Article 15 (Directors' Fees) — U.S. Income Tax Treaty

This Article provides that directors’ fees and other similar payments derived by a resident of a Contracting State for services performed in his capacity as a director of the company which is a resident of the other Contracting State may be taxed in such other Contracting State. This rule is an exception to the more general rules of Articles 7 (Business Profits) and 14 (Income from Employment). Thus, a resident of one Contracting State who is a director of a company that is a resident of the other Contracting State is subject to tax in that other Contracting State in respect of his directors’ fees regardless of where the services are performed. In determining whether a director’s fee is subject to tax in the country of residence of the company, whether the fee is attributable to a permanent establishment is not relevant.

The provision in the Convention is identical to the analogous provision in the OECD Model. The U.S. Model reaches a different result, providing that the Contracting State of residence of the company may tax nonresident directors with no time or dollar threshold, but only with respect to remuneration for services performed in that Contracting State.

The Convention refers to “similar payments,” while the U.S. Model refers to “other compensation.” The U.S. Model language was intended to make clear that Article 15 applies to any form of compensation, including payments in kind, regardless of whether the remuneration is “similar” to directors' fees. The recent addition of paragraph 1.1 to the Commentary to Article 16 of the OECD Model, which confirms that payments in kind are covered by the Article, ensures that the language of the Convention and of the OECD Model reaches the same result as the language of the U.S. Model.

This Article does not grant an exclusive taxing right, nor does it limit the effect of the saving clause of subparagraph 4(a) of Article 1. Thus, if a U.S. citizen is a director of a Japanese corporation, the United States may tax his full remuneration, subject, of course, to any foreign tax credit that may be available. Article 16 (Artistes and Sportsmen)

This Article deals with the taxation in a Contracting State of entertainers and sportsmen resident in the other Contracting State from the performance of their services as such. The Article applies both to the income of an entertainer or sportsman who performs services on his own behalf and one who performs services on behalf of another person, either as an employee of that person, or pursuant to any other arrangement. The rules of this Article take precedence, in some circumstances, over those of Articles 7 (Business Profits) and 14 (Income from Employment).

This Article applies only with respect to the income of entertainers and sportsmen. Others involved in a performance or athletic event, such as producers, directors, technicians, managers, coaches, etc., remain subject to the provisions of Articles 7 and 14. In addition, except as provided in paragraph 2 of Article 16, income earned by persons that are not individuals is not covered by Article 16.

Paragraph 1

Paragraph 1 describes the circumstances in which a Contracting State may tax the performance income of an entertainer or sportsman who is a resident of the other Contracting State. Under the paragraph, income derived by an individual resident of a Contracting State from activities as an entertainer or sportsman exercised in the other Contracting State may be taxed in that other Contracting State if the amount of the gross receipts derived by the performer exceeds $10,000 (or its equivalent in Japanese yen) for the taxable year. Gross receipts include expenses reimbursed to the individual or borne on his behalf. If the gross receipts exceed $10,000, the full amount, not just the excess, may be taxed in the Contracting State of performance.

The OECD Model provides for taxation by the country of performance of the remuneration of entertainers or sportsmen with no dollar or time threshold. This Convention introduces the dollar threshold test to distinguish between two groups of entertainers and athletes. The first group includes entertainers and athletes who are paid relatively large sums of money but are present in the country of performance for relatively short periods and because of that would be exempt from host country tax under the standard personal services income rules of Article 14. The second group includes entertainers and athletes who earn relatively modest amounts and therefore should be subject to the same rules of Article 14 that are applicable to those who earn other types of personal service income. The United States has entered a reservation to the OECD Model on the failure to provide such differentiation through a dollar threshold.

