ARTICLE 32

Entry into Force

This Article provides the rules for bringing the Convention into force and giving effect to its provisions. Paragraph 1 provides for the ratification of the Convention by both Contracting States and the prompt exchange of instruments of ratification at Washington.

Paragraph 2 provides that the Convention will enter into force on the date on which

instruments of ratification are exchanged. It further provides the general rules for the effective dates of the provisions of the Convention. Paragraphs 3 through 6 provide exceptions to these general effective date rules for particular classes of income. Under subparagraph 2(a) the Convention will have effect with respect to taxes withheld at source on dividends, interest and royalties, and to excise taxes imposed on insurance premiums, for amounts paid or credited on or after January 1, 1990. For all other income taxes, the Convention will have effect for any taxable year or assessment period beginning on or after January 1, 1990. This does not include income for any fiscal year beginning before January 1, 1990. This latter exception is necessary to assure that the Convention does not apply to a German assessment period which begins after January 1, 1990, but which includes income from a fiscal year which began prior to that date. With respect to taxes on capital, the Convention will have effect for taxes levied on items of capital owned on or after January 1, 1990.

Paragraph 3 provides a general exception to the effective date rules of paragraph 2. Under this paragraph, if the 1954 Convention would have afforded greater relief from tax to a person entitled to its benefits than would be the case under this Convention, that person may elect to remain subject to all of the provisions of the 1954 Convention for the first assessment period or taxable year with respect to which this Convention would have had effect under the provisions of paragraph 2(b) of this Article. Where, however, a provision has an effective date which is delayed beyond that provided in paragraph 2, under the provisions of paragraph 4, 5 or 6, the general exception in paragraph 3 does not apply. Under the general rule, for example, a resident performing independent personal services in Germany through a German fixed base for 30 days in 1990 would be subject to German tax under Article 14 (Independent Personal Services) of the Convention. Under Article X of the 1954 Convention, however, he would not be subject to German tax if he is under contract to a person who is not a German resident. Under paragraph 3 of Article 32, that individual may elect to be subject to the 1954 Convention for one additional year. If he makes such an election, he will not be subject to German tax on his personal services income. However, if, for example, he also derives portfolio dividend income from Germany which would be entitled to additional relief under the provisions of paragraph 3 of Article 10 (Dividends) of the Convention with respect to dividends paid after January 1, 1990, the election would postpone the effect of that benefit for one additional year as well.

An example of the exception to the general one-year grace period rule might involve the branch tax. The 1954 Convention has been interpreted as preventing the United States, subject to certain statutory limitations, from imposing the branch tax on income attributable to a U.S. permanent establishment of a German enterprise. This Convention permits the application of the branch tax, but its effective date is delayed one year under the provisions of paragraph 5 to assessment periods or taxable years beginning on or after January 1, 1991. A German enterprise with a permanent establishment in the United States may not elect to retain the benefits of the 1954 Convention for one additional year, and thus prevent application of the branch tax until 1992, because the effective date of the branch tax is provided under a special rule of subparagraph 5(a) rather than under the general rule of paragraph 2.

Paragraph 4 provides a special effective date rule for direct investment dividends which arc subject to the provisions of subparagraph 2(a) of Article 10 (Dividends). That subparagraph provides that the rate of tax at source on such dividends may not exceed 5 percent. Paragraph 4

provides that the maximum rate of 5 percent will apply to dividends distributed on or after January 1, 1992. Direct investment dividends paid or credited on or after January 1, 1990 but before January 1, 1992 will be subject to tax at source at a maximum rate of 10 percent. This rate applies regardless of whether the taxpayer has elected to claim the benefits of the grace period provided in paragraph 3.

Subparagraph 5(a) provides the effective date for the application of the branch tax under paragraph 8 of Article 10 (Dividends). Subparagraph 5(a) provides that the branch tax may first be imposed in respect of dividend equivalent amounts for assessment periods or taxable years beginning on or after January 1, 1991, but excluding fiscal years beginning before that date. For this purpose, the dividend equivalent amount is treated as paid on the last clay of the company's fiscal year. The rate of the tax will be 5 percent from the time the tax may first be imposed, in 1991, even though the rate of withholding at source on direct investment dividends will be 10 percent through December 31, 1991.

