Article 11. INTEREST

Paragraph 1 grants to each Contracting State the exclusive right (subject to paragraph 3) to tax interest derived and beneficially owned by its residents, without regard to source. Each Contracting State agrees to exempt from tax interest derived and beneficially owned by residents of the other State.

Paragraph 2 defines the term "interest" as used in the Convention to include income from debt claims of every kind other than those giving rise to dividends under paragraph 3 of Article 10 (Dividends), as well as income treated as interest by the taxation law of the source State. In particular, income from government securities, income from bonds or debentures, and any premiums or prizes attaching to such securities, bonds or debentures are considered interest. Interest on bank deposits and on loans secured by mortgages is also covered. The definition does not refer to penalties and fines for late payment, which are frequently explicitly excluded from the treaty definition of interest. Such amounts may be imposed in accordance with domestic law.

Paragraph 3 provides an exception from the rule of paragraph 1 in cases where the beneficial owner of the interest, a resident of one Contracting State, carries on business through a permanent establishment in the other Contracting State or performs independent personal services through a fixed based situated in that other State and the interest is attributable to that permanent establishment or fixed base. In such a case, the income is taxable to the permanent establishment or fixed base in accordance with the provisions of Article 7 (Business Profits) or Article 14 (Independent Personal Services). This rule applies

even if the permanent establishment or fixed base no longer exists when the interest is received or accrued, as long as the interest would be attributable to the permanent establishment or fixed base if it had been paid or accrued in the earlier year.

Paragraph 4 provides that, if as a result of a special relationship between persons, the interest paid is excessive, Article 11 applies only to the amount of interest payments that would have been made absent such special relationship ( i.e., an arm's length interest payment). Any excess amount of interest paid remains taxable according to the domestic law 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 4 of the Protocol reserves the right of the United States to tax an excess inclusion of a residual holder of a Real Estate Mortgage Investment Conduit (REMIC) in accordance with its law; thus, the tax on such an excess inclusion of a resident of Ukraine would be subject to the domestic rate of withholding tax, now 30 percent.

Because Article 11 provides for exemption at source of interest derived by a resident of the other Contracting State, the United States will not impose its tax on excess interest of a U.S. branch of a Ukrainian company (Code section 884(f)(1)(B)).