Article 6. SHIPPING AND AIR

TRANSPORT

This article provides that, notwith­ standing Article 5 (Business Profits), income which a resident of the United States derives from the operation in international traffic of ships or aircraft registered in either of the Contracting States or in a State with which Nor­ way has an income tax convention ex­ empting such income shall be exempt from tax in Norway.

This article provides a similar ex­ emption from United States tax for income derived by a resident of Nor­ way, or an international consortium of which a resident of Norway and resi­ dents of other States with which the United States has an income tax con­ vention exempting such income are the sole members, from the operation in international traffic of ships or air­ craft. The reference to a consortium is

sources within the State in which the permanent establishment is located.

While under the existing Norwegian Convention, as under most of the old United States Conventions negotiated prior to the income tax treaty between France and the United States signed in 1967, 1968-2 C.B. 691, industrial or commercial profits are not taxed in the absence of a permanent establish­ ment; once there is a permanent es­ tablishment the existing Convention, as did such old Conventions, provides generally that the provisions reducing the tax rate on interest, dividends, and royalties are not applicable. This rule is known as the “force of attrac­ tion” principle and is replaced in the proposed Convention, as in our other recent Conventions, with the effec­ tively connected concept. Under the new approach, only those interests, div­

idends, and royalties which are effec­ tively 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 attribu­ tion of industrial or commercial prof­ its under the proposed Convention, paragraph (2) of this article provides generally that a permanent establish­ ment will be treated as an independ­ ent entity and considered as realizing the profits which would be realized if the permanent establishment dealt with the resident of which it is a per­ manent establishment on an arm’s length basis. Under paragraph (3), expenses, wherever incurred, which are reasonably connected with profits attributable to the permanent estab­ lishment, including executive and gen­ eral 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 neces­ sary to allow a profit to the head office for ancillary services furnished to the permanent establishment as long as the permanent establishment is

allowed to deduct the allocable costs incurred by the head office.

Paragraph (4) of this article pro­ vides that the mere purchase of goods or merchandise in a State by the per­ manent establishment, or by the resi­ dent of which it is a permanent estab­ lishment, for the account of such resi­ dent will not cause attribution of prof­ its to such permanent establishment. It is not intended that paragraph (2) of this article should limit paragraph

(4) to any extent. Thus, attribution of industrial and commercial profits under paragraph (2) will be made with full regard to the provisions of paragraph (4).

This Convention departs from the form used in some of our more recent conventions by first defining the term “industrial or commercial activity” and then defining the term “industrial or commercial profits” to include in­ come derived from the industrial or commercial activity. In spite of the difference of approach, the term “in­ dustrial or commercial profits” has a meaning generally similar to that in our other recent treaties.

The term “industrial or commercial activity” 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 activ­ ities, fishing or mining activities, the operation of ships or aircraft, the fur­ nishing of services, the rental of tangi­ ble personal property, and the rental or licensing of motion picture films or films or tapes used for radio or televi­ sion broadcasting. The term does not include the performance of personal services by an individual either as an employee or in an independent capac­ ity.

The term “industrial or commercial profits” includes, in addition to in­ come from industrial or commercial activity, income derived from real property and natural resources and dividends, interest, royalties (as de­ fined in paragraph (2) of Article 10

(Royalties)), and capital gains but

more of the stock of the payer corpo­ ration and, generally, if not more than 25 percent of the gross income of the paying corporation for such period consists of dividends and interest.

The proposed Convention abandons the “force of attraction” concept in the existing Convention by providing that the reduced rates of tax on divi­ dends are denied only if the shares with respect to which the dividends are paid are effectively connected with a permanent establishment which the recipient has in the State of source. The elimination of the “force of attraction” principle will make uni­ form the rate of tax levied on divi­ dend income of a resident of one State from sources within the other State unless such income is effectively con­ nected with a permanent establish­ ment in the State of source. In those cases where the shares with respect to which the dividends are paid are so effectively connected, the dividends may be taxed as industrial or commer­ cial profits under Article 5 (Business Profits). Income which is so effec­ tively connected may be taxed at the normal rates aplicable to such in­ come in the State of source.

The proposed Convention continues the 15-percent rate with respect to dividends on portfolio investments but provides a maximum rate of 10 per­ cent with respect to intercorporate dividends if, during the part of the paying corporation’s taxable year which precedes the date of payment

of the dividend and during the whole of its prior taxable year, the recipient owns 10 percent or more of the voting shares of the paying corporation and, generally, if not more than 25 percent of the gross income of the paying cor­ poration for such prior taxable year consists of dividends and interest.

This Convention also contains a rule similar to that of our recent Belgian Convention. Specifically, the provision of paragraph (4) of this ar­ ticle which exempts dividends paid by a corporation of one of the Contract­ ing States to a person other than a

intended to ensure that the exemption applies to Scandinavian Airlines Sys­ tem (SAS), an entity in the nature of a partnership which was created jointly by the legislatures of Norway,

Sweden and Denmark. SAS is known as a consortium in those countries and thus the consortium is specifically re­ ferred to in this article. The exemp­ tion applies to the income of the con­ sortium in its entirety because, in ad­ dition to the present Convention, the United States income tax conventions with Denmark and Sweden provide similar exemptions to residents of those States.

Gains from the sale, exchange, or other disposition of ships or aircraft operated in international traffic are governed by the provisions of para­ graph (2) of Article 12 (Capital Gains).

In addition, letters were exchanged covering several specific situations that might arise under Article 6. It was agreed that income derived by a resi­ dent engaged in the operation in in­

ternational traffic of ships or aircraft from the use, maintenance, and lease of containers and related equipment in connection with such operations is exempt as falling within the scope of this article. It was agreed that income derived by a resident engaged in the operation in international traffic of ships or aircraft from a full or bare­ boat charter to another person is ex­ empt as falling within the scope of this article. Further, it was agreed that income derived by a partner who is a resident from an interest in a partnership which derives its income from the operation in international traffic of ships or aircraft shall be tax­ able only in the Contracting State in which such partner is a resident.

It was also agreed in the exchange of letters that all income earned by SAS, Inc. (Scandinavian Airline Sys­ tem, Inc., a New York corporation) from the operation in international traffic of aircraft would be treated as income of SAS, the consortium whose constituent corporate members own

the stock of SAS, Inc. SAS, Inc. was created and is operated as an entity apart from SAS to satisfy U.S. regula­ tions regarding foreign airlines, which SAS as a consortium could not meet. SAS, Inc. is a conduit for SAS with regard to receipts and its expenses are guaranteed by SAS. Therefore the in­ come of SAS, Inc. will be taxed no differently under the Convention than if it were earned directly by SAS.