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

for included services.

Paragraph 1 grants to the residence State the right to tax royalties and fees for included

services paid to its residents.

Paragraph 2 also grants to the source State the right to tax royalties and fees for included services according to its laws. However, if the beneficial owner of the royalties or fees or included services is a resident of the other Contracting State, the source State shall not impose a tax that exceeds certain limitations. Different limitations apply to payments of royalties and service fees depending the category to which the payments belong.

The first category of royalties and service fees consists of royalties defined in subparagraph (a) of paragraph 3 and fees for included services defined in paragraph 4, other than fees described in subparagraph (b) of paragraph 2. Subparagraph (a) of paragraph 2 limits the source State's right to tax such payments as follows. During the first five taxable years for which the Convention has effect, the source State's tax on the first category of royalties and fees may not exceed 15 percent of the gross amount of such royalties and fees if the payer of the royalties or fees is the Government, or a political subdivision or a public sector company, of a Contracting State. Otherwise the source State's tax is limited to 20 percent of the gross amount of such royalties or fees. During subsequent years, the source State's tax on the first category of royalties and fees may not exceed 15 percent.

The second category of royalties and service fees consists of royalties defined in subparagraph (b) of paragraph 3 (generally relating to payments for the use of, or the right to use, any industrial, commercial, or scientific equipment) and those fees for included services defined in paragraph 4 which are ancillary and subsidiary to the enjoyment of the property described in paragraph 3(b). Subparagraph (b) of paragraph 2 limits the source State's right to tax such payments to 10 percent of the gross amount during all years for which the Convention has effect.

Subparagraph (a) of paragraph 3 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, including cinematographic films or work on film, tape or other means of reproduction for use in connection with radio or television broadcasting, any patent, trademark, design or model, plan, secret formula or process, or for information concerning industrial, commercial, or scientific experience. The term "information concerning industrial, commercial, or scientific experience" alludes to the concept of know-how and means information that is not publicly available and that cannot be known from mere examination of a product and mere knowledge of the progress of technique. As provided in the Commentaries on the Articles of the OECD Model Convention (paragraph 12 of the Art. 12 Comm.): "In the know-how contract, one of the parties agrees to impart to the other, so that he can use them for his own account, his special knowledge and experience which remain unrevealed to the public".

The royalty definition under subparagraph (a) of paragraph 3 also applies to gains from the alienation of a right or property of the type described in that subparagraph only if the proceeds are contingent on the productivity, use, or further alienation thereof. Thus, a noncontingent payment for all rights to property described in subparagraph (a) is not a royalty.

The royalty definition in subparagraph (a) of paragraph 3 of the Convention differs from

the comparable provision in the U.S. Model in two respects. First, the Convention's royalty definition includes payments received in connection with the use or right to use cinematographic films or films or tapes used for radio or television broadcasting. Such payments are excluded from the royalty definition in the U.S. Model. Second, the Convention's royalty definition does not include "other like right or property" at the end of its listing of the types of rights for which a use payment is considered to be a royalty.

Subparagraph (b) of paragraph 3 includes within the definition of royalties payments of any kind received as consideration for the use of, or the right to use, any industrial, commercial, or scientific equipment, other than payments derived by an enterprise described in paragraph 1 of Article 8 (Shipping and Air Transport) from activities described in paragraph 2(c) or 3 of Article 8. The exclusion under Article 8 relates (1) to income of an enterprise engaged in the operation of ships or aircraft in international traffic to the extent the income is from the operation by that enterprise of ships or aircraft in international traffic or to the extent the income is incidental to such an activity and

(2) to profits of an enterprise engaged in the operation of ships or aircraft in international traffic from the use, maintenance, or rental of containers and container equipment in connection with the operation of ships or aircraft in international traffic.

Paragraph 4 of Article 12 defines fees for included services to mean payments of any kind to any person in consideration for the rendering of any technical or consultancy services (including through the provision of services of technical or other personnel) if such services either

(a) are ancillary and subsidiary to the application or enjoyment of the right, property or information for which a payment described in paragraph 3 is received; or

(b) make available technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design.

Paragraph 5 of Article 12 excludes from the definition of included services any amount described in any of the following categories:

(a) for services that are ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of property other than a sale described in paragraph 3(a);

(b) for services that are ancillary and subsidiary to the rental of ships, aircraft, containers or other equipment used in connection with the operation of ships or aircraft in international traffic;

(c) for teaching in or by educational institutions; (d) for services for the personal use of the individual or individuals making the payment; or

(e) to an employee of the person making the payments or to any individual or firm of individuals (other than a company) for professional services as defined in Article 15 (Independent Personal Services).

