Convention between the government of the United States of America and the government of the Grand Duchy of Luxembourg

 for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital

Article 1

General scope

1. This Convention shall apply only to persons who are residents of one or both of the Contracting States, except as otherwise provided in the Convention.

2. The Convention shall not restrict in any manner any benefit now or hereafter accorded :

(a) by the laws of either Contracting State; or

(b) by any other agreement between the Contracting States.

3. Notwithstanding any provision of the Convention except paragraph 4 of this Article, the United States may tax its residents (as determined under Article 4 (Residence)), and by reason of citizenship may tax its citizens, as if the Convention had not come into effect. For this purpose, the term “citizen” shall include a former citizen whose loss of citizenship had as one of its principal purposes the avoidance of tax, but only for a period of 10 years following such loss.

4. The provisions of paragraph 3 shall not affect :

(a) the benefits conferred by the United States under paragraph 2 of Article 9 (Associated enterprises), under subparagraph 1(b) of Article 19 (Pensions, social security, and annuities), and under Articles 25 (Relief from double taxation), 26 (Non-discrimination), and 27 (Mutual agreement procedure); and

(b) the benefits conferred by the United States under Articles 20 (Government service), 21 (Students, trainees, teachers, and researchers), and 29 (Diplomatic agents and consular officers), upon individuals who are neither citizens of, nor have been admitted for permanent residence in, the United States.

5. (a) Notwithstanding any other agreement to which the Contracting States may be parties, a dispute concerning whether a measure is within the scope of this Convention shall be considered only by the competent authorities of the Contracting States, as defined in subparagraph 1(e) of Article 3 (General definitions) of this Convention, and the procedures under this Convention exclusively shall apply to the dispute.

(b) Unless the competent authorities determine that a taxation measure is not within the scope of this Convention, the non-discrimination obligations of this Convention shall apply with respect to that measure, except for such national treatment or most-favoured-nation obligations as may apply to trade in goods under the General Agreement on Tariffs and Trade. No national treatment or most-favoured-nation obligation under any other agreement shall apply with respect to that measure.

(c) For the purposes of this paragraph, a “measure” is a law, regulation, rule, procedure, decision, administrative action, or any other form of measure.

Article 2

Taxes covered

1. The existing taxes to which this Convention shall apply are :

(a) in the United States :

(i) the Federal income taxes imposed by the Internal Revenue Code (but excluding social security taxes), and

(ii) the Federal excise taxes imposed on insurance premiums paid to foreign insurers. The Convention shall, however, not apply to the excise taxes imposed on premiums paid to foreign insurers for reinsurance. The Convention shall apply to the excise taxes imposed on premiums paid to foreign insurers for insurance other than reinsurance only to the extent that the risks covered by such premiums are not reinsured with a person not entitled to exemption from such taxes under an income tax convention that applies to such taxes;

 

(b) in Luxembourg :

(i) the income tax on individuals, including the surcharge thereon for the benefit of the employment fund (l’impôt sur le revenu des personnes physiques, y compris la contribution au fonds pour l’emploi);

(ii) the corporation tax, including the surcharge thereon for the benefit of the employment fund (l’impôt sur le revenu des collectivités, y compris la contribution au fonds pour l’emploi);

(iii) the tax on fees of directors of companies (l’impôt spécial sur les tantièmes);

(iv) the capital tax (l’impôt sur la fortune); and

(v) the communal trade tax (l’impôt commercial communal).

 

2. The Convention shall also apply to any identical or substantially similar taxes that are imposed after the date of signature of the Convention in addition to, or in place of, the existing taxes. The competent authorities of the Contracting States shall notify each other of any significant changes that have been made in their respective taxation laws and of any official published material concerning the application of the convention, including explanations, regulations, rulings, or judicial decisions.

Article 3

General definitions

1. For the purposes of this Convention, unless the context otherwise requires :

(a) the term “person” includes an individual, an estate, a trust, a partnership, a company, and any other body of persons;

(b) the term “company” means any body corporate or any entity that is treated as a body corporate for tax purposes;

(c) the terms “enterprise of a Contracting State” and “enterprise of the other Contracting State” mean respectively an enterprise carried on by a resident of a Contracting State and an enterprise carried on by a resident of the other Contracting State;

(d) the term “international traffic” means any transport by a ship or aircraft, except when such transport is operated solely between places in a Contracting State;

(e) the term “competent authority” means :

(i) in the United States : the Secretary of the Treasury or his delegate; and

(ii) in Luxembourg : the Minister of Finance or his authorized representative;

 

(f) the term “United States” means the United States of America, but does not include Puerto Rico, the Virgin Islands, Guam, or any other United States possession or territory;

(g) the term “Luxembourg” means the Grand Duchy of Luxembourg;

(h) the term “national,” in relation to a Contracting State, means :

(i) any individual possessing the nationality or citizenship of that Contracting State; and

(ii) any legal person, partnership or association deriving its status as such from the laws in force in that Contracting State;

 

(i) the term “beneficial owner” means in the case of a company that is treated as a partnership, or that is otherwise not subject to tax as a body corporate under the laws of the other Contracting State, the persons that are subject to tax on the income of the company under the laws of the other Contracting State.

