Article 11 - INTEREST

   Article 11 governs the taxation of interest. Generally, the
Article provides for full residence country taxation of interest
and for a limited source State right to tax such income.

                    -40­

TURKEY 228

Supp. No. 6 (1998)

Paragraph 1

   Paragraph 1 preserves the general right of each Contracting
State to tax its residents on interest arising in the other Con­
tracting State. The same result is achieved by the saving clause
of paragraph 3 of Article 1 (Personal Scope).

Paragraph 2

   Paragraph 2 grants to the source State the right to tax
interest payments beneficially owned by a resident of the other
Contracting State. The rate of the source country tax is limit­
ed. The maximum rate of tax allowed by the source State varies,
however, depending on the nature of the interest payment. Under
the provisions of paragraph 3, certain classes of interest
payments are exempt from source country tax.

   The general rate of source country tax applicable to inter­
est payments under paragraph 2 is 15 percent. This is higher
than the rate of source country tax on interest in most U.S.

treaties, and higher than that in the OECD Model. Turkey,

however, entered a reservation in the OECD Model indicating its
intention to provide for higher rates of withholding on interest
than the 10 percent provided for in the Model.

   Paragraph 2 also provides, however, that the rate of source

country tax on interest derived with respect-to any kind of loan granted by a financial institution may not exceed 10 percent.

For this purpose the term "financial institution" includes banks,
savings institutions and insurance companies.

   The beneficial owner of an interest payment for purposes of
Article 11 is the person to which the interest income is attrib­

utable for tax purposes. Thus, if interest arising in one of the

States is received, for example, by a nominee or agent that is a
resident of the other State on behalf of a person that is not a
resident of that other State, the interest will not be entitled
to the benefits of this Article. However, interest received by
the nominee on behalf of a resident of that other State would be
entitled to the benefits.

                    -41­

TURKEY 229

Supp. No. 6 (1998)

   Paragraph 3

   Paragraph 3 specifies certain categories of interest that
are exempt from source State taxation. The categories of exempt
interest are interest arising in one Contracting State paid to
the Government of the other Contracting State or to the central
bank of the other Contracting State (st, The Central Bank of
Turkey or any Federal Reserve Bank of the United States) and
interest arising in connection with a debt obligation that is
guaranteed or insured by the other Contracting State. Subpara­
graph 3 c) is understood to refer to loans guaranteed or insured
by such U.S. institutions as the Export-Import Bank and the Over­
seas Private Investment Corporation. The competent authorities
may interpret subparagraph c) as including other similar insti­
tutions of either Contracting State.

   Paragraph 4

   Paragraph 4 of Article 11 defines the term "interest" as
used in this Article. Subparagraph a) of paragraph 4 contains
the general definition. Under subparagraph a), "interest" is
defined to mean income from debt-claims of every kind, whether or
not the claim is secured by a mortgage, and whether or not it
carries a right to participate in the profits of the debtor. The
definition of interest includes all other forms of income that
are characterized as income from money lent under the laws of the
Contracting State in which the income arises. Income from
Government securities and from bonds or debentures, including
premiums or prizes attaching to such securities, bonds, or deben­

tures is considered interest for purposes of Article 11.
Although not made explicit in this paragraph, the definition of
interest also encompasses an excess inclusion with respect to a
residual interest in a real estate mortgage investment conduit.
A special rule is provided in paragraph 8 for the source

country's taxation of this category of interest. The definition
of interest excludes any item of income that is treated as a
dividend under Article 10 (Dividends), even if such dividends are
income arising from debt-claims. Unlike most U.S. treaties, the
definition of interest does not exclude from the scope of the
term penalty charges for late payment. Under Turkish law such

  -42­

TURKEY 230

Supp. No. 6 (1998)

payments are regarded as interest and will, therefore, be subject
to Turkish tax, subject to the provisions of Article 11.

   Subparagraph b) of paragraph 4 includes within the defini­
tion of interest, applicable only for purposes of U.S. tax,

certain "excess interest," on which U.S. tax is imposed under

section 884(f)(1)(B) of the Code. Under the Code rule, "excess
interest" is generally the excess of the total amount allowable
as a deduction in computing the U.S. effectively connected income
of a foreign corporation over the total interest paid by the
foreign corporation's U.S. trade or business. The Convention
permits the United States to apply its tax on excess interest

(but at the lowered treaty rate) to the excess, if any, of (i)

interest that is borne by (ie., deductible in computing the

income of) a U.S. permanent establishment, fixed base, or trade
or business subject to tax in the United States on a net basis,
over (ii) the interest paid by such permanent establishment,
fixed base, or trade or business. Under current U.S. law, the
excess amount is deemed paid by a U.S. corporation to a Turkish
corporation. Current U.S. law imposes branch level interest

taxes only on foreign corporations and not on non-corporate

foreign residents. Interest will be considered "borne by" a

permanent establishment even if the interest is not fully
deductible in that year, provided it is allocable in that year to
the permanent establishment's U.S. income under U.S. domestic

rules.