Thus, the relationship between Article 12 and Article 15 (Independent Personal Services) is clear. A payment to an individual or firm of individuals, such as a partnership, for professional services is not subject to tax under Article 12.

With respect to service fees that are described in paragraph 4 and not excluded under paragraph 5 ("included services"), Article 12 permits the source State to impose tax in an amount not to exceed the rate of tax on the gross amount under paragraph 2, if the fees are not attributable to a permanent establishment or fixed base in the other State. All services attributable to a permanent establishment or a fixed base (whether or not falling within the defined category of "included services") and all services other than those within the defined category of included services" are considered to be business profits, which are taxable in the source State only to the extent provided in Article 7 (Business Profits). The treatment of service fees provided under Article 12 is a departure from the domestic law of both Contracting States. Under Indian statutory law, a broad range of service fees (fees for technical, managerial or consultancy services performed anywhere) is subject to a 30 percent gross basis tax. Under U.S. statutory law, fees for services performed inside the United States are subject to tax on a net basis if effectively connected with a U.S. trade or business of a nonresident alien or foreign corporation or on a gross basis (30 percent) only if not effectively connected. Paragraph IV of the Protocol (Ad Article 12) clarifies that, where fees for included services may be taxed by the United States under Article 12 but are subject to net basis taxation under internal U.S. law, the level of that net basis taxation (or, where applicable, the sum of that net basis tax and the amount of the tax allowable under paragraph 1 of Article 14 (Permanent Establishment Tax) with respect to those fees) shall not exceed the gross basis tax limitations imposed by paragraph 2 of Article 12. The term "fees for included services" is new under the Convention and is defined in the Convention rather than in the domestic law of either Contracting State.

As explained in the Diplomatic Note Relating to the Memorandum of Understanding on Article 12, a memorandum of understanding was developed by the negotiators indicating how the provisions of the Article relating to the scope of "included services" are to be understood both by the competent authorities and by taxpayers in the Contracting States. As further explained in the Diplomatic Note, this memorandum of understanding represents the views of the Governments of both Contracting States when the Convention was signed. Both Governments anticipated that, as the competent authorities and taxpayers gain more experience with the concept of fees for included services, further guidance would be developed and made public.

The memorandum of understanding describes in some detail the category of services defined in paragraph 4 of Article 12 (Royalties and Fees for Included Services). It also provides examples of services intended to be covered within the definition of included services and those intended to be excluded, either because they do not satisfy the tests of paragraph 4, or because, notwithstanding the fact that they meet the tests of paragraph 4, they are dealt with under paragraph 5. The examples in either case are not intended as an exhaustive list but rather as illustrating a few typical cases. For ease of understanding, the examples in the Memorandum describe U.S. persons providing services to Indian persons, but the rules of Article 12 are reciprocal in application.

The memorandum of understanding first defines the terms "technical services" and "consultancy services", which are the only types of services that are considered "included services" if they are described in subparagraph (a) or (b) of paragraph 4 and are not excluded under paragraph 5. A technical service means a service requiring expertise in a technology. A

consultancy service means an advisory service. These two categories are to some extent overlapping because a consultancy service could also be a technical service. However, the category of consultancy services also includes an advisory service, whether or not expertise in a technology is required to perform it.

The memorandum of understanding next explains the conditions, either of which must exist before a service can be considered described in paragraph 4.

Under paragraph 4, technical and consultancy services are considered included services only to the following extent:

(1) as described in paragraph 4(a), if they are ancillary and subsidiary to the application or enjoyment of a right, property or information for which a royalty payment is made; or

(2) as described in paragraph 4(b), if they make available technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design. Thus, under paragraph 4(b), consultancy services which are not of a technical nature cannot be included services.

Paragraph 4(a) of Article 12 refers to technical or consultancy services that are ancillary and subsidiary to the application or enjoyment of any right, property1 or information for which a payment described in paragraph 3(a) or (b) is received. Thus, paragraph 4(a) includes technical and consultancy services that are ancillary and subsidiary to the application or enjoyment of an intangible for which a royalty is received under a license or sale as described in paragraph 3(a), as well as those ancillary and subsidiary to the application or enjoyment of industrial, commercial, or scientific equipment for which a royalty is received under a lease as described in paragraph 3(b).

