Article 12 - ROYALTIES

   Article 12 provides rules for source and residence country
taxation of royalties. Generally, the Article provides for full
residence country taxation of royalties and for a limited source
State right to tax such income.

Paragraph 1

   Paragraph 1 preserves the residence State's right to tax its
residents on royalties arising in the other 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
royalty payments but limits the rate of source State tax if the
royalties are beneficially owned by a resident of the other
Contracting State. The maximum rate of tax allowed by the source
State varies depending upon the nature of the payment. The

                    -46­

TURKEY 234

Supp. No. 6 (1998)

maximum rate of source country tax is 10 percent if the royalty
payment is described in paragraph 3 a). Paragraph 3 a) generally
describes royalties received for the use, the right to use, or
the contingent sale of literary and artistic property, certain
kinds of intellectual property, and certain property frequently
referred to as "know-how." The 10 percent rate is higher than
the rate of source country tax on royalties in most U.S. treaties
and in the OECD Model, which provides for exemption at source.
Turkey, however, entered a reservation in the OECD Model indicat­
ing its intention to provide for positive rates of withholding at
source on royalties. If the royalty payment is described in
paragraph 3 b), then paragraph 2 provides for a maximum rate of
source country tax of 5 percent. Paragraph 3 b) defines as a
"royalty" any payment received in connection with certain equip­
ment leases.

   The beneficial owner of royalty income for purposes of
Article 12 is the person to which the income is attributable for
tax purposes. Paragraph 2's focus on the "beneficial owner"
ensures that if a royalty 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 royalty will not be entitled to the
benefits of this Article. However, royaltiesreceived by the
nominee on behalf of a resident of that other State would be
entitled to the benefits.

Paragraph 3

   Paragraph 3 defines the term "royalties" for purposes of the
Article. Subparagraph a) of paragraph 3 defines the term 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; for the use of, or the right to use, any patent,
trademark, design or model, plan, secret formula or process; or
for information concerning industrial, commercial, or scientific
experience (sometimes referred to as "know-how"). The term
includes gains derived from the alienation of any such right or
property that are contingent on the productivity, use, or further
alienation thereof; as a consequence, such amounts may be taxed
in accordance with this Article rather than being exempt from tax

                    -47­

TURKEY 235

Supp. No. 6 (1998)

at source under paragraph 5 of Article 13 (Gains). In addition,
payments received in connection with the use or right to use
motion pictures or works on film, tape, or other means of repro­
duction used for radio or television broadcasting are included in
the definition of royalties. The reference to "other means of
reproduction" makes clear that future technological advances in
the field of radio and television broadcasting will not affect
the inclusion of payments relating to the use of such means of
reproduction within the definition of royalties. It is understood
that whether payments for the use or the right to use computer
software are treated as royalties or as business profits will
depend on the facts and circumstances of the transaction. It is
also understood that payments received in connection with the
transfer of so-called "shrink-wrap" computer software are treated
as business profits.

   Subparagraph b) of paragraph 3, in deviation from the OECD

Model and from most U.S. treaties, adds to the definition of the

term "royalties" payments received as consideration for the use
of, or the right to use, industrial, commercial or scientific
equipment.

   Some Turkish treaties specify in the definition of royalties
that the term does not include income payments for the perfor­
mance of personal services. It is understood that the absence of
this explicit exclusion in this Convention should not be inter­
preted as meaning that the income arising from the performance of
such services may be treated as royalties and-taxed under Article
12 on a gross basis. Such services income would be covered under
Article 7 (Business Profits) or 14 (Independent Personal Servic­
es).

Paragraph 4

   Paragraph 4 of Article 12 provides an exception to the rules
in paragraphs 1 and 2 in cases where the beneficial owner of the

royalties carries on business through a permanent establishment

in the source State or, in the case of a beneficial owner that is
resident of Turkey, performs independent personal services from a
fixed base situated in the United States. In such cases, the
source State may tax the royalties if they are attributable to

                    -48­

TURKEY 236

Supp. No. 6 (1998)

the permanent establishment or fixed base, in accordance with the
provisions of Article 7 (Business Profits) or Article 14 (Inde­
pendent Personal Services). Under those Articles, the State in
which the permanent establishment or fixed base is located
generally will tax the royalties on a net basis, using rates and
rules of taxation generally applicable in that State. In the
case of royalties attributable to a fixed base, paragraph 4
provides for net basis treatment only when the fixed base is that
of a Turkish resident in the United States and not when a U.S.
rsident has a fixed base in Turkey. This unilateral treatment is
a result of Turkey's internal law, which does not attribute
income other than personal services income to a fixed base;
royalties are not considered personal services income for this
purpose. Therefore, if paragraph 4 required Turkey to tax
royalties attributable to a fixed base that a U.S. resident has

in Turkey only as personal services income, Turkey would not be
in a position to tax the royalty at all, even if the royalty is
appropriately sourced in Turkey. Because of the unilateral

language in paragraph 4, Turkey may continue to tax royalties
sourced in Turkey and attributable to a U.S. resident's fixed
base in Turkey as royalties and in acordance with the limitations
of paragraph 2.