2. As regards the application of the Convention by a Contracting State any term not defined therein shall, unless the context otherwise requires or the competent authorities agree to a common meaning pursuant to the provisions of Article 27 (Mutual agreement procedure), have the meaning that it has under the law of that State concerning the taxes to which the Convention applies.

Article 4

Residence

1. For the purposes of this Convention, the term “resident of a Contracting State” means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, citizenship, place of management, place of incorporation, or any other criterion of a similar nature, provided, however, that :

(a) this term does not include any person who is liable to tax in that State in respect only of income from sources in that State or capital situated therein;

(b) in the case of income derived by a partnership, estate, or trust, this term applies only to the extent that the income derived by such partnership, estate, or trust is subject to tax in that State as the income of a resident, either in its hands or in the hands of its partners, beneficiaries or grantor;

(c) an individual who is a U.S. citizen or an alien admitted to the United States for permanent residence (a “green card” holder) and who is not a resident of Luxembourg under this paragraph is to be treated as a resident of the United States for purposes of this paragraph, only if the individual has a substantial presence, permanent home or habitual abode in the United States;

(d) the Government of a Contracting State or a political subdivision or local authority thereof or any agency or instrumentality of any such government, subdivision or authority is, for purposes of this paragraph, to be treated as a resident of that Contracting State; and

(e) a person that under the laws of a Contracting State is a resident of that State and that is wholly or partially exempt from tax in that State by virtue of the fact that it is organized and operated exclusively either :

(i) for a religious, charitable, educational, scientific, or other public purpose; or

(ii) to provide pensions or other benefits to employees pursuant to a plan

is to be treated for purposes of this paragraph as a resident of that Contracting State.

2. Where by reason of the provisions of paragraph 1, an individual is a resident of both Contracting States, then his status shall be determined as follows :

(a) he shall be deemed to be a resident of the State in which he has a permanent home available to him; if he has a permanent home available to him in both States, he shall be deemed to be a resident of the State with which his personal and economic relations are closer (center of vital interests);

(b) if the State in which he has his center of vital interests cannot be determined, or if he does not have a permanent home available to him in either State, he shall be deemed to be a resident of the State in which he has an habitual abode;

(c) if he has an habitual abode in both States or in neither of them, he shall be deemed to be a resident of the State of which he is a national; or

(d) if he is a national of both States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement.

3. Where by reason of the provisions of paragraph 1 a person other than an individual is a resident of both Contracting States, the competent authorities shall endeavour to settle the question by mutual agreement, having regard to the person’s place of effective management, the place where it is incorporated or constituted, and any other relevant factors. In the absence of such agreement, such person shall not be considered to be a resident of either Contracting State for purposes of enjoying benefits under this Convention.

Article 5

Permanent establishment

1. For the purposes of this Convention, the term “permanent establishment” means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

2. The term “permanent establishment” includes especially :

(a) a place of management;

(b) a branch;

(c) an office;

(d) a factory;

(e) a workshop; and

(f) a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources.

3. A building site or construction or installation project, or an installation or drilling rig or ship used for the exploration of natural resources, constitutes a permanent establishment only if it lasts more than twelve months.

4. Notwithstanding the preceding provisions of this Article, the term “permanent establishment” shall be deemed not to include :

(a) the use of facilities solely for the purpose of storage, display, or delivery of goods or merchandise belonging to the enterprise;

(b) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of storage, display, or delivery;

(c) the maintenance of a stock of goods or merchandise belonging to the enterprise solely for the purpose of processing by another enterprise;

(d) the maintenance of a fixed place of business solely for the purpose of purchasing goods or merchandise, or of collecting information, for the enterprise;

(e) the maintenance of a fixed place of business solely for the purpose of carrying on, for the enterprise, any other activity of a preparatory or auxiliary character; and

(f) the maintenance of a fixed place of business solely for any combination of the activities mentioned in subparagraphs (a) to (e).

5. Notwithstanding the provisions of paragraphs 1 and 2, where a person, other than an agent of an independent status to which paragraph 6 applies, is acting on behalf of an enterprise and has and habitually exercises in a Contracting State an authority to conclude contracts in the name of the enterprise, that enterprise shall be deemed to have a permanent establishment in that State in respect of any activities which that person undertakes for the enterprise, unless the activities of such person are limited to those mentioned in paragraph 4 which, if exercised through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph.

6. An enterprise shall not be deemed to have a permanent establishment in a Contracting State merely because it carries on business in that State through a broker, general commission agent, or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business as independent agents.

7. The fact that a company that is a resident of a Contracting State controls or is controlled by a company that is a resident of the other Contracting State, or that carries on business in that other State (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other.

Article 6

Income from real property (immovable property)

1. Income derived by a resident of a Contracting State from real property (immovable property), including income from agriculture or forestry, situated in the other Contracting State may be taxed in that other State.

2. The term “real property (immovable property)” shall have the meaning that it has under the laws of the Contracting State in which the property in question is situated.

3. The provisions of paragraph 1 shall apply to income derived from the direct use, letting, or use in any other form of real property.

