Article 22 follows the form used — U.S. Income Tax Treaty

states the general rule that a resident of a Contracting State is entitled to benefits otherwise accorded to residents only to the extent that the resident satisfies the requirements of the Article and any other specified conditions for the obtaining of such benefits and then lists a series of attributes of a resident of a Contracting State, any one of which suffices to make such resident entitled to all the benefits of the Convention. Paragraph 2 sets forth the active trade or business test, under which a person not entitled to benefits under paragraph 1 may nonetheless be granted benefits with regard to certain types of income. Paragraph 4 provides that benefits may also be granted if the competent authority of the Contracting State from which the benefits are claimed determines that it is appropriate to grant benefits in that case. Paragraphs 3 and 5 set out rules of application and definitions of terms used specifically in this Article.

Paragraph 1

Paragraph 1 provides that, except as otherwise provided in Article 22, a resident of a Contracting State will be entitled to all the benefits of the Convention otherwise accorded to

residents of a Contracting State only if the resident is described in one of the subparagraphs of that paragraph 1.

The benefits otherwise accorded to residents under the Convention include all limitations on source-based taxation under Articles 6 through 21, the treaty-based relief from double taxation provided by Article 23, and the protection afforded to residents of a Contracting State under Article 24. Some provisions do not require that a person be a resident in order to enjoy the benefits of those provisions. For example, Article 18 may apply to an employee of a Contracting State who is resident in neither State. Article 25 is not limited to residents of the Contracting States, and Article 28 applies to diplomatic agents or consular officials regardless of residence. Article 22 accordingly does not limit the availability of treaty benefits under these provisions.

Paragraph 1 has six subparagraphs, each of which describes a category of residents that are entitled to all benefits of the Convention. It is intended that the provisions of paragraph 1 will be self-executing. Claiming benefits under paragraph 1 does not require advance competent authority ruling or approval. The tax authorities may, of course, on review, determine that the taxpayer has improperly interpreted the paragraph and is not entitled to the benefits claimed.

Individuals -- Subparagraph 1(a)

Subparagraph (a) provides that individual residents of a Contracting State will be entitled to all benefits of the Convention. If such an individual receives income as a nominee on behalf of a third country resident, benefits may be denied under the respective articles of the Convention because in that case the beneficial owner of the income is not a resident of a Contracting State.

Governments and Central Banks -- Subparagraph 1(b)

Subparagraph (b) provides that the Contracting States, any political subdivision or local authority thereof, the Bank of Japan and the Federal Reserve Banks in the United States will be entitled to all benefits of the Convention.

Publicly-Traded Companies -- Subparagraph 1(c)

Subparagraph (c) applies to two categories of companies: publicly traded companies and subsidiaries of publicly traded companies. A company is entitled to all the benefits of the Convention under clause (i) of subparagraph (c) if the principal class of its shares, and any disproportionate class of shares, is listed on a recognized U.S. or Japanese stock exchange and is regularly traded on one or more recognized stock exchanges.

The term “principal class of shares” is not defined in the Convention and, accordingly, will be defined under the domestic laws of each Contracting State. In the United States, it means the common shares of the company representing the majority of the aggregate voting power and value of the company. If the company does not have a class of ordinary or common shares representing the majority of the aggregate voting power and value of the company, then the

“principal class of shares” is that class or any combination of classes of shares that represents, in the aggregate, a majority of the voting power and value of the company.

The term “disproportionate class of shares” is defined in subparagraph (a) of paragraph 5. A company has a disproportionate class of shares if it has outstanding a class of shares which is subject to terms or other arrangements that entitle the holder to a larger portion of the company’s income, profit, or gain in the other Contracting State than that to which the holder would be entitled in the absence of such terms or arrangements. Thus, for example, a company resident in Japan meets the test of subparagraph (a) of paragraph 5 if it has outstanding a class of “tracking stock” that pays dividends based upon a formula that approximates the company’s return on its assets employed in the United States.