   The same rule applies if the permanent establishment or
fixed base has ceased to exist when the royalties are received,
as long as the royalties would have been attributable to the
permanent establishment or fixed base had they been paid or
accrued in the earlier year.

Paragraph 5

   Paragraph 5 provides rules for determining the source of
royalty payments. Under paragraph 5, royalties are generally
deemed to arise in a Contracting State if paid by a resident of

that State. However, if the obligation to pay the royalties was
incurred in connection with a permanent establishment or a fixed
base in one of the Contracting States, and the royalties are
borne by that permanent establishment or fixed base, the royal­

ties are deemed to arise in that State, regardless of whether the
payor is resident in one of the Contracting States. In general,
royalties are considered borne by a permanent establishment or

  -49­

TURKEY 237

Supp. No. 6(1998)

fixed base if deductible in computing the taxable income of that
permanent establishment or fixed base. If royalties are neither
paid by a resident of one of the Contracting States nor borne by
a permanent establishment or fixed base in either State, but they
relate to the use of a right or property in one of the Contract­
ing States, they will be deemed to arise in the State where the
right or property is used. For example, if a Turkish resident
were to grant franchise rights to a resident of Mexico for use in
the United States, the royalty paid by the Mexican resident to
the Turkish resident for those rights would be U.S. source income
under this Article, subject to U.S. withholding at the 10 percent
rate provided in paragraph 2.

   The rules of this Article differ from those provided under
U.S. domestic law. Under U.S. domestic law, a royalty is consid­
ered to be from U.S. sources if it is paid for the use of, or the
privilege of using, an intangible within the United States; the
residence of the payor is irrelevant. If paid to a nonresident
alien individual or other foreign person, a U.S. source royalty
is generally subject to withholding tax at a rate of 30 percent
under U.S. domestic law. By reason of paragraph 2 of Article 1
(Personal Scope), a Turkish resident would be permitted to apply
the rules of U.S. domestic law to its royalty income if those
rules produced a more favorable result in its case than those of
this Article. However, under a basic principle of tax treaty
interpretation, the prohibition against so-called "cherry-pick­
ing," the Turkish resident would be precluded from claiming
selected benefits under the Convention (e.a., the tax rates only)

and other benefits under U.S. domestic law (etg., the source

rules only) with respect to its royalties. Sne, e.g., Rev. Rul.

84-17, 1984-1 C.B. 308. For example, if a Turkish company
granted franchise rights to a resident of the United States for
use 50 percent in the United States and 50 percent in Mexico, the
Convention would permit the Turkish company to treat all of its
royalty income from that single transaction as U.S. source income
entitled to the withholding tax reduction under paragraph 2.
U.S. domestic law would permit the Turkish company to treat 50
percent of its royalty income as U.S. source income subject to a

30 percent withholding tax and the other 50 percent as foreign
source income exempt from U.S. tax. The Turkish company could
choose to apply either the provisions of U.S. domestic law or the

  -50­

TURKEY 238

Supp. No. 6 (1998)

provisions of the Convention to the transaction, but would not be

permitted to claim both the U.S. domestic law exemption for 50

percent of the income and the convention's reduced withholding
rate for the remainder of the income.

   Paragraph 6

   Paragraph 6 deals with cases involving special relationships
between the payer and beneficial owner of a royalty. Paragraph 6
provides that the provisions of Article 12 will apply to royalty
payments between related persons only to the extent that such
payments would have been made absent their special relationship
(iU-e, an arm's length royalty payment). Any amount in excess of
an arm's length payment remains taxable according to the laws of

the source State, with due regard to the other provisions of the
Convention. If, for example, the excess amount is treated as a
distribution of profits under the law of the source State, such
excess amount will be taxed as a dividend rather than as a

royalty payment, but the tax imposed on the dividend payment will
be subject, if appropriate, to the rate limitations of paragraph

2 of Article 10 (Dividends).

   Relation to other articles

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

   As with other benefits 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).