Article 3 (General Definitions) — U.S. Income Tax Treaty

Paragraph 1

Paragraph 1 defines a number of basic terms used in the Convention. Certain other terms are defined in other articles of the Convention. For example, the term “resident of a Contracting State” is defined in Article 4 (Residence). The term “permanent establishment” is defined in Article 5 (Permanent Establishment). The term “real property” is defined in Article 8 (Real Property). The terms “dividends,” “interest” and “royalties” are defined in Articles 10 (Dividends), 11 (Interest) and 12 (Royalties), respectively.

The introduction to paragraph 1 makes clear that the definitions in Article 3 apply for all purposes of the Convention, unless the context requires otherwise. This latter condition allows the Convention to be interpreted in a manner that avoids unintended results. Paragraph 2 addresses terms that are not defined in the Convention.

The term “Japan”, when used in a geographical sense, is defined in subparagraph (a) to mean all the territory of Japan, including its territorial sea, in which the laws relating to Japanese tax are in force, and all the area beyond its territorial sea, including the seabed and subsoil thereof, over which Japan has jurisdiction in accordance with international law and in which the laws relating to Japanese tax are in force.

The term “United States” is defined in subparagraph (b) to mean the United States of America. When used in a geographical sense, the term “United States” includes the states, the District of Columbia and the territorial sea of the United States. The term does not include Puerto Rico, the Virgin Islands, Guam or any other U.S. possession or territory. The geographical meaning of the term “United States” also for certain purposes is extended to include the sea bed and subsoil of undersea areas adjacent to the territorial sea of the United States to the extent that the United States exercises sovereignty in accordance with international law for the purpose of natural resource exploration and exploitation of such areas. This extension of the definition applies, however, only if the person, property or activity to which the Convention is being applied is connected with such natural resource exploration or exploitation. Thus, it would not include any activity involving the sea floor of an area over which the United States exercised sovereignty for natural resource purposes if that activity was unrelated to the exploration and exploitation of natural resources.

It is understood that the term “jurisdiction” used in the definition of the term “Japan” as related to seabed and subsoil is to be interpreted in the same manner as the term “sovereignty” in the definition of the term “the United States”, as described above.

Subparagraph (c) states that the terms “a Contracting State” and “the other Contracting State” mean Japan or the United States, as the context requires.

Subparagraph (d) states that the term “tax” means a Japanese tax or United States tax, as the context requires, specifically referred to in paragraph 1 of Article 2. Thus, the term “tax” generally means a tax to which the Convention applies. Several provisions, including the provisions of Articles 24 (Non-Discrimination) and Article 26 (Exchange of Information), apply to taxes other than the taxes referred to in paragraph 1 of Article 2 and therefore specifically provide that they shall apply without regard to subparagraph (d).

Subparagraph (e) defines the term “person” to include an individual, a company and any other body of persons. Paragraph 2 of the Protocol further provides that the term “any other body of persons” includes an estate, trust, and partnership. The definition of “person” is significant for a variety of reasons. For example, under Article 4, only a “person” can be a “resident” and therefore eligible for most benefits under the treaty. Also, all “persons” are eligible to claim relief under Article 25 (Mutual Agreement Procedure).

The term “company” is defined in subparagraph (f) as a body corporate or an entity treated as a body corporate for tax purposes. Although the Convention does not add “in the state in which it is organized,” as does the U.S. Model, the result should be same as under the U.S. Model because the Commentary to Article 3 of the OECD Model interprets language identical to that of the Convention in a manner consistent with the U.S. Model.

Subparagraph (g) defines the term “enterprise” as applying to the carrying on of any business. Subparagraph (l) provides that the term “business” includes the performance of professional services and other activities of an independent character. Both definitions are identical to definitions recently added to the OECD Model in connection with the deletion of Article 14 (Independent Personal Services) from the OECD Model. The inclusion of the two

definitions in the Convention is intended to clarify that the performance of professional services or other activities of an independent character are considered to constitute an enterprise. Accordingly, income from such activities is dealt with under Article 7 (Business Profits) and not Article 21 (Other Income). The definitions are not included in the U.S. Model because the U.S. Model continues to include a separate article regarding the treatment of independent personal services.

The terms “enterprise of a Contracting State” and “enterprise of the other Contracting State” are defined in subparagraph (h) as an enterprise carried on by a resident of a Contracting State and an enterprise carried on by a resident of the other Contracting State. An enterprise of a Contracting State need not be carried on in that State. It may be carried on in the other Contracting State or a third state ( e.g., a U.S. corporation doing all of its business in Japan would still be a U.S. enterprise).

Subparagraph (i) defines the term “international traffic.” The term means any transport by a ship or aircraft operated by an enterprise of a Contracting State, except when such transport is solely between places within the other Contracting State. This definition is applicable principally in the context of Article 8 (Shipping and Air Transport).