Subparagraph 5(b) deals with the effective dates for the rules for relief from double taxation in Germany with respect to dividends paid by U.S. Regulated Investment Companies ("RICs"). Paragraph 2(a) of Article' 23 (Relief from Double Taxation) provides that the exemption otherwise allowable from German tax with respect to direct investment dividends will not apply to dividends paid by RICs and to other distributions which have been deducted by the company making the distribution in calculating its U.S. income tax. Subparagraph 5(b) of Article 32 delays that exemption denial to RIC dividends paid on or after January 1, 1991, by RICs which were in existence on October 1, 1988. Thus, dividends paid prior to January 1, 1991 by a RIC which existed on October 1, 1988 to a German company which owns at least 10 percent of the voting shares of the RIC will be exempt from German tax, provided that the dividend is taxable in the United States. U.S. tax on such RIC dividends paid after December 31, 1990 will be subject to a foreign tax credit in Germany.

Paragraph 6 provides special rules for items of income described in Article 11 (Interest) and in paragraphs 4 and 5 of Article 10 (Dividends). Which of these rules applies generally depends upon the treatment by the Contracting States of certain payments carrying the right to participate in profits of the payor. If a Contracting State denies deductibility of such payments by the payor, then such payments are subject to one set of rules. If a Contracting State does not deny deductibility, such payments are subject to a second set of rules. In addition, the treatment provided by the 1954 Convention is extended for a limited period with respect to certain payments.

Paragraph 6(a) provides that the 1954 Convention and not this Convention shall apply to interest, as that term is used in the 1954 Convention, that is paid or credited before January 1, 1991. Thus, interest payments made with respect to debt instruments carrying the right to participate in profits that are treated as interest for purposes of the 1954 Convention and otherwise meet the requirements of that Convention will continue to be exempt from source country taxation until 1991. Beginning in 1991, payments made with respect to such hybrid debt instruments (including, in the case of the United States "equity kicker" loans) will depend on the treatment of such payments under the national law of the Contracting States. Under current law, such payments would generally be subject to a 25 percent withholding tax when paid by a

resident of Germany and a 30 percent withholding tax when paid by a resident of the United States (unless treated as portfolio interest).

Paragraph 6(b) provides that income from debt obligations to which paragraph 4 of Article 10 (Dividends) applies (i.e., income that is subjected to the same taxation treatment as income from shares by the source state), as well as in the case of the German income from a partiarisehes Darlehen or a Gewinnobligation to which paragraph 5 of Article 10 does not apply (i.e., income that, in the event of a change in German law, is no longer deductible in determining the profits of the payor) that is paid or credited after January 1, 1991 shall be taxable in the source country at the rates provided for in paragraphs 2 and 3 of Article 10. Thus, if Germany or the United States amends its law to deny the deductibility of payments made with respect to hybrid debt instruments in order to assimilate such payments to dividends, payments treated as dividends under national law could be entitled to the 5 percent withholding rate on direct dividends as early as 1991, provided such payments otherwise meet the conditions of Article 10.

Paragraph 6(c) provides that in the case of Germany income derived under a Stille Gesellsehaft and income derived from jouissance shares or rights to which paragraph 5 of Article 10 applies (i.e., income that remains deductible under German law in determining the profits of the payor) that is paid or credited before January 1, 1991 shall not be taxable in Germany at a rate exceeding 15 percent. Thus, if the Federal Republic of Germany does not amend its law to deny deductibility of payments made with respect to a Stille Gesellschaft or jouissance shares or rights, payments made with respect to such rights will remain subject to the 15 percent dividend rate of the 1954 Convention until 1991. Thereafter, paragraph 5 of Article 10 permits Germany to apply its national law to such payments. Under current German law such payments would generally be subject to a withholding tax of 25 percent.

Paragraph 6(d) provides that in the case of Germany income derived under a Stille Gesellschaft and income derived from jouissance shares or rights to which paragraph 5 of Article 10 does not apply (i.e., income that, in the event of a change in German law, is no longer deductible in determining the profits of the payor) that is paid or credited on or after January 1, 1990 shall be taxable in Germany at the rates provided for in paragraphs 2 and 3 of Article 10. Thus, if Germany amends its law to deny the deductibility of payments made with respect to a Stille Gesellschaft or jouissance shares or rights, such payments could be entitled to the 5 percent withholding rate on direct dividends as early as 1990, provided such payments otherwise meet the conditions of Article 10.

Paragraph 6(e) makes clear that the special transition rules of paragraph 6 do not apply to dividends or interest attributable to a permanent establishment or fixed base situated in the source country.

The special effective date rules provided for in paragraphs 4, 5, and 6 of Article 32 are summarized in the following table indicating the level of source country taxation for different classes of income in each of the years 1989-1992:

Paragraph 7 provides that the 1954 Convention will cease to have effect at the time this Convention takes effect under the provisions of this Article. Thus, with respect to items of

income and taxes to which this Convention applies, the 1954 Convention will cease to have effect at the latest on January 1, 1992.