ARTICLE 28

General Rules of Taxation

Paragraph 1 states the general rule that a Contracting State may tax a resident of the other Contracting State only with respect to income derived from sources in the first-mentioned State. The source rules to be used for this purpose are contained in Article 7 (Source of Income).

Paragraph 2 States the general rule that the Convention is intended to benefit taxpayers and not to make them worse off than they would be in its absence. Thus, a taxpayer may always elect to apply the rules of domestic law or of another agreement between the Contracting States in lieu of the treaty rules. A taxpayer may not, however, make inconsistent choices between the rules of the Code and the rules of the Convention. For example, a taxpayer may not choose to apply the Convention's permanent establishment rules to one U.S. business operation and the Code trade or business rules to another to vary the treatment of profitable and loss operations, but it could apply the trade or business rules to all U.S. business operations and claim the reduced withholding rats under the Convention on U.S. dividends not effectively connected with a U.S. trade or business.

Paragraph 3 provides a "saving clause" which excepts the residents or citizens of a Contracting State from treaty benefits conferred by that States. Each State also preserves its right to tax certain former citizens under domestic law. (The latter provision, which is currently applicable only to the United States, preserves the taxing rules of Internal Revenue Code section 877.) Residence is defined under Article 4 (Fiscal Residence) for all purposes of the Convention, including this provision. Thus, a U.S. resident alien, who under the Convention is determined to be a resident of Indonesia, is a resident of Indonesia for all purposes of the Convention, including the limitations of tax at source provided, for example, in Article 11 (Dividends). A U.S. citizen resident in Indonesia under the Convention generally remains subject to U.S. tax on his worldwide income in accordance with the rules of the Internal Revenue Code.

Paragraph 4 provides certain exceptions to the saving clause of paragraph 3. U.S. residents, as determined under Article 4 (Fiscal Residence), and U.S. citizens are entitled to certain treaty benefits provided by the United States. Those benefits are the right to correlative adjustments of tax provided under paragraph 3 of Article 10 (Related Persons), the exemption from tax at source of alimony and child support payments provided under paragraph 3 of Article 21 (Private Pensions and Annuities), the exemption from tax in the country of residence of social security benefits from the other Contracting State provided in Article 22 (Social Security Payments), the foreign tax credit as provided in Article 23 (Relief from Double Taxation), and the provisions of Articles 24 (Non-discrimination) and 25 (Mutual Agreement Procedure).

Paragraph 4(b) provides that individuals who are not U.S. citizens and are not permanent immigrants to the United States ("green card" holders) are entitled to the treaty benefits granted by the United States to individuals working for or retired from the Indonesian government under Article 18 (Government Service), students end trainees under Article 19 (Students and Trainees),

teachers and researchers under Article 20 (Teachers and Researchers), and diplomatic and consular officers under Article 27 (Diplomatic and Consular Officers). This subparagraph applies only to persons who were residents of Indonesia when they came to the United States but become, under Article 4 of the Convention, residents of the United States. This might happen, for example, in the case of a trainee. The guarantee of treaty benefits provided in this subparagraph has become less important than under the law in effect when this provision was negotiated, because under the definition of residence introduced in section 7701 of the Internal Revenue Code in 1984 such individuals typically will not be considered U.S. residents under U.S. law.

Paragraph 5 confirms that each country may prescribe regulations to carry out the provisions of the Convention. In general, this technical explanation takes the place of regulations with respect to application of the Convention by the United States.

Paragraphs 6 and 7 provide rules to prevent treaty shopping" by parsons not intended to benefit from the provisions of the Convention. Paragraph 6 provides that a resident of a Contracting State, other than an individual, may not claim benefits under the Convention unless it meets two conditions. More than 50 percent of the beneficial interest in such person, (or more than 50 percent of the number of shares of each class of Shares in the case of a company) must be owned by any combination of individual U.S. residents and citizens, individual residents of Indonesia, publicly traded companies, and the Governments of the United States and Indonesia. In addition, the income of such person may not be used in substantial part, directly or indirectly, to meet liabilities to persons other than the kinds of persons identified above. The purpose of the second condition is to prevent residents of third countries from setting up a company in a Contracting State which meets the ownership requirements but which pays out a large share of its income through deductible expenses, such as interest and royalties, to third country residents. It is not meant to deny benefits to companies which, for business reasons, purchase supplies from third countries; the focus is on liabilities for interest, royalties and certain compensation, not on the cost of goods sold. This intent is confirmed in paragraph 7 which excepts from the conditions of paragraph 6 companies which are either publicly traded or which have a genuine business purpose and are not established or operated with a principal purpose of obtaining benefits under the Convention.

Paragraph 7 recognizes that a company which is a resident of a Contracting State may be primarily owned by residents of third countries and/or may make substantial deductible payments to residents of third countries in the ordinary course of business. Companies whose residence in a Contracting State does not have a principal purpose obtaining benefits under the Convention, i.e., which are established there for valid business purposes, are entitled to such benefits. Companies whose principal class of shares is regularly traded in substantial volume on a recognized stock exchange are presumed to satisfy this business purpose condition.

Paragraph 8 defines the recognized exchanges for this purpose and authorizes the competent authorities to agree on additional stock exchanges in the future as appropriate. Although the Convention does not preclude agreement on an exchange in a third country, it is anticipated that any additional exchanges agreed upon would be in either the United States or Indonesia.