4. The provisions of paragraphs 1 and 3 shall also apply to the income from real property of an enterprise and to income from real property used for the performance of independent personal services.

5. A resident of a Contracting State who is liable to tax in the other Contracting State on income from real property situated in the other Contracting State may elect to compute the tax on such income on a net basis as if such income were attributable to a permanent establishment in such other State.

Article 7

Business profits

1. The business profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the business profits of the enterprise may be taxed in the other State but only so much of them as are attributable to that permanent establishment.

2. Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the business profits that it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment.

3. In determining the business profits of a permanent establishment, there shall be allowed as deductions expenses that are incurred for the purposes of the permanent establishment, including a reasonable allocation of executive and general administrative expenses, research and development expenses, interest, and other expenses incurred for the purposes of the enterprise as a whole (or the part thereof which includes the permanent establishment), whether incurred in the State in which the permanent establishment is situated or elsewhere.

4. No business profits shall be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterprise.

5. For the purposes of this Convention, the business profits to be attributed to the permanent establishment shall include only the profits derived from the assets or activities of the permanent establishment and shall be determined by the same method of accounting year by year unless there is good and sufficient reason to the contrary.

6. Where business profits include items of income that are dealt with separately in other Articles of the Convention, then the provisions of those Articles shall not be affected by the provisions of this Article.

7. In applying paragraphs 1 and 2 of Article 7 (Business profits), paragraph 4 of Article 10 (Dividends), paragraph 3 of Article 12 (Interest), paragraph 3 of Article 13 (Royalties), paragraph 3 of Article 14 (Gains), Article 15 (Independent personal services) and paragraph 2 of Article 22 (Other income), any income or gain attributable to a permanent establishment or fixed base during its existence is taxable in the Contracting State where such permanent establishment or fixed base is situated even if the payments are deferred until such permanent establishment or fixed base has ceased to exist.

Article 8

Shipping and air transport

1. Profits of an enterprise of a Contracting State from the operation of ships or aircraft in international traffic shall be taxable only in that State.

2. For purposes of this Article, profits from the operation of ships or aircraft in international traffic include profits derived from the rental of ships or aircraft on a full (time or voyage) basis. They also include profits from the rental of ships or aircraft on a bareboat basis if such ships or aircraft are operated in international traffic by the lessee, or if the rental income is incidental to profits from the operation of ships or aircraft in international traffic. Profits derived by an enterprise from the inland transport of property or passengers within either Contracting State, shall be treated as profits from the operation of ships or aircraft in international traffic if such transport is undertaken as part of international traffic by the enterprise.

3. Profits of an enterprise of a Contracting State from the use, maintenance, or rental of containers (including trailers, barges, and related equipment for the transport of containers) used in international traffic shall be taxable only in that State.

4. The provisions of paragraphs 1 and 3 shall also apply to profits from participation in a pool, a joint business, or an international operating agency.

Article 9

Associated enterprises

1. Where :

(a) an enterprise of a Contracting State participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State; or

(b) the same persons participate directly or indirectly in the management, control, or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State,

and in either case conditions are made or imposed between the two enterprises in their commercial or financial relations that differ from those that would be made between independent enterprises, then, any profits that, but for those conditions, would have accrued to one of the enterprises, but by reason of those conditions have not so accrued, may be included in the profits of that enterprise and taxed accordingly.

2. Where a Contracting State includes in the profits of an enterprise of that State, and taxes accordingly, profits on which an enterprise of the other Contracting State has been charged to tax in that other State, and the other Contracting State agrees that the profits so included are profits that would have accrued to the enterprise of the first-mentioned State if the conditions made between the two enterprises had been those that would have been made between independent enterprises, then that other State shall make an appropriate adjustment to the amount of the tax charged therein on those profits. In determining such adjustment, due regard shall be paid to the other provisions of this Convention and the competent authorities of the Contracting States shall if necessary consult each other.

Article 10

Dividends

1. Dividends paid by a company that is a resident of a Contracting State to a resident of the other Contracting State may be taxed in that other State.

2. (a) However, such dividends may also be taxed in the Contracting State of which the company paying the dividends is a resident and according to the laws of that State, but if the beneficial owner of the dividends is a resident of the other Contracting State, except as otherwise provided in paragraph 6, the tax so charged shall not exceed :

(i) 5 percent of the gross amount of the dividends if the beneficial owner is a company that owns directly at least 10 percent of the voting stock of the company paying the dividends; or

(ii) 15 percent of the gross amount of the dividends in all other cases.

 

(b) Notwithstanding the provisions of subparagraph (a)(i), dividends paid by a company that is a resident of Luxembourg shall not be taxable in Luxembourg if the beneficial owner of the dividends is a company that is a resident of the United States and that has had, during an uninterrupted period of two years preceding the date of payment of the dividends, a direct shareholding of at least 25 percent of the voting stock of the company paying the dividends. This provision only applies to dividends attributable to that part of the shareholding that has been owned without interruption by the beneficial owner during such two-year period. Furthermore, the provisions of this subparagraph shall only apply if the distributed dividend is derived from the active conduct of a trade or business in Luxembourg (other than the business of making or managing investments, unless such business is carried on by a banking or insurance company).