It is understood that, in order for a service fee to be considered “ancillary and subsidiary” to the application or enjoyment of some right, property, or information for which a payment described in paragraph 3(a) or (b) is received, the service must be related to the application or enjoyment of the right, property, or information. In addition, the clearly predominant purpose of the arrangement under which the payment of the service fee and such other payment are made must be the application or enjoyment of the right, property, or information described in paragraph 3. The question of whether the service is related to the application or enjoyment of the right, property, or information described in paragraph 3 and whether the clearly predominant purpose of the arrangement is such application or enjoyment must be determined by reference to the facts and circumstances of each case. Factors which may be relevant to such determination (although not necessarily controlling) include:

1. the extent to which the services in question facilitate the effective application or enjoyment of the right, property, or information described in paragraph 3;

2. the extent to which such services are customarily provided in the ordinary course of business arrangements involving royalties described in paragraph 3;

3. whether the amount paid for the services (or which would be paid by parties operating at arm's length) is an insubstantial portion of the combined payments for the services and the right, property, or information described paragraph 3;

4. whether the payment made for the services and the royalty described in paragraph 3 are made under a single contract (or a set of related contracts); and

5. whether the person performing the services is the same person as, or a related person

to, the person receiving the royalties described in paragraph 3 (for this purpose, persons are considered related if their relationship is described in Article 9 (Associated Enterprises) or if the person providing the service is doing so in connection with an overall arrangement which includes the payer and recipient of the royalties).

To the extent that services are not considered ancillary and subsidiary to the application or enjoyment of some right, property, or information for which a royalty payment under paragraph 3 is made, such services shall be considered "included services" only to the extent that they are described in paragraph 4(b).

The memorandum of understanding presented two examples of the application of paragraph 4(a). The first example illustrates services that are "included services

Example (1)

Facts: U.S. manufacturer grants rights to an Indian company to use manufacturing processes in which the transferor has exclusive rights by virtue of process patents or the protection otherwise extended by law to the owner of a process. As part of the contractual arrangement, the U.S. manufacturer agrees to provide certain consultancy services to the Indian company in order to improve the effectiveness of the latter's use of the processes. Such services include, for example, the provision of information and advice on sources of supply for materials needed in the manufacturing process, and on the development of sales and service literature for the manufactured product. The payments allocable to such services do not form a substantial part of the total consideration payable under the contractual arrangement. Are the payments for these services fees for "included services"?

Analysis: The payments are fees for included services. The services described in this example are ancillary and subsidiary to the use of a manufacturing process protected by law as described in paragraph 3(a) of Article 12 because the services are related to the application or enjoyment of the intangible and the granting of the right to use the intangible is the clearly predominant purpose of the arrangement. Because the services are ancillary and subsidiary to the use of the manufacturing process, the fees for these services are considered fees for included services under paragraph 4(a) of Article 12, regardless of whether the services are described in paragraph 4(b).

Example 1 illustrates the application of paragraph 4(a) using services that are not also described in paragraph 4(b). These services are not described in section 4(b) because they do not make available technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design. The services described in Example 1 are limited to the provision of procurement and marketing information.

The second example illustrates services which are not "included services".

Example (2)

Facts: An Indian manufacturing company produces a product that must be manufactured under sterile conditions using machinery that must be kept completely free of bacterial or other harmful deposits. A U.S. company has developed a special cleaning process for removing such deposits from that type of machinery. The U.S. company enters into a contract with the Indian company under which the former will clean the latter's machinery on a regular basis. As part of the arrangement, the U.S. company leases to the Indian company a piece of equipment which allows the Indian company to measure the level of bacterial deposits on its machinery in order for it to know when cleaning is required. Are the payments for the services fees for included services?

Analysis: In this example, the provision of cleaning services by the U.S. company and the rental of the monitoring equipment are related to each other. However, the clearly predominant purpose of the arrangement is the provision of cleaning services. Thus, although the cleaning services might be considered technical services, they are not "ancillary and subsidiary" to the rental of the monitoring equipment. Accordingly, the cleaning services are not "included services within the meaning of paragraph 4(a).

