Article 7. ASSOCIATED ENTERPRISES

This Article allows the Contracting States to make appropriate adjustments to the taxable income and tax liability of related persons that engage in non-arm's length transactions

with one another. The Article provides that the States may make such adjustments as are necessary to reflect the income or tax that each party to the transaction would have had if the transaction had been at arm's length.

Paragraph 1 a) deals with the circumstance where a resident of a Contracting State participates, directly or indirectly, in the management, control, or capital of a resident of the other Contracting State, and paragraph 1 b) deals with a situation in which the same persons participate, directly or indirectly, in the management, control, or capital of a resident of one of the Contracting States and of any other person. The term "control" includes any kind of control, whether or not legally enforceable and however exercised or exercisable. If, in either of these related party cases, there are commercial or financial dealings that do not reflect arm's length terms or conditions, the competent authorities may adjust the income of their residents to reflect an arm's length transaction.

The adjustments allowed by the provisions of paragraph 1 can give rise to taxation of the same income by both Contracting States. To address this potential double taxation, paragraph 2 provides that, where a Contracting State has made an adjustment to the income of one of its residents to reflect arm's length terms, the other Contracting State will make a corresponding adjustment to the tax liability of a related person resident in that other State. It is understood that the other Contracting State need adjust its tax only if it agrees that the initial adjustment is appropriate. The other provisions of the Convention, where relevant, are to be taken into account. The competent authorities will consult, as necessary, in applying these provisions.

Paragraph 2 of Article 25 (Mutual Agreement Procedure) explains that the corresponding adjustment by the other Contracting State will not be prevented by a domestic statute of limitations or other procedural limitation. The "saving clause" of paragraph 3 of Article 1 (General Scope) does not apply to paragraph 2 of Article 25. (See Article 1 (4)(a).) Thus, even if the statute of limitations has run or if there is a closing agreement between the Internal Revenue Service and the taxpayer, a refund of tax may be required to implement a corresponding adjustment. Statutory or procedural limitations, however, cannot be overridden to impose additional tax because, under paragraph 2 of Article 1 (General Scope), the Convention cannot restrict any statutory benefit.

Paragraph 3 simply confirms this Article 7 does not restrict the application of either Contracting State's domestic laws that adjust the income of related persons. The reference in paragraph 1 to "income," for example, does not imply that adjustments may not relate to deductions, exemptions, credits, or other elements

affecting tax liability. Adjustments to the elements of tax liability are permitted even if they are different from, or go beyond, those authorized by paragraph 1 of this Article, as long as they accord with the general principles of paragraph 1, i.e ., the adjustments reflect what would have transpired had the related parties been acting at arm's length.