Article 12 provides rules for source and residence country taxation of royalties.

Paragraph 1 grants to the residence state the exclusive right to tax royalties derived and beneficially owned by its residents. Thus, the exemption at source for royalties in the 1954 Convention is carried forward to the Convention. Paragraph 10 of the Protocol provides that the source state shall treat the recipient of royalties as the beneficial owner of such royalties for purposes of Article 12 if the recipient is the person to which the income is attributable for tax purposes under the laws of the source state.

Paragraph 2 generally follows the U.S. Model and defines the term "royalties as used in Article 12 to mean payments of any kind received as a consideration for the use of, or the right to use, any copyright of a literary, artistic, or scientific work; for the use of, or the right to use, any patent, trademark, design or model, plan, secret formula or process, or other like right or property; or for information concerning industrial, commercial, or scientific experience. The term also includes gains derived from the alienation of any such right or property that are contingent on the productivity, use, or further alienation thereof. Payments received in connection with the use or right to use cinematographic films, or works on film, tape, or other means of reproduction in radio or television broadcasting are specifically excluded from the definition of royalties. Such payments are covered by the provisions of Article 7 (Business Profits). The reference to "other means of reproduction" makes clear that subsequent technological advances in the field of radio and television broadcasting will not affect the exclusion of payments relating to the use of such means of reproduction from the definition of royalties.

Paragraph 12 of the Protocol makes clear that when an artiste who is resident in one Contracting State records a performance in the other Contracting State, has a copyrightable interest in the recording as determined under the law of the other Contracting State, and receives consideration for the right to use the recording based on the sale or public playing of such recording, then the right of such other Contracting State to tax such consideration shall be governed by Article 12.

Paragraph 3 of Article 12 provides an exception from the rule of Paragraph 1 that bars a source country tax on royalties in cases where the beneficial owner of the royalties 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 right or property in respect of which the royalties are 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 tax such royalties.

Paragraph 4 provides that in cases involving special relationships between the payor and beneficial owner of a royalty, Article 12 applies only to the extent of royalty payments that would have been made absent such special relationships (i.e., an arm’s length royalty payment). Any excess amount of royalties 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. If, for example, the excess amount is treated as a distribution of profits under national law, such excess amount will be taxed as a dividend rather than as a royalty payment, but the tax imposed on the dividend payment will be subject to the rate limitations of paragraph 2 of Article 10 (Dividends).

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