Example 2 illustrates the treatment of a service that could be considered technical in nature but that is not described in paragraph 4(b) because it does not make available (as described below) to the purchaser technical knowledge or a technical plan, design or process. Because the service described in Example 2 is not "included services" within the meaning of example 4(a) or (b), it is not subject to tax under Article 12. The service is, therefore, taxable in India only to the extent provided under Article 7 (Business Profits) or Article 15 (Independent Personal Services).

Paragraph 4(b) of Article 12 refers to technical or consultancy services that make available to the person acquiring the service technical knowledge, experience, skill, know-how, or processes, or consist of the development and transfer of a technical plan or technical design to such person. The memorandum of understanding explains that, for this purpose, the person acquiring the service shall be deemed to include an agent, nominee, or transferee of such person. The category described in paragraph 4(b) is narrower than the category described in paragraph 4(a) because it excludes any service that does not make technology available to the person acquiring the service.

The memorandum of understanding states that generally technology will be considered "made available" when the person acquiring the service is enabled to apply the technology. The fact that the provision of the service may require technical input by the person providing the service does not per se mean that technical knowledge, skills, etc. are made available to the person purchasing the service, within the meaning of paragraph 4(b). Similarly, the use of a product which embodies technology shall not per se be considered to make the technology available.

As described in the memorandum of understanding, typical categories of services that

generally involve either the development and transfer of technical plans or technical designs, or making technology available as described in paragraph 4(b), include:

1. engineering services (including the subcategories of bioengineering and aeronautical, agricultural, ceramics, chemical, civil, electrical, mechanical, metallurgical, and industrial engineering);

2. architectural services; and

3. computer software development.

As explained in the memorandum of understanding, technical and consultancy services could make technology available in a variety of settings, activities and industries. Such services may, for example, relate to any of the following areas:

1. bio-technical services;
2. food processing;
3. environmental and ecological services;
4. communication through satellite or otherwise;
5. energy conservation;
6. exploration or exploitation of mineral oil or natural gas;
7. geological surveys;
8. scientific services; and
9. technical training.

The memorandum of understanding provides examples (Examples 3 - 12) in order to indicate the scope of the conditions in paragraph 4(b):

Example (3)

Facts: A U.S. manufacturer has experience in the use of a process for manufacturing wallboard for interior walls of houses which is more durable than the standard products of its type. An Indian builder wishes to produce this product for its own use. It rents a plant and contracts with the U.S. company to send experts to India to show engineers in the Indian company how to produce the extra-strong wallboard. The U.S. contractors work with the technicians in the Indian firm for a few months. Are the payments to the U.S. firm considered to be payments for "included services"?

Analysis: The payments would be fees for included services. The services are of a technical or consultancy nature; in the example they have elements of both types of services. The services make available to the Indian company technical knowledge, skill, and processes.

Example (4)

Facts: A U.S. manufacturer operates a wallboard fabrication plant outside India. An Indian builder hires the U.S. company to produce wallboard at that plant for a fee. The Indian company provides the raw materials, and the U.S. manufacturer fabricates the wallboard in its plant, using advanced technology. Arc the fees in

this example payments for included services?

Analysis: The fees would not be for included services. Although the U.S. company is clearly performing a technical service, no technical knowledge, skills, etc., are made available to the Indian company, nor is there any development and transfer of a technical plan or design. The U.S. company is merely performing a contract manufacturing service.

Example (5)

Facts: An Indian firm owns inventory control software for use in its chain of retail outlets throughout India. It expands its sales operation by employing a team of traveling salesmen to travel around the countryside selling the company's wares. The company wants to modify its software to permit the salesmen to access the company's central computers for information on what products are available in inventory and when they can be delivered. The Indian firm hires a U.S. computerprogramming firm to modify its software for this purpose. Are the fees which the Indian firm pays treated as fees for included services?

Analysis: The fees are for included services. The U.S. company clearly performs a technical service for the Indian company, and it transfers to the Indian company the technical plan (i.e., the computer program) which it has developed.

Example (6)

Facts: An Indian vegetable oil manufacturing company wants to produce a cholesterolfree oil from a plant which produces oil normally containing cholesterol. An American company has developed a process for refining the cholesterol out of the oil. The Indian company contracts with the U.S. company to modify the formulas which it uses so as to eliminate the cholesterol, and to train the employees of the Indian company in applying the new formulas. Are the fees paid by the Indian company for included services?

Analysis: The fees are for included services. The services are technical, and the technical knowledge is made available to the Indian company.

