ARTICLE 9 — U.S. Income Tax Treaty

Associated Enterprises

This Article incorporates into the Convention the general principles of section 482 of the Code. It provides that when related persons engage in transactions that are not at arm's length, the Contracting States may make appropriate adjustments to the taxable income and tax liability of such related persons to reflect what the income or tax of these persons with respect to such transactions would have been had there been an arm’s length relationship between the persons.

Paragraph 1 deals with the circumstance where an enterprise of a Contracting State is related to an enterprise of the other Contracting State, and those related persons make arrangements or impose conditions between themselves in their commercial or financial relations which are different from those that would be made between independent persons. Paragraph 1 provides that, under those circumstances, the Contracting States may adjust the income (or loss) of the enterprise to reflect the income which would have been taken into account in the absence of such a relationship. The paragraph specifies what the term "related persons" means in this context. An enterprise of one Contracting State is related to an enterprise of the other Contracting State if either participates directly or indirectly in the management, control, or capital of the other. The two enterprises are also related if any third person or persons participate directly or indirectly in the management, control, or capital of both. The term "control" includes any kind of control, whether or not legally enforceable and however exercised or exercisable.

Paragraph 2 provides that where a Contracting State has made an adjustment that is consistent with the provisions of paragraph 1, and the other Contracting State agrees that the adjustment was appropriate to reflect arm’s length conditions, that other Contracting State is obligated to make a corresponding adjustment to the tax liability of the related person in that other Contracting State. The Contracting State making such an adjustment will take the other provisions of the Convention, where relevant, into account. For example, if the effect of a correlative adjustment is to treat a German corporation as having made a distribution of profits to its U.S. parent corporation, the provisions of Article 10 (Dividends) will apply, and Germany may impose a 5 percent withholding tax on the dividend. The competent authorities are authorized, if necessary, to consult to resolve any differences in the application of these provisions. For example, there may be a disagreement over whether an adjustment made by a Contracting State under paragraph 1 was appropriate.

If a correlative adjustment is made under paragraph 2, it is to be implemented, pursuant to paragraph 2 of Article 25 (Mutual Agreement Procedure), notwithstanding any time limits or

other procedural limitations in the law of the Contracting State making the adjustment. The saving clause of subparagraph (a) of Paragraph 1 of the Protocol does not apply to paragraph 2 of Article 9 (see the exceptions to the saving clause in sub-subparagraph (b)(aa) of Paragraph 1 of the Protocol). Thus, even if the statute of limitations has run, or there is a closing agreement between the Internal Revenue Service and the taxpayer, a refund of tax can be made in order to implement a correlative adjustment. Statutory or procedural limitations, however, cannot be overridden to impose additional tax, because, under subparagraph (c) of Paragraph 1 of the Protocol, the Convention cannot restrict any statutory benefit.

Paragraph 7 of the Protocol relates to Article 9 of the Convention. It has the same purpose as paragraph 3 of Article 9 of the U.S. Model. That paragraph of the U.S. Model is not in the Convention. The paragraph preserves the rights of the Contracting States to apply internal law provisions relating to adjustments between related parties. Such adjustments - the distribution, apportionment, or allocation of income, deductions, credits or allowances - are permitted even if they are different from, or go beyond, those authorized by paragraph 1 of the Article, so long as they accord with the general principles of paragraph 1, i.e., that the adjustment reflects what would have transpired had the related parties been acting at arm's length. Paragraph 7 of the Protocol also makes clear that Article 9 does not limit the rights of the Contracting States to allocate income between related persons in cases where the relationship is different from that described in paragraph 1 of the Article. This rule would apply, for example, if a commercial or contractual relationship results in the ability of one party to exercise a controlling influence over another. Any adjustments made pursuant to this provision of the Protocol must accord with the general principles of paragraph 1 of Article 9.

It is understood that the "commensurate with income" standard for determining appropriate transfer prices for intangibles, added to Code section 482 by the Tax Reform Act of 1986, was designed to operate in such a way that it does not represent a departure in U.S. practice or policy from the arm’s length standard. It merely suggests alternative approaches, beyond those spelled out in current regulations, for achieving appropriate transfer prices. It is anticipated, therefore, that the application of this standard by the Internal Revenue Service will be in accordance with the general principles of paragraph 1 of Article 9 of the Convention, and of Paragraph 7 of the Protocol.