Article 24 ensures that source — U.S. Income Tax Treaty

to the Convention are limited to the intended beneficiaries -- residents of the other Contracting State -- and are not extended indirectly to residents of third States not having a substantial business in, or business nexus with, the other Contracting State. For example, a resident of a third State might establish an entity resident in a Contracting State for the purpose of deriving income from the other Contracting State and claiming source State benefits with respect to that income. Absent Article 24, the entity would generally be entitled to benefits as a resident of a Contracting State, subject, however, to such limitations (e.g., business purpose, substance-overform, step transaction or conduit principles) as may be applicable to the transaction or arrangement under the domestic law of the source State.

Paragraph 1 provides a two-part test, the so-called ownership and base erosion tests, both of which must be met by a person (other than an individual) if that person is to be entitled to benefits under this paragraph. If a person fails to qualify under this paragraph, benefits may still be granted if the person qualifies under the provisions of paragraphs 2 through 4. Under the tests of paragraph 1, benefits will be granted to a resident of a Contracting State, such as a corporation, partnership or trust, if both

(1) more than 50 percent of the beneficial interest in the person (or in the case of a corporation, more than 50 percent of each class of its shares) is owned, directly or indirectly, by individuals who are subject to tax in one of the Contracting States on worldwide income, or by one of the Contracting States, its political subdivisions or local authorities, and

(2) the person's income is not used in substantial part, directly or indirectly, to meet liabilities (including liabilities for interest or royalties) in the form of deductible payments to

persons, other than persons who are residents of a Contracting State, U.S. citizens, or a Contracting State, political subdivision or local authority.

The first test would be satisfied if a corporation claiming benefits is owned by another corporation which itself is owned (either directly or through additional tiers) by individual residents of a Contracting State, or other qualified owners under subparagraph 1(a). The term "substantial" is not defined. Deductible payments which are less than 50 percent of the relevant income, however, will generally not be considered substantial, although in appropriate circumstances a lower percentage of income will be considered substantial. It is understood that the term "income", as used in subparagraph (b) is to be interpreted as "gross income" under U.S. law, as determined without regard to the residence of the income recipient. Thus, in general, the tern should be understood to mean gross receipts less cost of goods sold.

The rationale for this two-part test is that since treaty benefits can be indirectly enjoyed not only by equity holders of an entity, but also by that entity's various classes of obligees, such as lenders, licensors, service providers, insurers and reinsurers, and others, it is not enough, in order to prevent such benefits from inuring substantially to third-country residents, merely to require substantial ownership of the entity by treaty country residents or their equivalent. It is also necessary to require that the entity's deductible payments be made in substantial part to such treaty country residents or their equivalents. For example, a third-country resident could lend funds to an Indian-owned Indian corporation to be reloaned to the United States. The U.S. source interest income of the Indian corporation would be subject to reduced U.S. withholding tax under Article 11 (Interest) of the Convention. While the Indian corporation would be subject to Indian corporation income tax, its taxable income could be reduced to near zero by the deductible interest paid to the third-country resident. If, under a Convention between India and the third country, that interest is subject to reduced Indian tax, a substantial portion of the U.S. treaty benefit with respect to the U.S. source interest income will have flowed to the third-country resident.

Under paragraph 1, individuals who are residents of a Contracting State are, without further testing, entitled to benefits. It is most unlikely that an individual would be used to derive treaty-benefited income, as the beneficial owner of the income, on behalf of a third-country person. If an individual is receiving income as a nominee on behalf of a third-country resident, benefits will be denied with respect to those items of income under the articles of the Convention which grant the benefit, because of the requirements in those articles that the beneficial owner of the income be a resident of a Contracting State.

Paragraph 2 provides a test for eligibility for benefits which looks not solely at objective characteristics of the person deriving the income, but at the nature of the activity engaged in by that person and the connection between the income and that activity. Under the paragraph, a resident of a Contracting State deriving income from the other Contracting State is entitled to benefits, regardless of the income recipient's ownership, if the recipient is engaged in an active trade or business in its State of residence, and the item of income in question is derived in connection with, or is incidental to, that trade or business. The U.S. tax authorities can be expected to interpret this provision with some flexibility. Thus, for example, if an Indian parent corporation derives income from a U.S. subsidiary, and the income is derived in connection with

activities in India carried on by an Indian subsidiary of the parent, the business connection would be deemed to be present. Income which is derived in connection with, or is incidental to, the business of making or managing investments will not qualify for benefits under this provision, unless the business is a bank or insurance company engaged in banking or insurance activities.

In general, it is expected that if a person qualifies for benefits under paragraphs 1 or 3, no inquiry will be made into whether the person qualifies for benefits under paragraph 2. If any of the other tests of Article 24 are satisfied, all items of income derived by the beneficial owner from the other Contracting State are entitled to treaty benefits. Under paragraph 2, however, the test is applied separately for each item of income.

It is intended that the provisions of paragraph 2 will be self-executing. Unlike the provisions of paragraph 4, discussed below, claiming benefits under this paragraph does not require advance competent authority ruling or approval. The tax authorities may, of course, on review, determine that the taxpayer has improperly interpreted the paragraph and is not entitled to the benefits claimed.

Under paragraph 3, a corporation which is a resident of a Contracting State is entitled to treaty benefits from the other Contracting State if there is substantial and regular trading in the corporation's principal class of shares on-a recognized stock exchange. Benefits are granted to such a corporation whether or not the ownership and base erosion tests of paragraph 1, or the business connection tests of paragraph 2, are met. The term recognized stock exchange" is defined in paragraph 3 of the Article to mean, in the United States, the NASDAQ System and any stock exchange which is registered as a national securities exchange with the Securities and Exchange Commission, and, in India, any stock exchange which is recognized by the Central Government under the Securities Contracts Regulation Act, 1956. The competent authorities may, by mutual agreement, recognize additional exchanges for purposes of paragraph 3.

Paragraph 4 provides that a resident of a Contracting State that derives income from the other Contracting State and is not entitled to the benefits of the Convention under other provisions of the Article may, nevertheless, be granted benefits at the discretion of the competent authority of the Contracting State in which the income arises.

The paragraph itself provides no guidance to competent authorities or taxpayers as to how the discretionary authority is to be exercised. It is understood, however, that in making determinations under paragraph 2, the competent authorities will take into account all relevant facts and circumstances. The factual criteria which the competent authorities are expected to take into account include the existence of a clear business purpose for the structure and location of the income earning entity in question; the conduct of an active trade or business (as opposed to a mere investment activity) by such entity; and a valid business nexus between that entity and the activity giving rise to the income.

It is assumed that, for purposes of implementing paragraph 2, a taxpayer will be permitted to present his case to the source State's competent authority for an advance determination based on the facts, and will not be required to wait until the tax authorities of one of the Contracting States have determined that benefits are denied. In these circumstances, it is

also expected that if the competent authority determines that benefits are to be allowed, they will be allowed retroactively to the time of entry into force of the relevant treaty provision or the establishment of the structure in question, whichever is later, provided that the taxpayer is otherwise entitled to claim such retroactive benefits.