ARTICLE 7

Source of Income

This Article provides rules for determining the source of items of income covered by the Convention. It is important in implementing the general rule set forth in paragraph 1 of Article 28 (General Rules of Taxation) that a contracting State may tax a resident of the other State only on income derived from Sources in the first-mentioned State. Paragraph 1 of Article 23 (Relief from Double Taxation) allows the United States to apply the source rules of the Internal Revenue

Code, rather than the source rules of this Article, solely for the purpose of limiting the foreign tax credit to income from sources without the United States.

Dividends paid by a resident of a Contracting State have their source in that State.

Interest paid by a resident of a Contracting State, or by that State or a political subdivision or local authority thereof, generally has its source in that State. However, if the person paying the interest has a permanent establishment in one of the Contracting States and the permanent establishment bears the interest payment, the interest has its source where the permanent establishment is situated. This rule applies whether or not the person paying the interest is a resident of one of the Contracting States; it would apply, for example, to interest paid by a bank incorporated in a third country which is borne by a branch of that bank in Indonesia or the United States. For this purpose, interest is "borne" by a permanent establishment if it is deductible by the permanent establishment.

Royalties, as defined in Article 13 (Royalties), have their source in the State where the right or property giving rise to the royalty is used.

Income from immovable property has its source where the property is situated.

Income from the rental of tangible personal property (movable property) also has its source where the property is situated, except in the case of ships, aircraft or containers used in international traffic. Income from the rental of such Ships, aircraft or containers is either taxable only in the State of residence under Article 9 (Shipping and Air Transport) or is defined as a royalty under Article 13 (Royalties) and sourced accordingly.

Income derived by an individual for personal services has its source where the services are performed. An exception applies to remuneration for services performed by the crew of a ship or aircraft used in international traffic, which has its source in the State of residence of the operator of the ship or aircraft. Pensions and similar remuneration from private Sector employers paid with respect to past services are sourced where the services were performed. This rule does not apply to payments covered by Article 22 (Social Security Payments), which are sourced in a Contracting State if paid out of public funds of that State or a political subdivision or local authority thereof. (The source rule says "only" if paid out of public funds; but since Article 22 defines such payments as made from public funds, this will always be the case.)

Income from the disposition of a U.S. real property interest or of an interest in real property situated in Indonesia is treated as income from sources in the United States or Indonesia, respectively.

Notwithstanding the above rules, income which is attributable to a permanent establishment in a Contracting State is treated as income from sources in that State, provided that the property or right giving rise to the income is effectively connected with that permanent establishment.

The source of any item of income not specified in this Article is determined under the

domestic laws of the respective States. If the result under the domestic laws is unclear or differs, the competent authorities may establish a common source rule for purposes of the Convention. This approach differs from the position of the U.S. Model, which establishes taxing rules for specified types of income and reserves to the State of residence the taxation of income for which a specific taxing rule is not provided. However, some conventions, especially with developing countries, allow taxation of such residual income in the State of source as well. (See, for example the U.S. Income Tax Conventions with Barbados and Jamaica. The proposed treaty with India also contains such a provision.) In such a case, the result is essentially the same as under this Article.