(c) This paragraph 2 shall not affect the taxation of the company in respect of the profits out of which the dividends are paid.

3. (a) The term “dividends” means income from shares, “jouissance” shares, or “jouissance” rights, mining shares, founders’ shares, or other rights, not being debt claims participating in profits, as well as income treated as a distribution by the taxation laws of the State of which the company making the distribution is a resident; and income from arrangements, including debt obligations, that carry the right to participate in, or are determined with reference to, profits of the issuer or one of its associated enterprises, to the extent that such income is characterized as a dividend under the laws of the Contracting State in which the income arises.

(b) The provisions of this Article shall apply where a beneficial owner of dividends holds depository receipts evidencing ownership of the shares in respect of which the dividends are paid, in lieu of the shares themselves.

4. The provisions of paragraphs 1 and 2 shall not apply if the beneficial owner of the dividends, being a resident of a Contracting State, carries on a business in the other Contracting State of which the company paying the dividends is a resident through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the dividends are attributable to such permanent establishment or fixed base. In such case the provisions of Article 7 (Business profits) or Article 15 (Independent personal services), as the case may be, shall apply.

5. Where a company that is a resident of one of the States derives profits or income from the other State, that other State may not impose any tax on the dividends paid by the company, except insofar as such dividends are paid to a resident of that other State or insofar as the holding in respect of which the dividends are paid forms part of the business property of a permanent establishment or pertains to a fixed base situated in that other State, nor, except as provided in Article 11 (Branch tax), subject the company’s undistributed profits to a tax, even if the dividends paid or the undistributed profits consist wholly or partly of profits or income arising in such other State.

6. Subparagraph (a)(i) of paragraph 2 shall not apply in the case of dividends paid by a United States person that is a Regulated Investment Company or a Real Estate Investment Trust (REIT). In the case of a United States person that is a REIT, subparagraph (a)(ii) of paragraph 2 also shall not apply, unless the dividend is beneficially owned by an individual holding a less than 10 percent interest in the REIT.

Article 11

Branch tax

Notwithstanding any other provision of this Convention, a company that is a resident of Luxembourg may be subject in the United States to a tax in addition to the tax on profits. Such additional tax, however, may not exceed 5 percent of the “dividend equivalent amount” of the business profits of the company that are either attributable to a permanent establishment in the United States or are subject to tax on a net basis in the United States under Article 6 (Income from real property (Immovable property)) or paragraph 1 of Article 14 (Gains).

Article 12

Interest

1. Interest arising in a Contracting State and paid to a resident of the other Contracting State shall be taxable only in that other State if such resident is the beneficial owner of the interest.

2. The term “interest” as used in this Convention means income from debt claims of every kind, whether or not secured by mortgage, and whether or not carrying a right to participate in the debtor’s profits, unless described in paragraph 3 of Article 10 (Dividends), and in particular, income from government securities and income from bonds or debentures, including premiums or prizes attaching to such securities, bonds, or debentures, and all other income that is treated as income from money lent by the taxation law of the Contracting State in which the income arises. Penalty charges for late payment shall not be regarded as interest for the purposes of this Convention.

3. The provisions of paragraph 1 shall not apply if the beneficial owner of the interest, being a resident of a Contracting State, carries on business in the other Contracting State in which the interest arises through a permanent establishment situated therein or performs in that other State independent personal services from a fixed base situated therein, and the interest is attributable to such permanent establishment or fixed base. In such case the provisions of Article 7 (Business profits) or Article 15 (Independent personal services), as the case may be, shall apply.

4. Interest shall be deemed to arise in a Contracting State when :

(a) the payer is a resident of that State; or

(b) the payer, whether a resident of a Contracting State or not, has in that Contracting State a permanent establishment or a fixed base in connection with which the indebtedness on which the interest paid was incurred and such interest is borne by such permanent establishment or fixed base.

5. Where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the interest, having regard to the debt claim for which it is paid, exceeds the amount that would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In such case the excess part of the payments shall remain taxable according to the taxation law of each State, due regard being had to the other provisions of this Convention.

6. Notwithstanding the provisions of paragraph 1 :

(a) interest arising in a Contracting State that is determined with reference to the profits of the issuer or of one of its associated enterprises, and paid to a resident of the other Contracting State, may be taxed in that other State;

(b) however, such interest may also be taxed in the Contracting State in which it arises, and according to the laws of that State, but if the beneficial owner is a resident of the other Contracting State, the gross amount of the interest may be taxed at a rate not exceeding the rate prescribed in subparagraph 2(a)(ii) of Article 10 (Dividends);

(c) interest that is an excess inclusion with respect to a residual interest in a real estate mortgage investment conduit may be taxed by each State in accordance with its domestic law.

Article 13

Royalties

1. Royalties arising in a Contracting State and paid to a resident of the other Contracting State shall be taxable only in that other State if such resident is the beneficial owner of the royalties.

