ARTICLE 8

Shipping and Air Transport

This Article governs the taxation of profits from the operation of ships and aircraft in international traffic. The term "international traffic" is defined in subparagraph 1(d) of Article 3 (General Definitions). The taxation of gains from the alienation of ships, aircraft or containers is not dealt with in this Article but in paragraph 3 of Article 13 (Capital Gains).

Paragraph 1

Paragraph 1 provides that profits derived by an enterprise of a Contracting State from the operation in international traffic of ships or aircraft are taxable only in that Contracting State. Because paragraph 7 of Article 7 (Business Profits) defers to Article 8 with respect to shipping income, such income derived by a resident of one of the Contracting States may not be taxed in the other State even if the enterprise has a permanent establishment in that other State. Thus, if a U.S. airline has a ticket office in Italy, Italy may not tax the airline's profits attributable to that office under Article 7. Since entities engaged in international transportation activities normally will have many permanent establishments in a number of countries, the rule avoids difficulties that would be encountered in attributing income to multiple permanent establishments if the income were covered by Article 7 (Business Profits).

The income from the operation of ships or aircraft in international traffic that is exempt from tax under paragraph 1 is defined in paragraph 7 of Article 1 of the Protocol. This paragraph is identical to the corresponding paragraph of the prior Convention. Subparagraph 7(a), consistent with paragraph 3 of Article 8 of the U.S. Model, explains that such income includes profits from the use, maintenance, or rental of containers (including trailers, barges, and related equipment for the transport of containers) used for the transport in international traffic of goods or merchandise. For example, if a U.S. resident leases containers for the international traffic of goods or merchandise, the rental income therefrom is exempt from tax in Italy, regardless of whether or not the leasing is incidental to the U.S. lessor’s operation of ships or aircraft in international traffic.

Subparagraph 7(b) of Article 1 of the Protocol provides that income from the operation of ships or aircraft in international traffic also includes profits derived from the rental of ships or aircraft on a full (time or voyage) basis. As in the prior Convention and the OECD Model (see paragraph 5 of the OECD Commentary to Article 8), but unlike the U.S. Model, profits derived from the rental of ships or aircraft on a bareboat basis are treated as income from the operation in international traffic of ships or aircraft only if such rental profits are incidental to other profits from the operation of ships or aircraft in international traffic. For example, if a U.S. airline which operates internationally leases a plane on a bareboat basis to an Italian airline, the rental income derived by the U.S. company is exempt from Italian tax under Article 8. However, if the U.S. airline otherwise operates only within the United States, or if a U.S. bank leases the plane to the Italian airline, that rental income is not exempt under this Article.

Income from the rental of ships, aircraft or containers which is not exempt from tax under this Article is taxable in accordance with Article 12 (Royalties) or, if attributable to a permanent establishment, in accordance with Article 7 (Business Profits). Under Article 12, the rental

income is considered to have its source in a Contracting State if the payer of the rental is a resident of that State or if the rental payment is for the use of the property in that State. For example, if a U.S. bank leases a plane on a bareboat basis to an Italian airline, the rental payment is of Italian source. If the bank leases the plane to a U.S. airline for use between New York and Rome, the portion of the rental payment attributable to the use of the plane within Italian territory is of Italian source. The tax at source on such leasing income is limited under subparagraph 2(a) of Article 12 to 5 percent of the gross rental.

Although not explicitly stated, consistent with the Commentary to Article 8 of the OECD Model, it is understood that income earned by an enterprise from the inland transport of property or passengers within either Contracting State falls within Article 8 if the transport is undertaken as part of the international transport of property or passengers by the enterprise. Thus, if a U.S. shipping company contracts to carry property from Italy to a U.S. city and, as part of that contract, it transports the property by truck from its point of origin to an airport in Italy (or it contracts with a trucking company to carry the property to the airport) the income earned by the U.S. shipping company from the overland leg of the journey would be taxable only in the United States. Similarly, Article 8 also would apply to income from lighterage undertaken as part of the international transport of goods.

Finally, certain non-transport activities that are an integral part of the services performed by a transport company are understood to be covered in paragraph 1. These include, for example, the performance of some maintenance or catering services by one airline for another airline, if these services are incidental to the provision of those services by the airline for itself. Income earned by concessionaires, however, is not covered by Article 8. These interpretations of paragraph 1 also are consistent with the Commentary to Article 8 of the OECD Model.

Paragraph 8 of Article 1 of the Protocol, which is carried over from the prior Convention, provides that Italy will provide an exemption for profits which a national of the United States not resident in Italy or a United States corporation derives from operating ships documented or aircraft registered under the laws of the United States. This exception would apply without regard to whether the income was derived from the operation of such ships or aircraft in “international traffic”.

Paragraph 2

This paragraph clarifies that the provisions of paragraph 1 also apply to profits derived by an enterprise of a Contracting State from participation in a pool, joint business or international operating agency. This refers to various arrangements for international cooperation by carriers in shipping and air transport. For example, airlines from two countries may agree to share the transport of passengers between the two countries. They each will fly the same number of flights per week and share the revenues from that route equally, regardless of the number of passengers that each airline actually transports. Paragraph 2 makes clear that with respect to each carrier the income dealt with in the Article is that carrier's share of the total transport, not the income derived from the passengers actually carried by the airline. This paragraph corresponds to paragraph 4 of Article 8 of the OECD Model.

Relation to Other Articles

As with other benefits of the Convention, the benefit of exclusive residence country taxation under Article 8 is available to an enterprise only if it is entitled to benefits under Article 2 of the Protocol, regarding limitation on benefits.

This Article also is subject to the saving clause of paragraph 2 of Article 1 (Personal Scope) of the Model. Thus, if a citizen of the United States who is a resident of Italy derives profits from the operation of ships or aircraft in international traffic, notwithstanding the exclusive residence country taxation in paragraph 1 of Article 8, the United States may, subject to the special foreign tax credit rules of paragraph 4 of Article 23 (Relief from Double Taxation), tax those profits as part of the worldwide income of the citizen. (This is an unlikely situation, however, because non-tax considerations (e.g., insurance) generally result in shipping activities being carried on in corporate form.)