Tax may be imposed under paragraph 1 even if the performer would have been exempt from tax under Article 7 (Business Profits) or 14 (Income from Employment). On the other hand, if the performer would be exempt from host-country tax under Article 16, but would be

taxable under either Article 7 or 14, tax may be imposed under either of those Articles. Thus, for example, if a performer derives remuneration from his activities in an independent capacity, and the performer does not have a permanent establishment in the host Contracting State, he may be taxed by the host Contracting State in accordance with Article 16 if his remuneration exceeds $10,000 annually, despite the fact that he generally would be exempt from host Contracting State taxation under Article 7. However, a performer who receives less than the $10,000 threshold amount and therefore is not taxable under Article 16, nevertheless may be subject to tax in the host country under Article 7 or 14 if the tests for host-country taxability under the relevant Article are met. For example, if an entertainer who is an independent contractor earns $7,000 of income in a Contracting State for the calendar year, but the income is attributable to his permanent establishment in the Contracting State of performance, that Contracting State may tax his income under Article 7.

Since it frequently is not possible to know until year-end whether the income an entertainer or sportsman derives from performances in a Contracting State will exceed $10,000, nothing in the Convention precludes that Contracting State from withholding tax during the year and refunding it after the close of the year if the taxability threshold has not been met.

As explained in paragraph 9 of the Commentary to Article 17 of the OECD Model, Article 16 of the Convention applies to all income connected with a performance by the entertainer, such as appearance fees, award or prize money, and a share of the gate receipts. Income derived from a Contracting State by a performer who is a resident of the other Contracting State from other than actual performance, such as royalties from record sales and payments for product endorsements, is not covered by this Article, but by other articles of the Convention, such as Article 12 (Royalties) or Article 7 (Business Profits). For example, if an entertainer receives royalty income from the sale of live recordings, the royalty income would be exempt from source state tax under Article 12, even if the performance was conducted in the source country, although the entertainer could be taxed in the source country with respect to income from the performance itself under Article 16 if the dollar threshold is exceeded.

In determining whether income falls under Article 16 or another article, the controlling factor will be whether the income in question is predominantly attributable to the performance itself or to other activities or property rights. For instance, a fee paid to a performer for endorsement of a performance in which the performer will participate would be considered to be so closely associated with the performance itself that it normally would fall within Article 16. Similarly, a sponsorship fee paid by a business in return for the right to attach its name to the performance would be so closely associated with the performance that it would fall under Article 16 as well. As indicated in paragraph 9 of the Commentary to Article 17 of the OECD Model, however, a cancellation fee would not be considered to fall within Article 16 but would be dealt with under Article 7 (Business Profits) or 14 (Income from Employment).

As indicated in paragraph 4 of the Commentary to Article 17 of the OECD Model, where an individual fulfills a dual role as performer and non-performer (such as a player-coach or an actor-director), but his role in one of the two capacities is negligible, the predominant character of the individual's activities should control the characterization of those activities. In other cases

there should be an apportionment between the performance-related compensation and other compensation.

Consistent with Article 14 (Income from Employment), Article 16 also applies regardless of the timing of actual payment for services. Thus, a bonus paid to a resident of a Contracting State with respect to a performance in the other Contracting State during a particular taxable year would be subject to Article 16 for that year even if it was paid after the close of the year.

Paragraph 2

Paragraph 2 is intended to address the potential for circumvention of the rule in paragraph 1 when a performer's income does not accrue directly to the performer himself, but to another person. Foreign performers frequently perform in the United States as employees of, or under contract with, a company or other person.

The relationship may truly be one of employee and employer, with no circumvention of paragraph 1 either intended or realized. On the other hand, the “employer” may, for example, be a company established and owned by the performer, which is merely acting as the nominal income recipient in respect of the remuneration for the performance (a “star company”). The performer may act as an “employee,” receive a modest salary, and arrange to receive the remainder of the income from his performance from the company in another form or at a later time. In such case, absent the provisions of paragraph 2, the income arguably could escape hostcountry tax because the company earns business profits but has no permanent establishment in that country. The performer may largely or entirely escape host-country tax by receiving only a small salary, perhaps small enough to place him below the dollar threshold in paragraph 1. The performer might arrange to receive further payments in a later year, when he is not subject to host-country tax, perhaps as dividends or liquidating distributions.