2. The term “royalties” as used in this Convention means :

(a) payments of any kind received as consideration for the use of, or the right to use, any copyright of literary, artistic, or scientific work (including cinematographic films, and audio and video tapes and disks and other means of reproduction), any patent, trademark, design or model, plan, secret formula or process, or other like right or property, for information concerning industrial, commercial, or scientific experience;

(b) gain derived from the alienation of any property described in subparagraph (a), provided that such gain is contingent on the productivity, use, or disposition of the property.

3. The provisions of paragraph 1 shall not apply if the beneficial owner of the royalties, being a resident of a Contracting State, carries on business in the other Contracting State in which the royalties arise through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the royalties are attributable to such permanent establishment or fixed base. In such case the provisions of Article 7 (Business profits) or Article 15 (Independent personal services), as the case may be, shall apply.

4. Royalties shall be deemed to arise in a Contracting State when they are in consideration of the use of, or the right to use, property, information or experience in that State.

5. Where, by reason of a special relationship between the payer and the beneficial owner or between both of them and some other person, the amount of the royalties, having regard to the use, right, or information for which they are paid, exceeds the amount which would have been agreed upon by the payer and the beneficial owner in the absence of such relationship, the provisions of this Article shall apply only to the last-mentioned amount. In such case the excess part of the payments shall remain taxable according to the laws of each Contracting State, due regard being had to the other provisions of the Convention.

Article 14

Gains

1. Gains derived by a resident of a Contracting State that are attributable to the alienation of real property situated in the other Contracting State may be taxed in that other State.

2. For the purposes of this Article the term “real property situated in the other Contracting State” shall include :

(a) real property referred to in Article 6 (Income from real property);

(b) a United States real property interest, as defined in the Internal Revenue Code on the date of signature of this Convention, and as amended from time to time without changing the general principles in this paragraph; and

(c) shares or comparable corporate rights in a company that is a resident of Luxembourg, the assets of which company consist for the greater part of real property situated in Luxembourg.

3. Gains from the alienation of personal property (movable property) that are attributable to a permanent establishment that an enterprise of a Contracting State has in the other Contracting State, or that are attributable to a fixed base that is available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, and gains from the alienation of such a permanent establishment (alone or with the whole enterprise) or such a fixed base, may be taxed in that other State.

4. Gains derived by an enterprise of a Contracting State from the alienation of ships, aircraft, or containers operated or used in international traffic or personal property (movable property) pertaining to the operation or use of such ships aircraft or containers shall be taxable only in that State.

5. Gains from the alienation of any property other than property referred to in paragraphs 1 through 4 shall be taxable only in the Contracting State of which the alienator is a resident.

Article 15

Independent personal services

1. Income derived by an individual who is a resident of a Contracting State from personal services in an independent capacity shall be taxable only in that State unless the individual has a fixed base regularly available to him in the other Contracting State for the purpose of performing his activities. If he has such a fixed base, the income may be taxed in the other State, but only so much of it as is attributable to that fixed base.

2. The term “personal services in an independent capacity” includes especially independent scientific, literary, artistic, educational, or teaching activities as well as the independent activities of physicians, lawyers, engineers, architects, dentists, and accountants.

3. In determining the income described in paragraph 1 that is taxable in the other Contracting State, the principles of paragraph 3 of Article 7 (Business profits) shall apply.

Article 16

Dependent personal services

1. Subject to the provisions of Articles 17 (Directors’ fees), 19 (Pensions, social security, and annuities) and 20 (Government service), salaries, wages, and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State, unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived therefrom may be taxed in that other State.

2. Notwithstanding the provisions of paragraph 1, remuneration derived by a resident of a Contracting State in respect of an employment exercised in the other Contracting State shall be taxable only in the first-mentioned State if :

(a) the recipient is present in the other State for a period or periods not exceeding in the aggregate 183 days in any twelve-month period commencing or ending in the taxable year concerned;

(b) the remuneration is paid by, or on behalf of, an employer who is not a resident of the other State; and

(c) the remuneration is not borne by a permanent establishment or a fixed base that the employer has in the other State.

3. Notwithstanding the preceding provisions of this Article, remuneration in respect of an employment exercised continuously or predominantly aboard a ship or aircraft operated in international traffic by an enterprise of a Contracting State may be taxed in that State. If that State fails to tax the income derived from such employment, such income shall be taxable in the State of which the employee is a resident.

Article 17

Directors’ fees

Directors’ fees and other similar payments derived by a resident of a Contracting State for services rendered in the other Contracting State in his capacity as a member of the board of directors of a company that is a resident of the other Contracting State may be taxed in that other Contracting State.

Article 18

Artistes and sportsmen

1. Notwithstanding Articles 15 (Independent personal services) and 16 (Dependent personal services), income derived by a resident of a Contracting State as an entertainer, such as a theatre, motion picture, radio, or television artiste, or a musician, or as a sportsman, from his personal activities as such exercised in the other Contracting State may be taxed in that other State, except where the amount of the gross receipts derived by such entertainer or sportsman, including expenses reimbursed to him or borne on his behalf, from such activities does not exceed then thousand United States dollars ($ 10,000), or its equivalent in Luxembourg francs, for the taxable year concerned.

