Article 6 (Income from Real Property)

Paragraph 1

The first paragraph of Article 6 states the general rule that income of a resident of a Contracting State derived from real property situated in the other Contracting State may be taxed in the Contracting State in which the property is situated. The paragraph specifies that income from real property includes income from agriculture and forestry. Income from agriculture and forestry thus are dealt with in Article 6 rather than in Article 7 (Business Profits). Paragraph 3 clarifies that the income referred to in paragraph 1 also includes income from any use of real property, including, but not limited to, income from direct use by the owner (in which case income may be imputed to the owner for tax purposes) and rental income from the letting of real property.

This Article does not grant an exclusive taxing right to the situs State; the situs State is merely given the primary right to tax. The Article does not impose any limitation in terms of rate or form of tax on the situs State. Thus, the Convention does not include paragraph 5 of Article 6 of the U.S. Model, regarding the allowance of an election to be taxed on a net basis on income from real property. Net basis taxation, however, is available under the domestic tax laws of the United States and Japan. Thus, taxpayers generally should be able to obtain the same tax treatment in the Contracting State where the real property is situated regardless of whether the income is treated as business profits attributable to a permanent establishment or income from real property.

Paragraph 2

The term “real property” is defined in paragraph 2 generally by reference to the internal law definition in the situs State. In the case of the United States, the term “real property” has the meaning given to it by Treas. Reg. section 1.897-1(b). Consistent with Treas. Reg. § 1.897-1(b), paragraph 2 provides that the term “real property” shall include: property accessory to real property; livestock and equipment used in agriculture and forestry; rights to which the provisions of general law respecting real property apply; usufruct of real property; and rights to variable or

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fixed payments as consideration for the working of, or the right to work, mineral deposits and other natural resources. Paragraph 2 also provides that ships and aircraft are not regarded as real property.

The term “real property” is defined in paragraph 2 for all purposes of the Convention. In addition to its use in Article 6, the term is used in Articles 10 (Dividends) and 13 (Gains).

Paragraph 3

Paragraph 2 makes clear that all forms of income derived from the exploitation of real property are taxable in the Contracting State in which the property is situated. In the case of a net lease of real property, the gross rental payment (before deductible expenses incurred by the lessee) may be treated as income from the property. Income from the disposition of an interest in real property, however, is not considered “derived” from real property and is not dealt with in this article. The taxation of that income is addressed in Article 13 (Gains). Also, the interest paid on a mortgage on real property and distributions by a U.S. Real Estate Investment Trust are not dealt with in Article 6. Such payments would fall under Article 10 (Dividends), 11 (Interest) or 13 (Gains). Finally, dividends paid by a United States Real Property Holding Corporation are not considered to be income from the exploitation of real property; such payments would fall under Article 10 (Dividends) or 13 (Gains).

Paragraph 4

This paragraph specifies that the basic rule of paragraph 1, as elaborated in paragraph 3, applies to income from real property of an enterprise. This clarifies that the situs country may tax the real property income (including rental income) of a resident of the other Contracting State in the absence of attribution to a permanent establishment in the situs State. This provision represents an exception to the general rule under Article 7 (Business Profits) that income must be attributable to a permanent establishment in order to be taxable in the host state.