A company whose principal class of stock is publicly traded will nevertheless not qualify for benefits under subparagraph (c) of paragraph 1 if it has a disproportionate class of shares that is not publicly traded. The following example illustrates this result.

Example. JCo is a corporation resident in Japan. JCo has two classes of shares: Common and Preferred. The Common shares are listed and regularly traded on the Tokyo Stock Exchange. The Preferred shares have no voting rights and are entitled to receive dividends equal in amount to interest payments that JCo receives from unrelated borrowers in the United States. The Preferred shares are owned entirely by a single investor that is a resident of a country with which the United States does not have a tax treaty. The Common shares account for more than 50 percent of the value of JCo and for 100 percent of the voting power. Because the owner of the Preferred shares is entitled to receive payments corresponding to the U.S. source interest income earned by JCo, the Preferred shares are a disproportionate class of shares. Because the Preferred shares are not regularly traded on a recognized stock exchange, JCo will not qualify for benefits under subparagraph (c) of paragraph 1.

The term “recognized stock exchange” is defined in subparagraph (b) of paragraph 5 as (1) any stock exchange established under the terms of the Securities and Exchange Law (Law No. 25 of 1948) of Japan, including the Tokyo Stock Exchange; (2) the NASDAQ System owned by the National Association of Securities Dealers and any stock exchange registered with the Securities and Exchange Commission as a national securities exchange for purposes of the Securities Exchange Act of 1934; and (3) any other stock exchange agreed upon by the competent authorities of the Contracting States.

Under paragraph 11 of the Protocol, a class of shares will be considered to be “regularly traded” in a taxable year if the aggregate number of shares of that class traded on one or more recognized exchanges in the prior taxable year is at least six percent of the average number of shares outstanding in that class during that prior taxable year. Trading on one or more recognized stock exchanges may be aggregated for purposes of meeting the “regularly traded” standard of subparagraph (c). For example, a U.S. company could satisfy the definition of “regularly traded” by taking into account trading on both a recognized stock exchange located in the United States and a recognized stock exchange located in Japan. Authorized but unissued shares are not considered for purposes of subparagraph (c).

A company resident in a Contracting State is entitled to the benefits of the Convention under clause (ii) of subparagraph (c) of paragraph 1 if five or fewer direct and indirect owners of at least 50 percent of the aggregate vote and value of the company’s shares are publicly traded companies described in clause (i). Thus, for example, a Japanese company, all the shares of which are owned by another Japanese company, would qualify for benefits under the Convention if the principal class of shares of the Japanese parent company were listed on the Tokyo Stock Exchange and regularly traded on the Tokyo Stock Exchange and the New York Stock Exchange. However, the Japanese company would not qualify for benefits under clause (ii) if the publicly traded parent company were a resident of Korea, not of the United States or Japan. Furthermore, if the Japanese parent indirectly owned the Japanese company through a chain of subsidiaries, each such subsidiary in the chain, as an intermediate owner, must be a resident of the United States or Japan that meets the requirements of clause (ii) in order for the Japanese company to meet the test in clause (ii).

With respect to withholding taxes, subparagraph (a) of paragraph 3 provides that the ownership requirements of clause (ii) of subparagraph (c) of paragraph 1 will be considered to be satisfied if they are met throughout a specified period. In general, the relevant period is the portion of the taxable year preceding the date on which the payment with respect to which benefits are claimed is made plus the entire preceding taxable year. In the case of dividend payments, the relevant end date of the period is the date on which entitlement to the dividend is determined rather than date on which the dividend is paid. (In the United States, this would be the “record date”.) When the payment (or dividend record date) is the last day of the taxable year, the relevant period consists of only that taxable year, and no part of the preceding taxable year. The ownership requirements of clause (ii) also are satisfied if they are met throughout the taxable year with respect to which the benefits are claimed.