2. Where income in respect of activities exercised by an entertainer or a sportsman in his capacity as such accrues not to the entertainer or sportsman himself but to another person, that income of that other person, notwithstanding the provisions of Articles 7 (Business profits) and 15 (Independent personal services), may be taxed in the Contracting State in which the activities of the entertainer or sportsman are exercised, unless it is established that neither the entertainer or sportsman nor persons related thereto (whether or not residents of that State) participate directly or indirectly in the receipts or profits of that other person in any manner, including the receipt of deferred remuneration, bonuses, fees, dividends, partnership distributions, or other distributions.

Article 19

Pensions, social security, and annuities

1. Subject to the provisions of Article 20 (Government service) :

(a) pensions and other similar remuneration derived and beneficially owned by a resident of a Contracting State in consideration of past employment shall be taxable only in that State; and

(b) notwithstanding the provisions of subparagraph (a), payments made by a Contracting State, or a statutory body thereof, under provisions of the social security or similar legislation of a Contracting State to a resident of the other Contracting State or to a citizen of the United States shall be taxable only in the first-mentioned State.

2. Annuities derived and beneficially owned by a resident of a Contracting State shall be taxable only in that State. The term “annuities” as used in this paragraph means a stated sum paid periodically at stated times during a specified number of years under an obligation to make the payments in return for adequate and full consideration (other than services rendered).

Article 20

Government service

1. Notwithstanding the provisions of Articles 15 (Independent Personal services), 16 (Dependent personal services), and 18 (Artistes and sportsmen) :

(a) remuneration, other than a pension, paid by a Contracting State or a political subdivision or a local authority thereof to an individual in respect of services rendered to that State or subdivision or authority shall, subject to the provisions of subparagraph (b), be taxable only in that State;

(b) such remuneration, however, shall be taxable only in the other Contracting State if the services are rendered in that State and the individual is a resident of that State who :

(i) is a national of that State; or

(ii) did not become a resident of that State solely for the purpose of rendering the services.

 

2. Notwithstanding the provisions of Article 19 (Pensions, social security, and annuities) :

(a) any pension paid by a Contracting State or a political subdivision or a local authority thereof to an individual in respect of services rendered to that State or subdivision or authority shall, subject to the provisions of subparagraph (b), be taxable only in that State;

(b) such pension, however, shall be taxable only in the other Contracting State if the individual is a resident and a national of that State.

3. The provisions of Articles 16 (Dependent personal services), 17 (Directors’ fees), and 19 (Pensions, social security, and annuities) shall apply to remuneration and pensions in respect of services rendered in connection with a business carried on by a Contracting State or a political subdivision or a local authority thereof.

Article 21

Students, trainees, teachers, and researchers

1. Payments received by a student, apprentice, or business trainee who is, or was immediately before visiting a Contracting State, a resident of the other Contracting State, and who is present in the first-mentioned State for the purpose of full-time education at a recognized educational institution, or for full-time training, shall not be taxed in that State, provided that such payments are for the purpose of his maintenance, education, or training. The exemption from tax provided by this Article shall apply to an apprentice or business trainee only for a period of time not exceeding two years from the date he first arrives in the first-mentioned Contracting State for the purpose of his training. If the visit exceeds two years, the first-mentioned State may tax the individual under its national law for the entire period of the visit, unless in a particular case the competent authorities of the States agree otherwise.

2. A resident of one of the Contracting States who, at the invitation of a university, college, school, or other recognized educational institutions situated in the other Contracting State, is temporarily present in the other State solely for the purpose of teaching, or engaging in research, or both, at that educational institution shall, for a period not exceeding two years from the date he first arrives in the other State, be exempt from tax by the other State on his remuneration for such teaching or research. If the visit exceeds two years, the other State may tax the individual under its national law for the entire period of the visit, unless in a particular case the competent authorities of the States agree otherwise.

3. No exemption shall be granted under paragraph 2 with respect to any remuneration for research carried on for the benefit of any person other than the educational institution that extended the invitation referred to in paragraph 2.

Article 22

Other income

1. Items of income beneficially owned by a resident of a Contracting State, wherever arising, not dealt with in the foregoing Articles of this Convention shall be taxable only in that State.

2. The provisions of paragraph 1 shall not apply to income, other than income from real property as defined in paragraph 2 of Article 6 (Income from real property (immovable property)), if the beneficial owner of the income, being a resident of a Contracting State, carries on business in the other Contracting State through a permanent establishment situated therein, or performs in that other State independent personal services from a fixed base situated therein, and the income is attributable to such permanent establishment or fixed base. In such case the provisions of Article 7 (Business profits) or Article 15 (Independent personal services), as the case may be, shall apply.

Article 23

Capital

1. Capital represented by real property (immovable property) referred to in Article 6 (Income from real property), owned by a resident of a Contracting State and situated in the other Contracting State, may be taxed in that other State.

2. Capital represented by movable property forming part of the business property of a permanent establishment which an enterprise of a Contracting State has in the other Contracting State or by movable property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, may be taxed in that other State.

3. Capital of an enterprise of a Contracting State operating in international traffic as referred to in Article 8 (Shipping and air transport) represented by ships, aircraft or containers and movable property pertaining to the operation of such ships, aircraft or containers, shall be taxable only in that State.

