Article 12. ROYALTIES

This Article limits the taxation at source by each Contracting State of royalties paid to a resident of the other Contracting State.

Paragraph 1 preserves the residence State's general right to tax its residents on royalties arising in the other Contracting State. The same result is achieved by the saving clause of paragraph 3 of Article 1 (General Scope).

Paragraph 2 permits the source State to tax royalties but limits the rate of source State tax to 10 percent of the gross amount of royalties beneficially owned by residents of the other State. Notwithstanding its treaty obligation to limit the rate of tax applied to royalties, the source State may, in accordance with point 4 of the Protocol, withhold on royalties at its domestic rates, as long as it timely refunds any excess amount withheld over the maximum rates established by the treaty.

As defined in paragraph 3, the term "royalties" includes payments for eguipment rentals. (Payments for the rental of ships, aircraft, and containers in connection with international traffic, however, are covered by Article 8 (Shipping and Air Transport).) Paragraph 2 provides that the beneficial owner of royalties arising from equipment rentals may elect to compute the source State tax on a net basis, as if the royalties were attributable to a permanent establishment or fixed base. In that case, the 10 percent maximum rate of paragraph 2, which limits any gross basis tax, will not be applicable. The election effectively treats income from the leasing of equipment as if it were attributable to a permanent establishment in the source State and covered by Article 6 (Business Profits). The preferred U.S. position is in fact to treat income from the rental of tangible personal property under Article 6. A beneficial owner of the payments from equipment rentals that makes the net election may, in addition to the source State tax on profits, be subject to any source State branch taxes under paragraph 5 of Article 10 (Dividends) or paragraph 7 of Article 11 (Interest).

Paragraph 2 further defines the term "royalties" as used in the Convention to mean payments of any kind received as a consideration for the use of, or the right to use, any copyright of a literary, artistic, or scientific work, including computer software programs, video cassettes, and films and tapes for radio

and television broadcasting. The term also includes payments for the use of, or right to use, any patent, trademark, design or model, plan, secret formula or process, or other like right or property; or for information concerning industrial, commercial, or scientific experience. The term "information concerning industrial, commercial, or scientific experience" alludes to the concept of "know-how" and means information that is not publicly available and that cannot be known from mere examination of a product and mere knowledge of the progress of technique. As provided in the Commentaries to the OECD Model (Paragraph 11 of the Article 12 Commentaries), "In the know-how contract, one of the parties agrees to impart to the other, so that he can use them for his own account, his special knowledge and experience which remain unrevealed to the public." This distinguishes the "know-how" contract from a contract for the provision of services or technical assistance, in which one party agrees himself to perform work for the other party.

Paragraph 4 provides an exception to the rules of paragraphs

1 and 2 in cases where royalties are attributable to a permanent establishment or fixed base that the beneficial owner, a resident of one Contracting State, has in the other Contracting State. In such a case, the royalties are taxable to the permanent establishment or fixed base in accordance with the provisions of Article 6 (Business Profits) or Article 14 (Independent Personal Services). The same rule applies if the permanent establishment or fixed base has ceased to exist when the royalties are received, so long as the royalties would have been attributable to it if they had been paid or accrued in the earlier year.

Paragraph 5 provides a source rule for royalties that

reflects the U.S. rule. That is, royalties will be deemed to arise in a Contracting State, and thus may be taxed there in accordance with the provisions of paragraph 2, if they are paid for the use or right to use in that State property giving rise to the royalty.

Paragraph 6 provides that if, as a result of a special relationship between persons, the royalty paid is excessive, Article 12 will apply only to the amount of royalty payments that would have been made absent such special relationship (i.e., an arm's length royalty payment). Any excess amount of royalties paid remains taxable according to the laws of the United States and Kazakhstan, respectively, with due regard to the other provisions of the Convention. If, for example, the excess amount is treated as a distribution of profits, such excess amount could be taxed as a dividend rather than as a royalty payment, but the tax imposed on the dividend payment would be subject, if appropriate, to the rate limitations of paragraph 2 of Article 10 (Dividends).