Article 14 provides — U.S. Income Tax Treaty

establishment or branch tax. Paragraph 1 of Article 14 confirms the right of the United States to impose a tax on the deemed distribution of certain profits of an Indian resident corporation with a U.S. trade or business and on the excess interest of such a corporation. Paragraphs 2 and 3, respectively, of Article 14 confirm the right of India to subject a U.S. company to tax in India at a rate higher than that applicable to Indian companies and to tax the Interest paid to a banking company's head office by a permanent establishment in India of the U.S. bank.

The base of the U.S. permanent establishment tax described in subparagraph (a)(i) of paragraph 1 is the "dividend equivalent amount". The Convention does not define this term, which is defined under section 884(b) of the Code and the regulations thereunder. Generally the dividend equivalent amount is the earnings and profits of the foreign corporation that are effectively connected with the conduct of its trade or business in the United States after payment of the corporate income tax, decreased by any increase during the taxable year in the corporation's U.S. assets ("U.S. net equity") or increased by any decrease in its U.S. net equity.

Under the Convention, the dividend equivalent amount is roughly the amount that would be distributed as a dividend if the permanent establishment were operating as a locally incorporated subsidiary, subject to several adjustments. The dividend equivalent amount is determined taking into account not only effectively connected profits (or profits that are deemed to be effectively connected) that are attributable to a permanent establishment in the United States but also profits from the disposition or operation of real estate which are subject to net basis income taxation in the United States under Article 6 (Income from Immovable Property

(Real Property)) or Article 13 (Gains), as well as fees for included services if the United States is permitted to tax them under Article 12 (Royalties and Fees for Included Services).

Paragraph V of the Protocol (Ad Article 14) emphasizes that such profits described in Articles 6, 12, 13, are only taken into account in paragraph 1 to the extent to which the profits are subject to U.S. tax based on net income (i.e., by virtue of being effectively connected, or being treated as effectively connected, with the conduct of a trade or business in the United States). Any income which is subject to tax under those Articles based on gross income is not subject to tax under Article 14.

Determining the dividend equivalent amount taking into account fees for included services that are not attributable to a permanent establishment of an Indian company in the United States is appropriate because India imposes a high gross basis tax on such fees paid to a U.S. company to the extent the fees are not attributable to a permanent establishment of the company in India. The total U.S. tax imposed with respect to fees for such included services may not exceed the limitation provided under paragraph 2 of Article 12.

Thus, for example, the United States may impose a permanent establishment tax under subparagraph (a)(i) of paragraph 1 on the business profits of an Indian company attributable to a permanent establishment in the United States. In addition. the United States may impose this tax on income of an Indian corporation that is, in accordance with the Convention, subject to taxation under internal U.S. law on a net basis either because the Indian corporation has elected under Code section 882(d) to treat income from real property not otherwise taxed on a net basis as effectively connected income or because the income is gain which is taxable on a net basis, such as gain that arises from the disposition of a United States Real Property Interest (although not including, under current U.S. law, an interest in a United States corporation). Finally, the United States may impose this tax on income from services that are subject to U.S. tax under Article 12. The United States may not impose its branch tax on the business profits of an Indian corporation that are effectively connected with a U.S. trade or business but that are not included within any of the above-described categories.

The rationale for the net equity adjustment to the permanent establishment tax provided in subparagraph (a)(i) of paragraph 1 is that the corporation decreases the amount of earnings available to the home office to the extent it increases its U.S. net equity (i.e., to the extent it reinvests its U.S. earnings in its U.S. business). Conversely, the corporation increases the amount of earnings available to the home office to the extent it decreases its U.S. net equity (i.e., to the extent it withdraws from the United States its previously reinvested earnings).

Subparagraph (a)(ii) of paragraph 1 provides for the imposition of the U.S. tax on excess interest. Under section 884(f)(l)(B) of the Code, excess interest is the excess of the total amount allowable as a deduction in computing the U.S. effectively connected income of a foreign corporation over the total interest paid by the foreign corporation's U.S. trade or business. Under the Convention, the tax on excess interest applies only to the excess of interest which is deductible

(1) in computing the U.S. tax on net profits that are attributable to a permanent establishment of an Indian corporation in the United States and

(2) in computing the U.S. tax on net income or gain from real property (although not including, under current U.S. law, gain on shares in a domestic corporation) and fees for included services, over the interest paid by the foreign corporation's U.S. permanent establishment or U.S. trade or business. It is understood that interest paid is determined without regard to capitalized interest. The excess interest tax can be viewed as a withholding tax on deemed

interest payments from the U.S. branch of a foreign corporation to its head office.

Subparagraph (c)(i) of paragraph 1 provides that the rate applicable to the permanent establishment tax described in subparagraph (a)(i) shall not exceed the rate provided in paragraph 2(a) of Article 10 (Dividends). Thus, the rate shall not exceed 15 percent of the dividend equivalent amount.

Subparagraph (c)(ii) of paragraph 1 provides that the rate applicable to the excess interest tax described in subparagraph (a)(ii) shall not exceed the rate specified in paragraph 2(a) or (b) of Article 11 (Interest). Thus, the rate shall not exceed 10 percent if imposed on a bank carrying on a bona fide banking business or a similar financial institution (including an insurance company); the rate shall not exceed 15 percent in all other cases.

In the case of India, paragraph 2 provides that a company which is a resident of the United States may be subject to tax in India at a rate higher than that applicable to Indian companies. The maximum difference between the tax rate imposed on a U.S. and an Indian company shall not, however, exceed the difference of 15 percentage points that existed at the time the treaty was signed.

Under paragraph 3, India may impose a tax on interest considered under Indian law to be paid by a permanent establishment in India of a banking company that is a U.S. resident to the head office of such company. However, the rate shall not exceed the rate specified in paragraph 2(a) of Article 11 (Interest). Thus, the rate shall not exceed 10 percent. Such interest is deductible in determining the profits of the banking company's permanent establishment in India under Indian law and paragraph 3 of Article 7 (Business Profits).