This ownership requirements of clause (ii) of subparagraph (c) of paragraph 1 differs from the requirements under clause (i) in that 50 percent of each class of the company's shares, not merely the class or classes accounting for more than 50 percent of the company's votes and value, must be held by publicly-traded companies described in clause 1(c)(i). Thus, the test under clause 1(c)(ii) considers the ownership of every class of shares outstanding, while the test under clause 1(c)(i) only considers those classes that account for a majority of the company's voting power and value as well as any disproportionate class of shares.

Tax Exempt Organizations -- Subparagraph 1(d)

Under subparagraph (d) of paragraph 1, a tax-exempt organization described in subparagraph (c) of paragraph 1 of Article 4 is entitled to all the benefits of the Convention, without regard to the residence of its beneficiaries or members. Entities qualifying under this subparagraph generally are those that are exempt from tax in their Contracting State of residence and that are organized and operated exclusively to fulfill religious, charitable, educational, scientific, artistic, cultural, or public purposes.

Pension Funds – Subparagraph 1(e)

A pension fund is entitled to all the benefits of the Convention if, as of the close of the end of the prior taxable year, more than 50 percent of the beneficiaries, members or participants of the organization are individuals resident in either Contracting State. For purposes of this provision, the term “beneficiaries” should be understood to refer to the persons receiving benefits from the organization.

Ownership/Base Erosion -- Subparagraph 1(f)

Subparagraph 1(f) provides an additional test that applies to any form of legal entity that is a resident of a Contracting State. The test provided in subparagraph (f), the so-called ownership and base erosion test, is a two-part test. Both prongs of the test must be satisfied for the resident to be entitled to benefits under subparagraph 1(f).

The ownership prong of the test, under clause (i), requires that 50 percent or more of each class of stock or other beneficial interests in the person be owned directly or indirectly by persons that themselves would be entitled to all the benefits of the Convention under specified other tests of paragraph 1 -- subparagraphs (a), (b), (d) or (e), or clause (i) of subparagraph (c). Paragraph (b) of paragraph 3 provides rules for determining whether the ownership prong of the test will be considered to be satisfied in the case of withholding taxes and other taxes.

With respect to withholding taxes, clause (i) of subparagraph (b) of paragraph 3 provides that the ownership prong of the test will be considered to be satisfied if the ownership requirements of clause (i) of subparagraph (f) of paragraph 1 are met throughout a specified period. In general, the relevant period is the portion of the taxable year preceding the date on which the payment with respect to which benefits are claimed is made plus the entire preceding taxable year. In the case of dividend payments, the relevant end date of the period is the date on which entitlement to the dividend is determined rather than when the dividend is paid. (In the United States, this would be the “record date”.) When the payment (or dividend record date) is the last day of the taxable year, the relevant period consists of only that taxable year, and no part of the preceding taxable year. The ownership requirements of clause (i) also are satisfied if they are met throughout the taxable year with respect to which the benefits are claimed.

With respect to taxes other than withholding taxes, clause (ii) of subparagraph (b) of paragraph 3 provides that the ownership prong will be considered to be satisfied with respect to a taxable year only if the ownership requirement is met on at least half the days of the resident’s taxable year in which the payment is made.

Trusts may be entitled to benefits under this provision if they are treated as residents under Article 4 and they otherwise satisfy the requirements of this subparagraph. For purposes of this subparagraph, the beneficial interests in a trust will be considered to be owned by its beneficiaries in proportion to each beneficiary's actuarial interest in the trust. The interest of a remainder beneficiary will be equal to 100 percent less the aggregate percentages held by income beneficiaries. A beneficiary's interest in a trust will not be considered to be owned by a person entitled to benefits under the other provisions of paragraph 1 if it is not possible to determine the

beneficiary's actuarial interest. Consequently, if it is not possible to determine the actuarial interest of any beneficiaries in a trust, the ownership test under clause (i) cannot be satisfied, unless all possible beneficiaries are persons entitled to benefits under the other subparagraphs of paragraph 1.