4. All other elements of capital of a resident of a Contracting State shall be taxable only in that State.

Article 24

Limitation on benefits

1. A resident of a Contracting State shall be entitled to all the benefits of this Convention only if it is a “qualified resident” as defined in this Article. A person that is not a qualified resident may be entitled to benefits of this Convention with respect to certain items of income under paragraphs 3, 4 and 7.

2. A resident of a Contracting State is a qualified resident for a taxable year only if :

(a) that person is an individual;

(b) that person is a Contracting State, a political subdivision or a local authority thereof or any agency or instrumentality of any such government, subdivision or authority;

(c) that person is a company, if :

(i) at least 50 percent of the principal class of shares in the company is ultimately owned by persons that are qualified residents or U.S. citizens pursuant to this paragraph ; and

(ii) amounts paid or accrued by the company during its taxable year

(A) to persons that are neither qualified residents nor U.S. citizens, and

(B) that are deductible for income tax purposes in the company’s state of residence (but not including arm’s length payments in the ordinary course of business for services or purchases or rentals of tangible property including immovable property),

do not exceed 50 percent of the gross income of the company for that year;

 

(d) that person is a company whose principal class of shares is substantially and regularly traded on one or more recognized stock exchanges; the shares in a class of shares are considered to be substantially and regularly traded on one or more recognized stock exchanges in a taxable year if the aggregate number of shares of that class traded in such stock exchange or exchanges during the previous taxable year is at least 6 percent of the average number of shares outstanding in that class during that taxable year;

(e) that person is a company that is controlled, directly or indirectly, by publicly-traded corporations described in subparagraph (d), which are residents of one of the Contracting States, provided its payments to persons who are not qualified residents satisfy the requirements of subparagraph (c)(ii); or

(f) that person is a not-for-profit organization that, by virtue of that status, is generally exempt from income taxation in its Contracting State of residence, provided that more than half of the beneficiaries, members or participants, if any, in such organization are qualified residents.

3. (a) A resident of a Contracting State that is not a qualified resident shall be entitled to the benefits of this Convention with respect to an item of income derived from the other State, if such resident is directly (or indirectly through an associated enterprise) engaged in the active conduct of a trade or business in the first-mentioned State (other than the business of making or managing investments, unless such business is conducted by a banking or insurance company), and :

(i) the item of income is derived in connection with the trade or business in the first-mentioned State, and such trade or business is substantial in relation to the resident’s proportionate interest in the activity in the other State that generated the income; or

(ii) the item of income derived from the other State is incidental to that trade or business in the first- mentioned State.

 

(b) The item of income is derived in connection with a trade or business if :

(i) such item of income accrues in the ordinary course of such trade or business and the beneficial owner owns, directly or indirectly, less than 5 percent of the shares (or other comparable rights) in the payer of the item of income; or

(ii) the activity in the other State that generated the item of income is a line of business that forms a part of or is complementary to the trade or business conducted in the first-mentioned State by the income recipient.

 

(c) Whether a trade or business is substantial for purposes of this paragraph will be determined based on all the facts and circumstances. In any case, however, a trade or business will be considered to be substantial if, for the preceding taxable year, each of the following three ratios for factors that are related to the trade or business within the first-mentioned State equals at least 7.5 percent and the average equals at least 10 percent :

(i) the asset value;

(ii) gross income; and

(iii) payroll expense in relation to the proportionate share of the asset value, the gross income and the payroll expense, respectively, that are related to the activity that generated the income in the other State. If any separate factor does not meet the 7.5 percent test in the first preceding taxable year, the average of the ratios for that factor for the three preceding taxable years may be substituted. If the resident owns, directly or indirectly, less than 100 percent of an activity conducted in either State, only the resident’s proportionate interest in such activity will be taken into account for purposes of the test described in this subparagraph (c).

 

(d) The item of income derived from the other State is incidental to a trade or business conducted in the first-mentioned State if the income is not described in subparagraph (b) and the production of such item of income facilitates the conduct of the trade or business in the first-mentioned State (for example, the investment of working capital of such trade or business).

4. Except as provided in subparagraph (c), a company that is a resident of a Contracting State shall also be entitled to all the benefits of this Convention if :

(a) 95 percent of the company’s shares is ultimately owned by seven or fewer residents of a state that is a party to NAFTA or that is a member State of the European Union and with which the other State has a comprehensive income tax convention; and

(b) amounts paid or accrued by the company during its taxable year

(i) to persons that are not residents of a state that is a party to NAFTA, residents of a member State of the European Union, or U.S. citizens, and

(ii) that are deductible for income tax purposes in the company’s state of residence (but not including arm’s length payments in the ordinary course of business for services or purchases or rentals of tangible property),

do not exceed 50 percent of the gross income of the company for that year.

(c) Notwithstanding the other provisions of this paragraph 4, a resident described in this paragraph will be entitled to the benefits of Articles 10 (Dividends), 11 (Branch tax), 12 (Interest), and 13 (Royalties) with respect to an item of income described in one of such Articles only if the comprehensive income tax convention referred to in subparagraph (a) between one of the States and a third state provides a rate of tax equal to or less than the rate provided under this Convention with respect to the item of income derived from the other State.

