Article 11 provides rules for source and residence country taxation of interest.

Paragraph 1 grants to the residence state the exclusive right to tax interest derived and beneficially owned by its residents. Thus, the exemption at source for interest in the 1954 Convention is generally carried forward to this Convention. Paragraph 10 of the Protocol provides that the source state shall treat the recipient of interest income as the beneficial owner of such income if the recipient is the person to which the income is attributable for tax purposes under the laws of the source state.

Paragraph 2 defines the term "interest" as used in Article II to include, inter alia, income from debt-claims of every kind, whether or not secured by a mortgage, as well as income treated as income from money lent by the taxation law of the source state. Penalty charges for late payment arc excluded from the definition of interest. Income dealt within Article 10 is also excluded from the definition of interest. Thus, for example, income from a debt obligation carrying the right to participate in profits is not covered by Article 11, even if such income is treated as interest under the law of the source state. Rather, the respective rights of the source and residence states to tax such income are determined under Article 10.

Paragraph 3 provides an exception from the rule of Paragraph 1 that bars a source country tax on interest in cases where the beneficial owner of the interest carries on business through a permanent establishment in the source state or performs independent personal services from a fixed base situated in the source state and the debt-claim in respect of which the interest is paid forms part of the business property of such permanent establishment or fixed base. In such cases the provisions of Article 7 (Business Profits) or Article 14 (Independent Personal Services) will apply and the source state will generally retain the right to impose tax on such interest income.

Paragraph 4 provides that in cases involving special relationships between persons, Article 11 applies only to interest payments that would have been made absent such special relationships (i.e., an arm's length interest payment). Any excess amount of interest paid remains taxable according to the laws of the United States and the Federal Republic of Germany, respectively, with due regard to the other provisions of the Convention. Thus, for example, if the excess amount would be treated as a distribution of profits, such amount could be taxed as a dividend rather than as interest, but the tax would be subject to the rate limitations of paragraph 2 of Article 10 (Dividends).

Paragraph 5 limits the right of one Contracting State to impose tax on interest payments made by a company deriving income from such State that is a resident of the other Contracting State. Such a tax may be imposed only on interest paid by a permanent establishment of such company located in the first-mentioned state, interest paid out of income subject to the branch profits tax permitted by paragraph 8(a)(bb) of Article 10 (Dividends) in the first-mentioned State, interest paid to a resident of the first-mentioned State, or interest paid with respect to a debtclaim that forms part of the business property of a permanent establishment or fixed base situated in the first-mentioned State. Thus, for example, if a German company derives income from the United States that is subject to the United States branch profits tax even though such German company has no permanent establishment in the United States (e.g., because such company makes an election to be taxed on a net basis under section 882(d) of the Code or such company disposes of a United States Real Property Interest), the United States retains the right to tax interest payments made by such company. Interest paid by a U.S. permanent establishment of a German company to a resident of Germany, however, is not subject to U.S. tax by virtue of paragraph 1 of Article 11.

Paragraph 11 of the Protocol provides that the excess of the amount of interest deductible by a German company over the interest actually paid by such permanent establishment shall be treated as interest derived and beneficially owned by a resident of Germany. Thus, the Article II

exemption from source country taxation will generally prevent the collection of the excess interest tax imposed by section 884(f) of the Code.

Notwithstanding the foregoing limitations on source country taxation of interest, the saving clause of subparagraph (a) of Paragraph 1 of the Protocol permits the United States to tax its residents and citizens, subject to the special foreign tax credit rules of paragraph 3 of Article 23 (Relief from Double Taxation), as if the Convention had not come into force.