The base erosion prong of clause (ii) of subparagraph (f) requires that less than 50 percent of a person’s gross income for the taxable year is paid or accrued in that taxable year to a person or persons who are not residents of either Contracting State in the form of payments deductible for tax purposes in the payer’s State of residence. Subparagraph (c) of paragraph 3 provides that, in the case of withholding taxes imposed by Japan on U.S. residents, this prong will be considered to be satisfied with respect to the taxable year in which a payment is made if the requirements were satisfied for each of the preceding three taxable years. The base erosion prong also is satisfied in the case of withholding taxes imposed by Japan and in all other cases if it is satisfied for the taxable year with respect to which the benefits are claimed.

Subparagraph (c) of paragraph 5 provides that the term “gross income” means total revenues derived by a resident of a Contracting State from its business, less the direct costs of obtaining such revenues. In the case of the United States, this definition corresponds to the definition of the term “gross income” in section 61 of the Code and the regulations thereunder.

Depreciation and amortization deductions, which do not represent payments or accruals to other persons, are disregarded for the purpose of determining gross income. Deductible payments do not include arm’s length payments in the ordinary course of business for services or tangible property or with respect to financial obligations to banks that are residents of either Contracting State, or that have a permanent establishment in either Contracting State to which the payment is attributable. To the extent they are deductible from the taxable base, however, trust distributions are deductible payments.

Paragraph 2

Paragraph 2 sets forth a test under which a resident of a Contracting State that is not entitled to all the benefits of the Convention under paragraph 1 may receive treaty benefits with respect to certain items of income that are connected to an active trade or business conducted in its State of residence.

Subparagraph (a) sets forth the general rule that a resident of a Contracting State engaged in the active conduct of a trade or business in that Contracting State may obtain the benefits of the Convention with respect to an item of income derived in the other Contracting State. The item of income, however, must be derived in connection with or be incidental to that trade or business.

The term “trade or business” is not defined in the Convention. Pursuant to paragraph 2 of Article 3 (General Definitions), when determining whether a resident of Japan is entitled to the benefits of the Convention under paragraph 2 of this Article with respect to an item of income, profit, or gains derived from sources within the United States, the United States will interpret this term in accordance with the meaning that it has under the law of the United States. Accordingly,

the U.S. competent authority will refer to the regulations issued under section 367(a) for the definition of the term “trade or business.” In general, therefore, a trade or business will be considered to be a specific unified group of activities that constitute or could constitute an independent economic enterprise carried on for profit. Furthermore, a company generally will be considered to carry on a trade or business only if the officers and employees of the company conduct substantial managerial and operational activities.

The business of making or managing investments for the resident’s own account will be considered to be a trade or business only when part of banking, insurance or securities activities conducted by a bank, an insurance company, or a registered securities dealer. Such activities conducted by a person other than a bank, insurance company or registered securities dealer will not be considered to be the conduct of an active trade or business, nor would they be considered to be the conduct of an active trade or business if conducted by a bank, insurance company or registered securities dealer but not as part of the company’s banking, insurance or dealer business.

Because a headquarters operation is in the business of managing investments, a company that functions solely as a headquarters company will not be considered to be engaged in an active trade or business for purposes of subparagraph (a).

Income is derived in connection with a trade or business if the income-producing activity in the Contracting State of source is a line of business that “forms a part of” or is “complementary” to the trade or business conducted in the Contracting State of residence by the income recipient.

A business activity generally will be considered to form part of a business activity conducted in the Contracting State of source if the two activities involve the design, manufacture or sale of the same products or type of products, or the provision of similar services. The line of business in the Contracting State of residence may be upstream, downstream, or parallel to the activity conducted in the Contracting State of source. Thus, the line of business may provide inputs for a manufacturing process that occurs in the Contracting State of source, may sell the output of that manufacturing process, or simply may sell the same sorts of products that are being sold by the trade or business carried on in the Contracting State of source.

Example 1. USCo is a corporation resident in the United States. USCo is engaged in an active manufacturing business in the United States. USCo owns 100 percent of the shares of JCo, a company resident in Japan. JCo distributes USCo products in Japan. Because the business activities conducted by the two corporations involve the same products, JCo’s distribution business is considered to form a part of USCo’s manufacturing business.

