Article 8 (Shipping and Air Transport)

This Article governs the taxation of profits from the operation of ships and aircraft in international traffic, and from the use of containers. The term “international traffic” is defined in subparagraph 1(i) of Article 3 (General Definitions). The taxation of gains from the alienation of ships, aircraft or containers is dealt with not in this Article but in paragraphs 5 and 6 of Article 13 (Gains).

Paragraph 1

Paragraph 1 provides that profits from the operation in international traffic of ships or aircraft carried on by an enterprise of a Contracting State are taxable only in that Contracting State. Because paragraph 7 of Article 7 (Business Profits) defers to Article 8 with respect to shipping income, such income derived by a resident of one of the Contracting States may not be taxed in the other Contracting State even if the enterprise has a permanent establishment in that other Contracting State. Thus, if a U.S. airline has a ticket office in Japan, Japan may not tax the airline's profits attributable to that office under Article 7. Since entities engaged in international transportation activities normally will have many permanent establishments in a number of countries, the rule avoids difficulties that would be encountered in attributing income to multiple permanent establishments if the income were covered by Article 7 (Business Profits).

Paragraph 2

The income from the operation of ships or aircraft in international traffic that is exempt from tax under paragraph 1 is defined in paragraph 2. In addition to income derived directly from the operation of ships and aircraft in international traffic, this definition also includes certain items of rental income that are closely related to those activities. First, income of an enterprise of a Contracting State from the rental of ships or aircraft on a full basis ( i.e., with crew) when such ships or aircraft are used in international traffic is income of the lessor from the operation of ships and aircraft in international traffic and, therefore, is exempt from tax in the other Contracting State under paragraph 1. Also, paragraph 2 encompasses income from the lease of ships or aircraft on a bareboat basis ( i.e., without crew) when the income is incidental to other income of the lessor from the operation of ships or aircraft in international traffic. Thus, the coverage of Article 8 of the Convention is generally consistent with Article 8 of the OECD Model although narrower than the U.S. Model, which also covers rentals from bareboat leasing that are not incidental to the operation of ships or aircraft by the lessee. The classes of income derived by an enterprise of a Contracting State from the rental of ships and aircraft not included in this Article are covered by Article 7 (Business Profits) and thus are subject to tax in the other Contracting State only to the extent not attributable to a permanent establishment in that other Contracting State.

Paragraph 2 also clarifies, consistent with the Commentary to Article 8 of the OECD Model, that income earned by an enterprise from the inland transport of property or passengers within either Contracting State falls within Article 8 if the transport is undertaken as part of the international transport of property or passengers by the enterprise. Thus, if a U.S. shipping company contracts to carry property from Japan to a U.S. city and, as part of that contract, it

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transports the property by truck from its point of origin to an airport in Japan (or it contracts with a trucking company to carry the property to the airport) the income earned by the U.S. shipping company from the overland leg of the journey would be taxable only in the United States. Similarly, Article 8 would apply to income from lighterage undertaken as part of the international transport of goods.

Finally, certain non-transport activities that are an integral part of the services performed by a transport company are understood to be covered in paragraph 1, though they are not specified in paragraph 2. These include, for example, the performance of some maintenance or catering services by one airline for another airline, if these services are incidental to the provision of those services by the airline for itself. Income earned by concessionaires, however, is not covered by Article 8. See paragraphs 7 through 10.1 of the Commentary to Article 8 of the OECD Model.

Paragraph 3

Paragraph 3 provides for an exemption from certain local taxes in Japan in respect of the operation of ships or aircraft in international traffic by U.S. enterprises, provided that no state or local government in the United States imposes a similar tax on a Japanese enterprise in respect of such operations. In particular, paragraph 3 provides that a U.S. enterprise will be exempt from the local inhabitant taxes and the enterprise tax in Japan in respect of the operation of ships or aircraft in international traffic provided that no state or local government in the United States imposes a similar tax on a Japanese enterprise in respect of such operations. Absent paragraph 3, Japan could apply these taxes to U.S. shipping and aircraft enterprises because the local inhabitant tax and the enterprise tax are not covered taxes under Article 2. Paragraph 3 generally is consistent with the current treatment of local Japanese taxes by the prior Convention and the notes thereto.

Paragraph 1 of the Notes further provides that if a state or local authority of the United States seeks to levy a tax similar to these taxes on the profits of any Japanese enterprise from the operation of ships or aircraft in international taxes in circumstances where the Convention would preclude the imposition of Federal income tax on those profits, the Government of the United States will use its best endeavors to persuade that political subdivision or local authority to refrain from imposing such tax. At the present time, it is the understanding of the Treasury Department that no such state or local tax is imposed on Japanese airlines and shipping companies in the United States.

Paragraph 4

Under this paragraph, profits of an enterprise of a Contracting State from the use, maintenance or rental of containers (including equipment for their transport) are exempt from tax in the other Contracting State except where such containers are used solely within the other Contracting State. This result is the same as that under paragraph 3 of Article 8 of the U.S. Model, which provides that profits of an enterprise from the use, maintenance or rental of containers (including equipment for their transport) “that are used for the transport of goods in international traffic” are exempt from tax in the other Contracting State. Because the definition

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of “international traffic” in subparagraph 1(i) of Article 3 (General Definitions) is limited to transport by a ship or aircraft operated by an enterprise of a Contracting State, however, a reference to “international traffic” in paragraph 4 would have reached results inconsistent with the U.S. Model, for example, in a case of a U.S. enterprise that rented containers for use in the international transport by a ship operated by an enterprise of a third State.

Paragraph 4 exempts profits of an enterprise of a Contracting State from containers from tax in the other Contracting State regardless of whether the recipient of the income is engaged in the operation of ships or aircraft in international traffic, and regardless of whether the enterprise has a permanent establishment in that other Contracting State. By contrast, Article 8 of the OECD Model covers only income from the use, maintenance or rental of containers that is incidental to other income from international traffic.

Paragraph 5

This paragraph clarifies that the provisions of Article 8 also apply to profits derived by an enterprise of a Contracting State from participation in a pool, joint business or international operating agency. This refers to various arrangements for international cooperation by carriers in shipping and air transport. For example, airlines from two countries may agree to share the transport of passengers between the two countries. They each will fly the same number of flights per week and share the revenues from that route equally, regardless of the number of passengers that each airline actually transports. Paragraph 5 makes clear that with respect to each carrier the Article exempts all the income earned by that carrier with respect to the pool, and not just the income derived directly by that carrier. This paragraph corresponds to paragraph 4 of Article 8 of the U.S. Model.

Relation to Other Articles

This Article is subject to the saving clause of subparagraph 4(a) of Article 1 (General Scope) of the Convention. Thus, if a citizen of the United States who is a resident of Japan derives profits from the operation of ships or aircraft in international traffic, notwithstanding the exclusive residence country taxation in paragraph 1 of Article 8, the United States may, subject to the special foreign tax credit rules of paragraph 3 of Article 23 (Relief from Double Taxation), tax those profits as part of the worldwide income of the citizen. (This is an unlikely situation, however, because non-tax considerations ( e.g., insurance) generally result in shipping activities being carried on in corporate form.)

As with other benefits of the Convention, the benefit of exclusive residence country taxation under Article 8 is available to an enterprise only if it is entitled to benefits under Article 22 (Limitation on Benefits).