ARTICLE 8

Business Profits

This Article provides rules for the taxation by a Contracting State of income from business activity carried on by a resident of the other State.

Paragraph 1 provides that the business profits of a resident of a Contracting State shall be taxable only by that State unless the resident carries on business in the other Contracting State through a permanent establishment there. If the enterprise has a permanent establishment in the other Contracting State, that other State may tax the portion of the enterprise's business profits which is attributable either to the permanent establishment itself, or to sales in that other State of goods or merchandise of the same kind as those sold through the permanent establishment, or to other business transactions carried on in that other State which are of the same kind as those effected through the permanent establishment. The reference to similar transactions, which is taken from the U.N. Model Convention, gives the State in which the permanent establishment is situated a broader taxing right over the business profits of an enterprise of the other State than under the U.S. or OECD Model Conventions, but it is narrower than the limited "force of attraction" rule of Code Section 864(c)(3).

Paragraph 2 provides that the profits to be attributed to the permanent establishment are those which it might be expected to make if it were an independent entity engaged in the same or similar activities under the same or similar conditions and dealing on an arm’s-length basis with its home office. The term "attributable to" means that, subject to the rules described above, the limited "force-of-attraction" rule of Code section 864(c)(3) does not apply for U.S. tax purposes under the Convention. Profits may, however, be from sources within or without a Contracting State and be "attributable to" a permanent establishment. Thus, for example, items of income described in Section 864(c)(4) of the Code which are attributable to a permanent establishment in the United States are subject to tax by the United States.

Paragraph 3 provides that there shall be allowed as deductions those expenses reasonably connected with the income of the permanent establishment, whether incurred in the State where the permanent establishment is located or elsewhere. Deductible expenses include a reasonable allocation to the permanent establishment of administrative and executive expenses. A portion of research and development expenses, interest, and other expenses incurred by the home office for purposes of the enterprise as a whole may be deductible by the permanent establishment if they

are reasonably connected with its profits. The paragraph adds the provision of the U.N. Model that payments of interest, royalties, fees and commissions by a permanent establishment to its home office are not deducted in determining the profits of the permanent establishment except to the extent that they represent reimbursement of costs incurred (i.e., no profit is permitted on Such payments).

Paragraph 4 provides that the mere purchase by a permanent establishment of goods or merchandise for the resident of which it is a permanent establishment shall not result in profits being attributed to the permanent establishment.

Paragraph 5 provides that, where business profits include items of income dealt with separately in other articles of the Convention, the provisions of those separate articles supersede the provisions of this Article. Thus, for example, the taxation of income from international shipping and air transport is dealt within Article 9 (Shipping and Air Transport). The taxation of dividends, interest, and royalties is controlled by Articles 11 (Dividends), 12 (Interest), and 13 (Royalties); however, those Articles provide that, where the assets giving rise to dividends, interest, or royalties derived by a resident of a Contracting State are effectively connected with a permanent establishment or fixed base of that resident in the other Contracting State, the resulting income is taxable on a net basis in that other State in accordance with this Article or Article 15 (Independent Personal Services).