Example 2. The facts are the same as in Example 1, except that USCo does not manufacture. Rather, USCo operates a large research and development facility in the United States that licenses intellectual property to affiliates worldwide, including JCo. JCo and other USCo affiliates then manufacture and market the USCo-designed products in their respective markets. Because the activities conducted by JCo and USCo involve the same product lines, these activities are considered to form a part of the same trade or business.

For two activities to be considered to be “complementary,” the activities need not relate to the same types of products or services, but they should be part of the same overall industry and be related in the sense that the success or failure of one activity will tend to result in success or failure for the other. Where more than one trade or business is conducted in the Contracting State of source and only one of the trades or businesses forms a part of or is complementary to a trade or business conducted in the Contracting State of residence, it is necessary to identify the trade or business to which an item of income is attributable. Royalties generally will be considered to be derived in connection with the trade or business to which the underlying intangible property is attributable. Dividends will be deemed to be derived first out of earnings and profits of the treaty-benefited trade or business, and then out of other earnings and profits. Interest income may be allocated under any reasonable method consistently applied. A method that conforms to U.S. principles for expense allocation will be considered a reasonable method.

Example 3. Americair is a corporation resident in the United States that operates an international airline. JSub is a wholly-owned subsidiary of Americair resident in Japan. JSub operates a chain of hotels in Japan that are located near airports served by Americair flights. Americair frequently sells tour packages that include air travel to Japan and lodging at JSub hotels. Although both companies are engaged in the active conduct of a trade or business, the businesses of operating a chain of hotels and operating an airline are distinct trades or businesses. Therefore JSub’s business does not form a part of Americair’s business. However, JSub’s business is considered to be complementary to Americair’s business because they are part of the same overall industry (travel), and the links between their operations tend to make them interdependent.

Example 4. The facts are the same as in Example 3, except that JSub owns an office building in Japan instead of a hotel chain. No part of Americair’s business is conducted through the office building. JSub’s business is not considered to form a part of or to be complementary to Americair’s business. They are engaged in distinct trades or businesses in separate industries, and there is no economic dependence between the two operations.

Example 5. USFlower is a company resident in the United States. USFlower produces and sells flowers in the United States and other countries. USFlower owns all the shares of JHolding, a corporation resident in Japan. JHolding is a holding company that is not engaged in a trade or business. JHolding owns all the shares of three corporations that are resident in Japan: JFlower, JLawn, and JFish. JFlower distributes USFlower flowers under the USFlower trademark in Japan. JLawn markets a line of lawn care products in Japan under the USFlower trademark. In addition to being sold under the same trademark, JLawn and JFlower products are sold in the same stores and sales of each company’s products tend to generate increased sales of the other’s products. JFish imports fish from the United States and distributes it to fish wholesalers in Japan. For purposes of paragraph 2, the business of JFlower forms a part of the business of USFlower, the business of JLawn is complementary to the business of USFlower, and the business of JFish is neither part of nor complementary to that of USFlower.

Finally, an item of income derived from the Contracting State of source is “incidental to” the trade or business carried on in the Contracting State of residence if production of the item facilitates the conduct of the trade or business in the Contracting State of residence. An example

of incidental income is the temporary investment of working capital of a person in the Contracting State of residence in securities issued by persons in the Contracting State of source.

Subparagraph (b) of paragraph 2 states a further condition to the general rule in subparagraph (a) in cases where the trade or business generating the item of income in question is carried on either by the person deriving the income or by any associated enterprises. Subparagraph (b) states that the trade or business carried on in the Contracting State of residence, under these circumstances, must be substantial in relation to the activity in the Contracting State of source. This determination is made based upon all the facts and circumstances and takes into account the comparative sizes of the trades or businesses in each Contracting State (measured by reference to asset values, income and payroll expenses), the nature of the activities performed in each Contracting State, and the relative contributions made to that trade or business in each Contracting State.