Paragraph 5

   Paragraph 5 provides an exception from the rules of para­
graphs 1, 2, and 3 in cases where interest is attributable to a
permanent establishment or, in the case of a resident of Turkey,

to a fixed base in the United States. Such interest instead is
governed by Article 7 (Business Profits) or 14 (Independent

Personal Services). Under these Articles, the State in which the
permanent establishment or fixed base is located may tax the
interest on a net basis using the rules and rates of taxation
generally applicable in that State, as long as the taxation is in
accordance with the rules set forth in Article 7 or 14. In the
case of interest attributable to a fixed base, paragraph 5
provides for net basis tax only when the fixed base is that of a

  -43­

TURKEY 231

Supp. No. 6(1998)

Turkish resident in the Unted States and not when a U.S. resident has a fixed base in Turkey. This unilateral treatment was necessary because of particular provisions in Turkish law. Turkey does not have the capacity under its internal law to attribute income, other than personal services income, to a fixed

base; interest income is not considered to be personal services

income. Therefore; if paragraph 5 required Turkey to tax

interest attributable to a Turkish fixed base of a U.S. resident
only as personal services income, Turkey would not be in a
position to tax the interest at all, even if the interest is

appropriately sourced in Turkey. Because of the unilateral

language in paragraph 5, Turkey may continue to tax interest
sourced in Turkey and attributable to a U.S. resident's fixed
base in Turkey as interest and in accordance with the limitations
of paragraphs 2 and 3.

Paragraph 6

    Paragraph 6 provides a source rule for interest. It
provides that interest shall be deemed to arise in a State when

the payer is the State itself or a political subdivision, local

authority, or resident of that State. In addition, interest paid

by any person (whether or not a resident) and borne ^{by a perma­} nent establishment, fixed base, or trade or business subject to

tax on a net basis in one of the States is deemed to arise in the
State in which the permanent establishment, fixed base, or trade

or business is situated. Paragraph 6 clarifies that the excess interest described in subparagraph b) of paragraph 4 is treated as arising in the United States. As indicated in connection with the discussion of paragraph 4 b), interest is considered "borne

by" a permanent establishment, fixed base, or trade or business

if it is allocable to (whether or not deductible from) taxable income of that permanent establishment, fixed ^{base, or trade or} business. If the actual amount of interest on the books of a U.S. branch of a Turkish business exceeds the ^{amount of interest}

allocated to the branch under Section 882, any such interest will
not be considered U.S. source interest for purposes of this

Article. Conversely, the total amount of interest allocated ^to

the branch under the section 882 regulations will be U.S. source

even if the amount exceeds branch book interest.

  -44­

TURKEY 232

Supp. No. 6 (1998)

Paragraph 7

   Paragraph 7 deals with cases where there is a special
relationship between the payer and the beneficial owner of

interest. The provisions of Article 11 will apply only to the

amount of interest payment that would have been made absent such

special relationship (i.., an arm's length interest payment).

Any excess amount of interest paid remains taxable according to
the laws of the source State, with due regard to the other

provisions of the Convention. Thus, for example, if the excess

amount would be treated as a distribution of profits, such amount
could be taxed as a dividend rather than as interest, but the tax
would be subject, if appropriate, to the rate limitations of
paragraph 2 of Article 10 (Dividends).

   Paragraph 8

   Paragraph 8 deals with two additional classes of interest
that are not subject to the limitations of paragraphs 2 and 3.
Subparagraph a) of paragraph 8 deals with excess inclusions with
respect to a residual interest in a U.S. real estate mortgage

investment conduit (REMIC). Such income may be taxed in the United States under its internal law. Under U.S. law, this class

of income is subject to a statutory withholding tax of 30 per­

cent. The legislation that created REMICs in 1986 provided that

such excess inclusions were to be taxed at the full 30 percent
statutory rate, regardless of any then-existing treaty provisions

to the contrary. Without a full tax at source, foreign purchas­

ers of residual interests would have a competitive advantage over
U.S. purchasers at the time these interests are initially of­

fered. Also, absent this rule, the U.S. fisc would suffer a

revenue loss with respect to mortgages held in a REMIC because of

opportunities for tax avoidance created by differences in the

timing of taxable and economic income produced by these inter­
ests.

Subparagraph b) of paragraph 8 deals with contingent inter­

est of the type that does not qualify as portfolio interest under
U.S. law and to analogous types of interest under Turkish law.
Paragraph VII of the Protocol notes the understanding that the

term "contingent interest" is to be defined for purposes of

-45­

TURKEY 233

Supp. No. 6 (1998)

paragraph 8 in accordance with the definition in sections 871(h)­
(4) and 881(c)(4) of the Code. Such interest will be subject to
tax at source under the provisions of Article 10 (Dividends).
Thus, such interest payments would be subject to source country
tax at the rates specified in paragraph 2 of Article 10.

   Relation to other articles

   Notwithstanding the limitations on source country taxation
of interest contained in this Article, the saving clause of
paragraph 3 of Article 1 (Personal Scope) permits the United
States to tax interest received by its residents and citizens as
if the Convention had not come into effect.

   As with any other benefit of the Convention, a resident of
one of the States claiming the benefit of this Article must be
entitled to the benefit under the provisions of Article 22
(Limitation on Benefits).