Paragraph 2 seeks to prevent this type of abuse while at the same time protecting the taxpayers' rights to the benefits of the Convention when there is a legitimate employee-employer relationship between the performer and the person providing his services. Under paragraph 2, when the income accrues to a person other than the performer, the income may be taxed in the Contracting State where the performer's services are exercised, without regard to the provisions of the Convention concerning business profits (Article 7) or income from employment (Article 14), unless the contract pursuant to which the personal activities are performed allows the person other than the performer to designate the individual who is to perform the personal activities. This rule is based on the U.S. domestic law provision characterizing income from certain personal service contracts as foreign personal holding company income in the context of the foreign personal holding company provisions. See Code sections 552 and 553. The premise of this rule is that, in a case where a performer is using another person in an attempt to circumvent the provisions of paragraph 1, the recipient of the services of the performer would contract with a person other than that performer ( i.e., a company employing the performer) only if the recipient of the services were certain that the performer himself would perform the services. If instead the person is allowed to designate the individual who is to perform the services, then likely the person is a service company not formed to circumvent the provisions of paragraph 1. The following example illustrates the operation of this rule.

Example. Company O, a resident of Japan, is engaged in the business of operating an orchestra. Company O enters into a contract with Company A pursuant to which Company O agrees to carry out two performances in the United States in consideration of which Company A will pay Company O $200,000. The contract designates two individuals, a conductor and a flutist, that must perform as part of the orchestra, and allows Company O to designate the other members of the orchestra. Because the contract does not give Company O any discretion to determine whether the conductor or the flutist perform personal services under the contract, the portion of the $200,000 which is attributable to the personal services of the conductor and the flutist may be taxed by the United States pursuant to paragraph 2. The remaining portion of the $200,000, which is attributable to the personal services of performers that Company O may designate, is not subject to tax by the United States pursuant to paragraph 2.

In cases where paragraph 2 is applicable, the income of the “employer” may be subject to tax in the host Contracting State even if it has no permanent establishment in the host country. Taxation under paragraph 2 is on the person providing the services of the performer. This paragraph does not affect the rules of paragraph 1, which apply to the performer himself. The income taxable by virtue of paragraph 2 is reduced to the extent of salary payments to the performer, which fall under paragraph 1.

For purposes of paragraph 2, income is deemed to accrue to another person ( i.e., the person providing the services of the performer) if that other person has control over, or the right to receive, gross income in respect of the services of the performer.

Since pursuant to Article 1 (General Scope) the Convention only applies to persons who are residents of one of the Contracting States, income of the star company would not be eligible for benefits of the Convention if the company is not a resident of one of the Contracting States.

Paragraph 2 differs from the analogous provision in the U.S. Model, paragraph 2 of Article 17 of the U.S. Model, although each is directed at mitigating the circumvention of paragraph 1 through the formation of an entity. Paragraph 2 of Article 17 of the U.S. Model looks to whether the performer participates in the profits of the company in any manner rather than whether the company has the ability to designate the individual to perform the services. Both Paragraph 2 of the Convention and the analogous provision in the U.S. Model are significantly narrower in scope than the analogous provision of the OECD Model, with respect to which the United States has entered a reservation.

Relationship to other Articles

This Article is subject to the provisions of the saving clause of subparagraph 4(a) of Article 1 (General Scope). Thus, if an entertainer or a sportsman who is resident in Japan is a citizen of the United States, the United States may tax all of his income from performances in the United States without regard to the provisions of this Article, subject, however, to the special foreign tax credit provisions of paragraph 3 of Article 23 (Relief from Double Taxation). In addition, benefits of this Article are subject to the provisions of Article 22 (Limitation on Benefits).