temporary U.S. residents, but not to U.S. citizens and immigrants. If beneficiaries of these provisions come to the United States from Germany and remain in the United States long enough to become residents under the Code, but do not acquire immigrant status (i.e., they do not become "green card" holders) and are not citizens of the United States, the United States will continue to grant these benefits even if they conflict with the Code rules. The benefits preserved by this paragraph are the host country exemptions for the following items of income: Government service salaries and pensions under subparagraph 1(b) of Article 19 (Government Service; Social Security); certain income of visiting teachers, students and trainees under Article 20 (Visiting Professors and Teachers; Students and Trainees); and the income of diplomatic and consular officers under Article 30 (Members of Diplomatic Missions and Consular Posts).

Subparagraph (c) of Paragraph 1 of the Protocol is the same as paragraph 2 of Article 1 of the U.S. Model. It is also essentially the same as paragraph 2 of Article XVIII of the 1954 Convention. This paragraph makes explicit, on a reciprocal basis, the generally accepted principle that no provision in the Convention may restrict any exclusion, exemption, deduction, credit or other allowance accorded by the tax laws of the Contracting States. Thus, for example, if a deduction would be allowed under the Code in computing the taxable income of a resident of Germany, the deduction will be available to that person in computing income under the treaty. In no event may the treaty increase the tax burden on residents of the Contracting States. Thus, a right to tax given by the treaty cannot be exercised by the United States unless that right also exists under the Code.

A taxpayer may always rely on the more favorable Code treatment. This does not mean, however, that a taxpayer may pick and choose among Code and treaty provisions in an inconsistent manner in order to minimize tax. For example, assume a resident of Germany has three separate businesses in the United States. One is a profitable permanent establishment and the other two are trades or businesses which would earn taxable income under the Code but which do not meet the permanent establishment threshold tests of the Convention. One is profitable and the other incurs a loss. Under the Convention, the income of the permanent establishment is taxable, and both the profit and loss of the other two businesses are ignored. Under the Code, all three would be taxable. The loss would be offset against the profits of the

two profitable ventures. The taxpayer may not invoke the Convention to exclude the profits of the profitable trade or business and invoke the Code to claim the loss of the loss trade or business against the profit of the permanent establishment. (See Rev. Rul. 84-17 C.B. 1984-1, 10.) If the taxpayer invokes the Code for the taxation of all three ventures, he would not be precluded from invoking the Convention with respect, for example, to any dividend income he may receive from the United States which is not effectively connected with any of his business activities in the United States.

Similarly, nothing in the Convention can be used to deny any benefit granted by any other agreement between the United States and Germany. For example, if certain benefits are provided for military personnel or military contractors under the Status of Forces Agreement, or if certain protection, not found in the Convention, is afforded under the Treaty of Friendship, Commerce and Navigation, or the Treaty of Friendship, Commerce and Consular Rights, those benefits or protections will be available to residents of the Contracting States regardless of any provisions to the contrary (or silence) in the Convention.

Subparagraph (d) of Paragraph 1 of the Protocol contains a rule relating to German tax. In much the same way that the saving clause preserves U.S. taxing rights with respect to its citizens and residents, this paragraph preserves German statutory rights with respect to the income of German residents. It further provides that if any tax imposed by virtue of this paragraph results in double taxation, the competent authorities will seek to eliminate the double taxation by use of the mutual agreement procedure, particularly paragraph 3 of Article 25 (Mutual Agreement Procedure) which provides, among other things, for consultation between the competent authorities to eliminate double taxation in cases not provided for in the Convention.