Example (7)

Facts: The Indian vegetable oil manufacturing firm has mastered the science of producing cholesterol-free oil and wishes to market the product worldwide. It hires an American marketing consulting firm to do a computer simulation of the world market for such oil advise it on marketing strategies. Are the to the U.S. company for included services?

Analysis: The fees would not be for included services. The American company is providing

a consultancy service which involves the use of substantial technical skill and expertise. It is not, however, making available to the Indian company any technical experience, knowledge or skill, etc., nor is it transferring a technical plan or design. What is transferred to the Indian company through the service contract is commercial information. The fact that technical skills were required by the performer of the service in order to perform the commercial information service does not make the service a technical service within the meaning of 4(b).

Examples 3, 5 and 6 illustrate services that would be described in paragraph 4(b). Example 3 refers to services that could be considered typical of the type of service that is described in that paragraph because the Indian builder is paying to have a technical process made available to it. Examples 5 and 6 illustrate other services, each of which is technical in nature under circumstances in which a technical process is made available to the purchaser.

Examples 4 and 7, however, do not illustrate a service that is described in paragraph 4(b) because, although performing each service requires technical knowledge and skill, no technical knowledge, plan, design or process is made available to the purchaser. In Example 4, the technical knowledge used in making wallboard is retained by the U.S. company acting as a contract manufacturer in the transaction. The Indian purchaser is paying for the manufacture of a product by the U.S. company -- a type of commercial service. Similarly, in Example 7, the technical knowledge required to complete a computer survey of the world market for a product is retained by the marketing consultant. The Indian purchaser is paying for a commercial service.

Under subparagraphs (a) through (e), paragraph 5 of Article 12 describes several categories of services which are not intended to be treated as included services even if they otherwise satisfy the tests of paragraph 4. The memorandum of understanding provides examples of cases where fees would be included under paragraph 4, but are excluded because of the application of one of the conditions of paragraph 5.

Example (8)

Facts: An Indian company purchases a computer from a U.S. computer manufacturer. As part of the purchase agreement, the manufacturer agrees to assist the Indian company in setting up the computer and installing the operating system, and to ensure that the staff of the Indian company is able to operate the computer. Also as part of the purchase agreement, the seller agrees to provide, for a period of ten years, any updates to the operating system and any training necessary to apply the update. Both of these service elements to the contract would qualify under paragraph 4(b) as an included service. Would either or both be excluded from the category of included services, under paragraph 5(a), because they are ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of the computer?

Analysis: The installation assistance and initial training are ancillary and subsidiary to the

sale of the computer, and they are also inextricably and essentially linked to the sale. The computer would be of little value to the Indian purchaser without these

services, which are most readily and usefully provided by the seller. The fees for installation assistance and initial training, therefore, are not fees for included services, since these services are not the predominant purpose of the arrangement.

The services of updating the operating system and providing associated necessary training may well be ancillary and subsidiary to the sale of the computer but they are not inextricably and essentially linked to the sale Without the upgrades, the computer will continue to operate as it did when purchased, and will continue to accomplish the same functions. Acquiring the updates cannot, therefore, be said to be inextricably and essentially linked to the sale of the computer.

Example (9)

Facts: An Indian hospital purchases an X-ray machine from a U.S. manufacturer. As part of the purchase agreement, the manufacturer agrees to install the machine, to perform an initial inspection of the machine in India, to train hospital staff in the use of the machine, and to service the machine periodically during the usual warranty period (2 years). Under an optional service contract purchased by the hospital, the manufacturer also agrees to perform certain other services throughout the life of the machine, including periodic inspections and repair services, advising the hospital about developments in X-ray film or techniques which could improve the effectiveness of the machine, and training hospital staff in the application of those new developments. The cost of the initial installation, inspection, training, and warranty service is relatively minor as compared with the cost of the X-ray machine. Is any of the service described here ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of the x-ray machine?

Analysis: The initial installation, inspection, and training services in India and the periodic service during the warranty period are ancillary and subsidiary, as well as inextricably and essentially linked, to the sale of the X-ray machine because the usefulness of the machine to the hospital depends on this service, the manufacturer has full responsibility during this period, and the cost of the services is a relatively minor component of the contract. Therefore, under paragraph 5(a) these fees are not fees for included services, regardless of whether they otherwise would fall within paragraph 4(b).

Neither the post-warranty period inspection and repair services, nor the advisory and training services relating to new developments are "inextricably and essentially linked" to the initial purchase of the X-ray machine. Accordingly, fees for these services may be treated as fees for included services if they meet the tests of paragraph 4(b).

