Article 21 follows the form used — U.S. Income Tax Treaty

tax treaties. See, e.q., the Convention between the United States of America and the Federal Republic of Germany for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital and to Certain Other Taxes. The structure of the Article is as follows: Paragraph 1 lists a series of attributes of a resident of a Contracting State, the presence of any one of which will entitle that person to benefits of the Convention in the other Contracting State. Paragraph 2 provides that benefits also may be granted to a person not entitled to benefits under the tests of paragraph 1, if the competent authority of the source State determines that it is appropriate to provide benefits in that case. Paragraph 3 defines the term "gross income" as used in paragraph 1(e)(ii).

The first category of persons eligible for benefits from the other Contracting State under paragraph 1 consists of individual residents of a Contracting State. It is unlikely that individuals can be used to derive treaty-benefitted income on behalf of a third-country resident. If such an individual is receiving income as a nominee on behalf of a third country resident, benefits will be denied under the respective articles of the Convention by the reguirement that the beneficial owner of the income be a resident of a Contracting State.

The second category consists of active businesses that are residents of one of the Contracting States and derive income from the other Contracting State that is connected with, or incidental to, that business. For this purpose, the business of making or managing investments is not considered an active business unless carried on by a bank or insurance company. The first six examples in the Memorandum of Understanding regarding the scope of the Limitations on Benefits Article in the Convention Between the Federal Republic of Germany and the United States of America illustrate the situations covered by subparagraph (b).

The third category, in subparagraph (c), consists of companies whose shares are regularly traded in substantial volume on an officially recognized securities exchange, or a company

wholly owned, directly or indirectly, by a company that is a resident of the same State and whose shares are so traded. Point 7 of the Protocol specifies that the term "officially recognized securities exchange" means, in the case of the United States, the NASDAQ System owned by the National Association of Securities Dealers, Inc., and any stock exchange registered with the Securities Exchange Commission as a national securities exchange for purposes of the Securities Exchange Act of 1934. The Memorandum of Understanding between the two States provides that any other exchange will be treated as an "officially recognized exchange" under subparagraph (c) only if it is officially recognized by either State and agreed upon by the competent authorites of both States. This clarifies that point 7 neither limits the U.S. exchanges that may be "officially recognized" under paragraph 1 (c) to those specified in the Protocol nor implies that any exchange recognized by Kazakhstan is automatically within subparagraph (c). Thus, any future exchange officially recognized by Kazakhstan will be reviewed by the competent authorites and, only if they agree that it provides adequate requirements for listing and trading, will be treated as an "officially recognized exchange" for purposes of granting treaty benefits to companies listed and traded on it.

The fourth category covers tax-exempt organizations. If more than half of its beneficiaries, members, or participants (if any) are individual residents of either Contracting State or persons who meet the other criteria of this Article, the taxexempt organization will be a qualified resident.

The fifth category provides a two-part test, the so-called ownership and base erosion tests. Both must be satisfied for the resident to be entitled to benefits under subparagraph (e). The ownership test requires that more than 50 percent of the beneficial interest in the person (or, in the case of a corporation, more than 50 percent of each class of its shares) be owned, directly or indirectly, by persons who are themselves entitled to benefits under the other tests of paragraph l (other than subparagraph (b)). The base erosion test requires that not more than 50 percent of the person’s gross income be used, directly or indirectly, to meet liabilities to persons other than persons eligible for benefits under the other tests of paragraph 1 (other than subparagraph (b)). For this purpose "gross income" means gross receipts or, in the case of a manufacturing or producing activity, gross receipts less the direct costs of labor and materials. (See paragraph 3.)

The rationale for this two-part test is that, to prevent treaty benefits from inuring substantially to third-country residents, it is not sufficient to require substantial ownership of the equity of the entity by treaty country residents. it is also necessary to ensure that the entity's tax base not be eroded by deductible payments to third country residents.

It is intended that the provisions of paragraph 1 will be self-executing. Unlike the provisions of paragraph 2, discussed below, claiming benefits under paragraph 1 does not require advance competent authority ruling or approval. The tax authorities may, of course, on review, determine that the tax payer has improperly interpreted the paragraph and is not entitled to the benefits claimed.

It is understood that, just as the two Contracting States and their political subdivisions are to be treated as residents of those States for purposes of Convention benefits, they also are entitled to benefits under Article 21.

Paragraph 2 permits the competent authority of the State in which income arises to grant Convention benefits in additional cases, even if the beneficial owner of the income does not meet the safe harbor standards of paragraph 1 (or the information is not available to make such a determination). This discretionary provision is included in recognition that, with the increasing scope and diversity of international economic relations, there may be cases where significant participation by third country residents in an enterprise of a Contracting State is warranted by sound business practice and does not indicate a motive of attempting to derive unintended Convention benefits.

Paragraph 3 defines the term "gross income" as used in paragraph 1(e)(ii).