The exclusion from the definition of international traffic of transport solely between places within the other Contracting State means, for example, that carriage of goods or passengers solely between San Francisco and Denver by a Japanese carrier (assuming that were possible under U.S. law) would not be treated as international traffic. The substantive taxing rules of the Convention relating to the taxation of income from transport, principally Article 8 (Shipping and Air Transport), therefore, would not apply to income from such carriage. Thus, if a Japanese carrier engaged in internal U.S. traffic (assuming that were possible under U.S. law), the United States would not be required to exempt the income from that transport under Article 8. The income, however, would be treated as business profits under Article 7 (Business Profits), and therefore would be taxable in the United States only if attributable to a U.S. permanent establishment of the Japanese carrier, and then only on a net basis. The gross basis U.S. tax imposed by section 887 would never apply under the circumstances described.

If, however, goods or passengers are carried by a carrier resident in Japan from a nonU.S. port to, for example, San Francisco, and some of the goods or passengers continue on to Denver, the entire transport would be international traffic. This would be true even if the international carrier transferred the goods at the U.S. port of entry from a ship to a land vehicle, from a ship to a lighter, or even if the overland portion of the trip in the United States was handled by an independent carrier under contract with the original international carrier, so long as both parts of the trip were reflected in original bills of lading.

Finally, a “cruise to nowhere” ( i.e., a cruise beginning and ending in a port in the same Contracting State with no stops in a foreign port) would not constitute international traffic.

The term “national,” as it relates to the United States and to Japan, is defined in clauses (i) and (ii) of subparagraph (j). This term is relevant for purposes of Article 18 (Government Services) and Article 24 (Non-Discrimination). With respect to Japan, a national is (1) any

individual possessing the nationality of Japan; and (2) any juridical person deriving its status as such from the law in force in Japan. With respect to the United States, a national is (1) an individual who is a citizen of the United States, and (2) any legal person, partnership or association deriving its status as such from the law in force in the United States.

Subparagraph (k) defines the term “competent authority” for Japan and the United States respectively. The Japanese competent authority is the Minister of Finance or his authorized representative. The U.S. competent authority is the Secretary of the Treasury or his delegate. The Secretary of the Treasury has delegated the competent authority function to the Commissioner of Internal Revenue, who in turn has delegated the authority to the Director, International (LMSB). With respect to interpretative issues, the Director acts with the concurrence of the Associate Chief Counsel (International) of the Internal Revenue Service.

Subparagraph (m) defines the term “pension fund” to include any person organized under the laws of a Contracting State which is established and maintained in that Contracting State primarily to provide pension or retirement benefits or other similar remuneration, including social security payments, and which is generally exempt from income taxation with respect to such pension activities in that Contracting State. Paragraph 3 of the Protocol provides that a Japanese pension fund shall be treated as exempt from tax with respect to pension activities even though it is subject to the tax stipulated in Articles 8 or 10-2 of the Corporation Tax Law of Japan or paragraph 1 of Article 20 of its supplementary provisions. This tax is not an income tax, but rather a tax intended to prevent the excess funding of pension funds. The base of this tax is the amount contributed to a pension fund less amounts withdrawn, without regard to the income earned on pension assets. This tax has no effect on the amount received by beneficiaries.

In the case of the United States, the term “pension fund” includes the following plans under existing U.S. law: qualified plans under section 401(a), individual retirement plans (including individual retirement plans that are part of a simplified employee pension plan that satisfies section 408(k), individual retirement accounts, individual retirement annuities, section 408(p) accounts, and Roth IRAs under section 408A), section 457 governmental plans, section 403(a) qualified annuity plans, section 403(b) plans, and any fund identical or substantially similar to the foregoing schemes that are established pursuant to legislation introduced after the date of signature of the Convention. Section 401(k) plans qualify as pension funds because a 401(k) plan is a type of 401(a) plan.

Paragraph 2

Paragraph 2 provides that in the application of the Convention, any term used but not defined in the Convention will have the meaning that it has under the law of the Contracting State whose tax is being applied, unless the context requires otherwise. The paragraph makes clear that if the term is defined under both the tax and non-tax laws of a Contracting State, the definition in the tax law will take precedence over the definition in the non-tax laws. Finally, there also may be cases where the tax laws of a Contracting State contain multiple definitions of the same term. In such a case, the definition used for purposes of the particular provision at issue, if any, should be used.

If the meaning of a term cannot be readily determined under the law of a Contracting State, or if there is a conflict in meaning under the laws of the two Contracting States that creates difficulties in the application of the Convention, the competent authorities may agree to the meaning of a term for purposes of applying the Convention pursuant to the provisions of Article 25 (Mutual Agreement Procedure). This agreed meaning need not conform to the meaning of the term under the laws of either Contracting State.

The reference in paragraph 2 to the internal law of a Contracting State means the law in effect at the time the treaty is being applied, not the law as in effect at the time the treaty was signed. The use of “ambulatory” definitions, however, may lead to results that are at variance with the intentions of the negotiators and of the Contracting States when the treaty was negotiated and ratified. The reference in both paragraphs 1 and 2 to the “context otherwise requir[ing]” a definition different from the treaty definition, in paragraph 1, or from the internal law definition of the Contracting State whose tax is being imposed, under paragraph 2, refers to a circumstance where the result intended by the Contracting States is different from the result that would obtain under either the paragraph 1 definition or the statutory definition. This allows the Convention to be interpreted in a manner that avoids unintended results.