Example (10)

Facts: An Indian automobile manufacturer decides to expand into the manufacture of

helicopters. It sends a group of engineers from its design staff to a course of study conducted by MIT for two years to study aeronautical engineering. The Indian firm pays tuition fees to MIT on behalf of the firm's employees. Is the tuition fee a fee for an included service within the meaning of Article 12?

Analysis: The tuition fee is clearly intended to acquire a technical service for the firm. However, the fee paid is for teaching by an educational institution, and is, therefore, under paragraph 5(c), not an included service. It is irrelevant for this purpose whether MIT conducts the course on its campus or at some other location.

Example (11)

Facts: As in Example (10), the automobile manufacturer wishes to expand into the manufacture of helicopters. It approaches an Indian university about establishing a course of study in aeronautical engineering. The university contracts with a U.S. helicopter manufacturer to send an engineer to be a visiting professor of aeronautical engineering on its faculty for a year. Are the amounts paid by the university for these teaching services fees for included services?

Analysis: The fees are for teaching in an educational institution. As such, pursuant to paragraph 5(c), they are not fees for included services.

Example (12)

Facts: An Indian wishes to install a computerized system in his home to control lighting, heating and air conditioning, a stereo sound system and a burglar and fire alarm system. He hires an American electrical engineering firm to design the necessary wiring system, adapt standard software, and provide instructions for installation. Are the fees paid to the American firm by the Indian individual fees for included services?

Analysis: The services in respect of which the fees are paid are of the type which would generally be treated as fees for included services under paragraph 4(b). However, because the services are for the personal use of the individual making the payment, under paragraph 5(d) the payments would not be fees for included services.

Paragraph 6 of Article 12 provides an exception from the applicability of paragraphs 1 and 2. This exception applies 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 royalties or fees for included services are attributable to such permanent establishment or fixed base. In such cases the provisions of Article 7 (Business profits) or Article 15 (Independent personal Services) will apply and the source State will generally retain the right to tax such royalties on a net basis rather than a gross basis.

Paragraph III of the Protocol elaborates on paragraph 6 by incorporating into the Convention the principle of Code section 864(c)(6). Like the Code section on which it is based, Paragraph III of the Protocol provides that any income or gain attributable to a permanent establishment or fixed base during its existence is taxable in the Contracting State where the permanent establishment or fixed base is situated even if the payments are deferred until after the permanent establishment or fixed base no longer exists.

Paragraph 7 of Article 12 provides source rules for royalties and fees for included services. Under subparagraph (a), royalties and fees for included services will be deemed to arise in a contracting State when the payer is that State itself, a political subdivision, a local authority, or a resident of that State. Where the payer is a nonresident of a Contracting State that has a permanent establishment or fixed base in the Contracting State in connection with which the liability to pay the royalties and fees for related services, was incurred and the amounts are borne by the permanent establishment or fixed base, then the royalties and fees will be deemed to arise in the Contracting State in which the permanent establishment or fixed base is situated. Thus a royalty payment by a resident of India is sourced in India unless the payer has a permanent establishment or fixed base in the United States and the payment is both in satisfaction of a liability incurred in connection with the permanent establishment or fixed base and borne by the permanent establishment or fixed base.

Under subparagraph (b), a royalty that does not arise in one of the Contracting States under subparagraph (a) and that relates to the use of, or the right to use, a right or property in one of the Contracting States will be deemed to arise in that State. Similarly, a fee for included services that does not arise in one of the Contracting States under subparagraph (a) and that relates to services performed in one of the Contracting States will be deemed to arise in that State. Thus, for example, a royalty that is paid by an individual who is an Indian citizen and German resident will be deemed to arise in India if the payment is for the use of a right in India, even if the German resident has no permanent establishment or fixed base in India. Such a royalty will be deemed to arise in the United States if it is for the use of a right in the United States.

Paragraph 8 provides that, in cases involving special relationships between the payer 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 India, respectively, with due regard to the other provisions of the Convention. Thus, for example, if 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 and the tax imposed on the dividend payment would be subject to the rate limitations of paragraph 2 of Article 10 (Dividends).

Notwithstanding the foregoing limitations on source country taxation of royalties, paragraph 3 of Article 1 (General Scope) permits the United States to tax its citizens and residents as if the Convention had not come into effect.