ARTICLE 4

General Rules of Taxation

The general rules of taxation applicable under the Convention are as follows:

A resident of one State may be taxed by the other State only on in come from sources within that other State (including industrial or commercial profits attributable to a permanent establishment located in that other State), subject to the limitations set forth in the Convention. For this purpose, the source rules contained in Article 6 of the Convention are to be applied. The jurisdictional rules of the Convention parallel those set forth in section 872 (a) of the United States Internal Revenue Code, relating to nonresident alien individuals, and section 882 (b), relating to foreign corporations, as amended by the Foreign Investors Tax Act of 1966 [1966-2 C.B. 656].

The Convention continues the general rule (also found in our new Belgian, French, Finnish, Norwegian and Trinidad and Tobago conventions) that the Convention will not affect in any manner any exclusion, exemption, deduction, credit, or other allowance now or hereafter accorded by' the laws of a State in the determination of a tax imposed by that State, or by any other agreement between the Contracting States. This rule represents the position of the United States under all conventions to which it is a party.

The Convention also contains the traditional savings clause under which each Contracting State reserves the right to tax its residents as if the Convention had not come into effect. In the case of the United States, the savings clause also applies to its right to tax its

citizens. However, the savings clause does not apply in several specified cases in which its application would contravene policies reflected in the Convention. Thus, the savings clause does not affect the benefits relating to relief from double taxation (Article 5), nondiscrimination (Article 7), governmental functions (Article 21) or the mutual agreement procedure (Article 25). Moreover, the savings clause will not cause the benefits of the Convention to be denied to teachers and researchers (Article 19) or to students or trainees (Article 20) or those arising under Article 22, relating to rules applicable to the personal income articles, except, in the case of such benefits conferred by the United States, the benefits will be denied if such individuals are citizens of the United States or have immigrant status in the United States. In addition, the savings clause does not affect Article 24, which recognizes the fiscal privileges of diplomatic and consular officials.

Another general rule of taxation is that there shall be allowed, for purposes of the United States tax in the case of a resident of Japan who is not a resident of the United States (other than an officer or employee of the Japanese government or local authority thereof), in addition to the deduction for one personal exemption provided in section 873 of the Internal Revenue Code as in effect on December 1, 1968, a deduction for personal exemptions, subject to the conditions prescribed in sections 151 through 154 of the Internal Revenue Code as in effect on December 1, 1968, for the spouse and each child of the taxpayer present in the United States and residing with him in the United States at any time during the taxable year. Reference is made to sections 151 through 154 for purposes of setting forth the conditions of obtaining the deduction. The amount of the deduction is determined on the basis of the amount of the exemption taxed in the Internal Revenue Code for the taxable year. However, the taxpayer is not entitled by reason of the Convention to the additional exemptions for age and blindness. The amount of the additional deduction provided by the Convention is the proportion of the exemption fixed by the Internal Revenue Code which the taxpayer's gross income from sources within the United States which is treated as effectively connected with the conduct of a trade or business within the United States within the meaning of section 864 (c) of the Internal Revenue Code of 1954 for the taxpayers taxable year bears to his entire income from all sources for such taxable year. Article XVI (1) of the 1954 Convention with Japan provided substantially the same exemptions as the new Convention. However, under the 1954 Convention the limitation on the additional deduction for the taxpayer's spouse and children provided that the deduction could not exceed the proportion thereof which the taxpayer's entire gross income from sources within the United States for his taxable year bore to his entire income from all sources for the fiscal or calendar year in which such taxable year ended. The taxpayer's own personal exemption is not limited under either Convention.

In this article, the United States also reserves the right to impose its personal holding company tax in any taxable year except in cases in which a Japanese corporation is wholly owned, directly or indirectly, by one or more individuals who are residents of Japan, and not citizens of the United States, for that entire taxable year. The United States may not impose its accumulated earnings tax in any taxable year on a Japanese corporation unless such corporation is engaged in trade or business in the United States through a permanent establishment at some time during that taxable year. The limitations on the right of the United States to tax do not expand upon the limitations now found in the Internal Revenue Code.

This Article also contains the rule that whenever any provision of the Convention provides for a State to reduce the rate of tax on, or exempt the income of, a resident of the other State and such resident is subject to tax by that other State, the reduction or exemption shall apply only to so much of such income as is remitted to or received in that other State. Under Japanese law, a person who is a nonpermanent resident of Japan is only taxed on income derived from sources within Japan and on income from other sources which is remitted to or received in Japan. Consequently, that person should not be able to avail himself of the benefits of the Convention to the extent his income is not currently taxed by Japan.