ARTICLE 1

Taxes Covered

This article designates the taxes of the respective States which are the subject of the Convention. With respect to the United States, the taxes included are the United States Federal income tax imposed by the Internal Revenue Code. This includes, for example, the surtax and would also include such taxes as the temporary surcharge which was in force from 1968 to 1970. However, the Convention does not, in general, apply to taxes which are in the nature of a penalty such as the taxes imposed under section 531 (accumulated earnings tax) and section 541 (personal holding company tax) of the Internal Revenue Code (see, however, paragraph (6) of Article 4 and Articles 7 and 26).

With respect to Japan, the taxes included are the income tax, imposed on individuals, and the corporation tax (as modified by the Special Taxation Measures Law and other special laws which provide for special measures applicable to taxpayers in Japan).

The Japanese income tax is imposed upon resident individuals at graduated rates. There are two categories of residents for this purpose. Except in the circumstances described in the next sentence, an individual who either has a domicile in Japan or has a residence in Japan for one year or more is treated as a resident. Unless he is a nonpermanent resident he is taxed on his worldwide income. An individual who has no intention of residing in Japan permanently is treated as a nonpermanent resident if he has had residence or domicile in Japan for an uninterrupted period of not more than 5 years. A nonpermanent resident is taxed only on income derived from sources within Japan and on income derived from foreign sources which is paid in or remitted to Japan. An individual who has no domicile in Japan and is either not resident in Japan or has had residence there for less than one year is treated as a nonresident and is taxed solely upon income from sources within Japan. In the case of income attributable to a Japanese business, the nonresident is subject to tax at graduated rates on a net income basis. However, in calculating net income for this purpose, the nonbusiness deductions, exemptions, and tax credits allowed (for a nonresident) are limited to the deduction for casualty losses on assets situated in Japan, the basic exemption, and credits for dividends and for contributions. In the case of Japanese source nonbusiness income, received by a nonresident of Japan, a flat rate of 20 percent is applicable to the gross amount of passive income such as dividends, interest, royalties and annuities.

The Japanese corporate tax rate is 36.75 percent on undistributed profits and 26 percent on distributed profits. A foreign corporation is taxed at the higher rate on income which is derived from sources within Japan and attributable to business conducted in Japan through a permanent establishment. However, the rate on undistributed profits of Japanese corporations and on profits of foreign corporations is 28 percent (22 percent on distributed profits of Japanese corporations) if the corporations annual income is not in excess of 3 million yen and the capital is 100 million yen or less. Taxable income of a foreign corporation is computed generally in the

same manner as taxable income of a domestic corporation.

Income of a foreign corporation without a permanent establishment in Japan derived from sources in Japan is taxed on a flat rate of 20 percent on gross amount of passive income such as dividends, interest, rents and royalties. (This 20 percent flat rate also applies to the Japanese source income of certain types of foreign corporations with permanent establishments if the income is not attributable to the permanent establishment.)

In addition to the taxes described above, prepayment of tax in the form of withholding is generally required by Japanese law. In the case of a resident individual (including a nonpermanent resident), tax is withheld at the source of interest income, original issue discount on bonds bearing no interest, dividend income, employment income, retirement income, and remuneration or lump sum payments for certain personal services. In the case of a nonresident individual or a foreign corporate of 20 per cent on certain income derived from sources in Japan, including dividends, interest on certain loans, rent for the use of immovable property, and royalties. An exemption from such withholding can be obtained if the taxpayer has a permanent establishment in Japan. However, the exemption does not extend to dividends or interest on loans.

Pursuant to paragraph (2) of this article, the Convention also applies to taxes substantially similar to those enumerated which are imposed, in addition to or in place of the existing income taxes, after the date of signature of the Convention, March 8, 1971.

For purposes of Article 7 (relating to nondiscrimination), the Convention applies to taxes of every kind which are, or may be, imposed in the respective States, at the National, State or local level. For purposes of Article 26 (relating to exchange of information), the Convention applies to taxes of every kind which are, or may be, imposed by the respective States at the National level. Thus, the United States will be able to obtain information with respect to the Interest Equalization Tax.