Article 21 generally assigns exclusive taxing jurisdiction over income not dealt with in

the other articles (Articles 6 through 20) of the Convention to the Contracting State of residence of the beneficial owner of the income. An item of income is “dealt with” in another article if it is the type of income described in the article and it has its source in a Contracting State. For example, all royalty income that arises in a Contracting State and that is beneficially owned by a resident of the other Contracting State is “dealt with” in Article 12 (Royalties).

Examples of items of income covered by Article 21 include income from gambling, punitive (but not compensatory) damages, covenants not to compete, and income from certain financial instruments to the extent derived by persons not engaged in the trade or business of dealing in such instruments (unless the transaction giving rise to the income is related to a trade or business, in which case it is dealt with under Article 7 (Business Profits)). The article also applies to items of income that are not dealt with in the other articles because of their source or some other characteristic. For example, Article 12 (Royalties) addresses only the taxation of

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royalties arising in a Contracting State. Royalties arising in a third State that is not attributable to a permanent establishment, therefore, is subject to Article 21.

Under paragraph 8 of the Protocol, fees in connection with a loan of securities, guarantee fees and commitment fees paid by a resident of a Contracting State and beneficially owned by a resident of the other Contracting State shall be taxable only in the Contracting State of residence unless such fees are attributable to a permanent establishment of the beneficial owner in the Contracting State of source. This rule is consistent with the rules applicable to income not dealt with in the taxing articles other than Article 21.

Distributions from partnerships are not generally dealt with under Article 21 because partnership distributions generally do not constitute income. Under the Code, partners include in income their distributive share of partnership income annually, and partnership distributions themselves generally do not give rise to income. This is also the case under U.S. law with respect to distributions from trusts. Under the Code, trust income and distributions have the character of the associated distributable net income and therefore would generally be covered by another article of the Convention. See Code section 641 et seq.

Paragraph 1

The general rule of Article 21 is contained in paragraph 1. Items of income not dealt with in other articles and beneficially owned by a resident of a Contracting State will be taxable only in the Contracting State of residence. This exclusive right of taxation applies whether or not the residence Contracting State exercises its right to tax the income covered by the Article.

The reference in this paragraph to “items of income beneficially owned by a resident of a Contracting State” rather than simply “items of income of a resident of a Contracting State,” as in the OECD Model, is intended merely to make explicit the implicit understanding in other treaties that the exclusive residence taxation provided by paragraph 1 applies only when a resident of a Contracting State is the beneficial owner of the income. Thus, source taxation of income not dealt with in other articles of the Convention is not limited by paragraph 1 if it is nominally paid to a resident of the other Contracting State, but is beneficially owned by a resident of a third State. However, income received by a nominee on behalf of a resident of that other State would be entitled to benefits.

The term “beneficially owned” is not defined in the Convention, and is, therefore, defined as under the internal law of the country imposing tax ( i.e., the source country). The person who beneficially owns the income for purposes of Article 21 is the person to which the income is attributable for tax purposes under the laws of the source Contracting State.

Paragraph 2

This paragraph provides an exception to the general rule of paragraph 1 for income, other than income from real property, that is attributable to a permanent establishment maintained in a Contracting State by a resident of the other Contracting State. The taxation of such income is governed by the provisions of Article 7 (Business Profits). Therefore, income arising outside the

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United States that is attributable to a permanent establishment maintained in the United States by a resident of Japan generally would be taxable by the United States under the provisions of Article 7. This would be true even if the income is sourced in a third State.

Paragraph 3

Paragraph 3 corresponds to rules dealing with interest and royalties in paragraph 8 of Article 11 (Interest) and paragraph 4 of Article 12 (Royalties). Paragraph 3 restricts the operation of Article 21 where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of other income paid exceeds the amount which would have been agreed upon by the parties had they stipulated at arm’s length. This rule applies, for example, to payments pursuant to non-traditional financial instruments, such as equity swaps. Article 21 applies in such a case only to the arm’s-length amount, and the excess part of the payment may be taxable in the Contracting State in which it arises at a rate not to exceed 5 percent. An explanation of this rule is provided in the explanation of paragraph 8 of Article 11 (Interest), above. Although paragraph 3 of Article 21 is not found in the U.S. or OECD Models, the Commentary to Article 21 of the OECD Model includes it as an optional provision of Article 21 of the OECD Model.

Paragraph 4

Paragraph 4 provides that a resident of a Contracting State shall not be considered the beneficial owner of other income in certain “back-to-back” arrangements. The benefits of Article 21 therefore are not available with respect to such other income. This rule is similar to rules dealing with interest, royalties, and other income in paragraph 11 of Article 10 (Dividends), paragraph 11 of Article 11 (Interest), and paragraph 5 of Article 12 (Royalties). These limited “anti-conduit” rules are discussed collectively in the explanation of paragraph 11 of Article 10 above.

Paragraph 4 in particular provides that a resident of a Contracting State shall not be considered the beneficial owner of other income in respect of a right or property if such other income would not have been paid unless the resident pays other income in respect of the same right or property to a person that is not entitled to the same or more favorable treaty benefits and that is not a resident of either Contracting State.

Relation to Other Articles

This Article is subject to the saving clause of subparagraph 4(a) of Article 1 (General Scope). Thus, the United States may tax the income of a resident of Japan that is not dealt with elsewhere in the Convention, if that resident is a citizen of the United States.

The benefits of this Article are also subject to the provisions of Article 22 (Limitation on Benefits). Thus, only a resident of a Contracting State that satisfies one of the conditions in Article 22 is entitled to the benefits of this Article.

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