The substantiality requirement is intended to prevent a narrow case of treaty-shopping abuses in which a company attempts to qualify for benefits by engaging in de minimis connected business activities in the treaty country in which it is resident ( i.e., activities that have little economic cost or effect with respect to the company business as a whole).

The application of the substantiality test only to income from related parties focuses only on potential abuse cases, and does not hamper certain other kinds of non-abusive activities, even though the income recipient resident in a Contracting State may be very small in relation to the entity generating income in the other Contracting State. For example, if a small U.S. research firm develops a process that it licenses to a very large, unrelated, Japanese electronics manufacturer, the size of the U.S. research firm would not have to be tested against the size of the Japanese manufacturer. Similarly, a small U.S. bank that makes a loan to a very large unrelated Japanese business would not have to pass a substantiality test under subparagraph (b) in order to receive treaty benefits.

Paragraph 12 of the Protocol provides special rules for determining whether a resident of a Contracting State is engaged in the active conduct of a trade or business within the meaning of subparagraph (a). Under that paragraph, the activities of a partnership are attributed to each of its partners. The paragraph also attributes to a person activities conducted by persons “connected” to such person. A person (“X”) is connected to another person (“Y”) if X possesses 50 percent or more of the beneficial interest in Y (or if Y possesses 50 percent or more of the beneficial interest in X). For this purpose, X is connected to a company if X owns shares representing 50 percent or more of the aggregate voting power and value of the company or 50 percent or more of the beneficial equity interest in the company. X also is connected to Y if a third person possesses 50 percent or more of the beneficial interest in both X and Y. For this purpose, if X or Y is a company, the threshold relationship with respect to such company or companies is 50 percent or more of the aggregate voting power and value or 50 percent or more of the beneficial equity interest.

Paragraph 3

Paragraph 3 includes rules regarding the application of the ownership tests under clause (ii) of subparagraph (c) of paragraph 1 and clause (i) of subparagraph (f) of paragraph 1 and the base erosion test under clause (ii) of subparagraph (f) or paragraph 1. These rules, which are discussed above in connection with the tests to which they relate, provide in particular in the case of withholding taxes that those tests will be considered to be satisfied if they are satisfied for specified periods ending on or before the date on which the income that may be entitled to treaty benefits is paid. Providing rules that allow withholding agents to determine with certainty whether these tests are met on the date of payment is particularly important in light of the obligations imposed on withholding agents by the Japanese withholding system. These rules ensure that withholding agents are able to withhold the appropriate amount of tax, if any, under the Convention at the time of the payment.

Paragraph 4

Paragraph 4 provides that a resident of one of the Contracting States that is neither described in paragraph 1 nor entitled to the benefits of the Convention with respect to an item of income under paragraph 2 of this article still may be granted benefits under the Convention at the discretion of the competent authority of the Contracting State from which benefits are claimed. In making determinations under paragraph 4, that competent authority will take into account as its guideline whether the establishment, acquisition, or maintenance of the person seeking benefits under the Convention, or the conduct of such person’s operations, has or had as one of its principal purposes the obtaining of benefits under the Convention. Thus, persons that establish operations in one of the Contracting States with a principal purpose of obtaining the benefits of the Convention ordinarily will not be granted relief under paragraph 4.

The competent authority may determine to grant all benefits of the Convention, or it may determine to grant only certain benefits. For instance, it may determine to grant benefits only with respect to a particular item of income in a manner similar to paragraph 2. Further, the competent authority may set time limits on the duration of any relief granted.

For purposes of implementing paragraph 4, a taxpayer will be permitted to present its case to the relevant competent authority for an advance determination based on the facts. In these circumstances, it is also expected that if the competent authority determines that benefits are to be allowed, they will be allowed retroactively to the time of entry into force of the relevant treaty provision or the establishment of the structure in question, whichever is later.

Paragraph 5

Paragraph 5 defines several key terms for purposes of Article 22. Each of the defined terms is discussed above in connection with the subparagraphs of paragraph 1 in which it occurs.