ARTICLE 8

Business Profits

This article sets forth the usual treaty rule that industrial or commercial profits of a resident of one State are taxable in the other State only if the resident has a permanent establishment in that other State. Where there is a permanent establishment, only the profits attributable to the permanent establishment can be taxed by that other State. For purposes of Article 5 (relating to relief from double taxation) which provides for the granting of a foreign tax credit by a State with respect to the other State's taxes on income from sources within that other

State, such profits are considered to be from sources within the State in which the permanent establishment is located.

While under the 1954 Convention, as under most of the old United States conventions, industrial or commercial profits were not taxed in the absence of a permanent establishment, once there was a permanent establishment the 1954 Convention (as did all such old conventions) provided generally that the provisions reducing the tax rate on interest, dividends, and royalties were not applicable. This rule, known as the "force of attraction" principle, is replaced in the new Convention, as in all our recent conventions, with the "effectively connected" concept. Under the new approach, only interest, dividends, and royalties which are effectively connected with the permanent establishment are taxable as part of the industrial or commercial profits and do not benefit from the reduced rate.

In determining the proper attribution of industrial or commercial profits under the new Convention, paragraph (2) of this article provides generally that a permanent establishment will be treated as if it were an independent entity and considered as realizing the profits which would be realized if the permanent establishment dealt with the resident of which it is a permanent establishment on an arm’s length basis. Under paragraph (3), expenses, wherever incurred, which are reasonably connected with profits attributable to the permanent establishment, including executive and general administrative expenses, will be allowed as deductions by the State in which the permanent establishment is located in computing the tax due to such State. However, it is not necessary to allow a profit to the head office for ancillary services furnished to the permanent establishment even though the permanent establishment deducts the allocable costs incurred by the head office.

Paragraph (4) of this article provides that the mere purchase of goods or merchandise in a State by a permanent establishment of a resident of the other State, or by the resident, for the account of such resident will not cause attribution of profits to such permanent establishment. It is not intended that paragraph (2) of this article should override paragraph (4). Thus, where a permanent establishment maintained in one of the States by a resident of the other State purchases goods for the account of that resident, and the purchasing activity is not an integral part of a broader range of activities carried on by the permanent establishment, no attribution of industrial and commercial profits will be made under paragraph (2) with respect to that activity of the permanent establishment.

The term "industrial or commercial profits" is defined by setting forth several examples of activities which constitute the active conduct of a trade or business, including, inter alia, insurance activities, agricultural activities the furnishing of personal services, and the rental of tangible personal property other than ships or aircraft. The term also includes income derived from real property and natural resources, dividends, interest, royalties, and capital gains arising from property which is effectively connected with a permanent establishment. The term does not include income received by an individual as compensation for personal services (either as an employee or in an independent capacity) and income derived by a corporation or other entity of a State from sources within the other State from furnishing personal services of an individual who does not or would not qualify for exemption under paragraph (2) of Article 18 (relating to dependent personal services) by reason of paragraph (3) thereof.

Income from the rental of ships or aircraft is discussed under Article 10 (relating to shipping and air transport) and Article 14 (relating to royalties).