(d) (i) The term “resident of a member State of the European Union” means a person that would be entitled to the benefits of a comprehensive income tax convention in force between any member State of the European Union and the Contracting State from which the benefits of this Convention are claimed, provided that if such convention does not contain a comprehensive Limitation on Benefits article (including provisions similar to those of subparagraphs 2(c) and 2(d) and paragraph 3), the person would be entitled to the benefits of this Convention under the principles of paragraphs 2 or 3 if such person were a resident of one of the Contracting States under Article 4 (Resident) of this Convention.

(ii) The term “resident of a state that is a party to NAFTA” means a person that would be entitled to the benefits of a comprehensive income tax convention in force between any member State of the North American Free Trade Agreement and the Contracting State from which the benefits of this Convention are claimed, provided that if such convention does not contain a comprehensive Limitation on Benefits article (including provisions similar to those of subparagraphs 2(c) and 2(d) and paragraph 3), the person would be entitled to the benefits of this Convention under the principles of paragraphs 2 or 3 if such person were a resident of one of the Contracting States under Article 4 (Resident) of this Convention.

(iii) When applying the principles of paragraph 3, an item of income derived from one of the Contracting States with respect to which treaty benefits are claimed must be derived in connection with an active trade or business conducted by the resident of the third state in that state.

 

5.Notwithstanding the other provisions of this Convention, where :

(a) an enterprise of a Contracting State derives income from the other Contracting State,

(b) that income is attributable to a permanent establishment which that enterprise has in a third jurisdiction, and

(c) the enterprise is exempt from tax in the first-mentioned State on the profits attributable to the permanent establishment,

the tax benefits that otherwise would apply under the Convention will not apply to any item of income on which the combined tax in the first-mentioned State and in the third jurisdiction is less than 50 percent of the tax that would be imposed in the first-mentioned State if the income were earned in that State by the enterprise and were not attributable to the permanent establishment. Any dividends, interest or royalties to which the provisions of this paragraph apply shall be subject to tax in the other State at a rate not exceeding 15 percent of the gross amount thereof. Any other income to which the provisions of this paragraph apply shall be subject to tax under the provisions of the domestic law of the other Contracting State. The provisions of this paragraph shall not apply if the income derived from the other Contracting State is in connection with or incidental to the active conduct of a trade or business carried on by the permanent establishment in the third jurisdiction (other than the business of making or managing investments unless these activities are banking or insurance activities carried on by a bank or insurance company).

6. Notwithstanding the other provisions of this Article, the benefits of this Convention shall not apply to the disproportionate part of the income (i.e., that part of the income exceeding the income that would have been received absent the terms or arrangements mentioned in subparagraph (a) of this paragraph) derived from a Contracting State by a company that is resident of the other Contracting State if that company, or a company that controls that company, has outstanding a class of shares :

(a) the terms of which, or which is subject to other arrangements that, entitle its holders to a portion of the income of the company derived from the first-mentioned State that is larger than the portion such holders would receive absent such terms or arrangements; and

(b) 50 percent or more of the vote and value of which is owned by persons who are not qualified residents of either a Contracting State or of a State that is a party to NAFTA or that is a member State of the European Union.

7. A resident of a Contracting State that is not entitled to the benefits of the Convention under the preceding paragraphs of this Article shall, nevertheless, be granted the benefits of the Convention if the competent authority of the other Contracting State so determines.

8. The following provisions apply for purposes of this Article :

(a) The term “a recognized stock exchange” means :

(i) any stock exchange registered with the U.S. Securities and Exchange Commission as a national securities exchange for purposes of the U.S. Securities Exchange Act of 1934;

(ii) the Luxembourg stock exchange;

(iii) the NASDAQ System owned by the National Association of Securities Dealers; and

(iv) any other stock exchange agreed upon by the competent authorities.

With respect to closely-held companies, the term “recognized stock exchange” shall not include the stock exchanges mentioned under subparagraphs (ii) and (iii), and if so indicated in mutual agreement between the competent authorities, under subparagraph (iv).

(b) The term “closely-held company” means a company of which 50 percent or more of the principal class of shares is owned by persons, other than qualified residents, residents of a member State of the European Union, or residents of a State that is a party to NAFTA, each of whom beneficially owns, directly or indirectly, alone or together with related persons, more than 5 percent of such shares for more than 30 days during a taxable year.

9. The competent authorities of the Contracting States shall consult together with a view to developing a commonly agreed application of the provisions of this Article, including the publication of regulations or other public guidance. The competent authorities shall, in accordance with the provisions of Article 28 (Exchange of information), exchange such information as is necessary for carrying out the provisions of this Article.

10. Notwithstanding the other provisions of this Article, Luxembourg holding companies, within the meaning of the Act (loi) of 31 July, 1929 and the Decree (arrêté grand-ducal) of 17 December 1938, or any subsequent revision thereof, or such other companies that enjoy a similar special fiscal treatment by virtue of the laws of Luxembourg, are not residents.

Article 25

Relief from double taxation

1. In accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle hereof), the United States shall allow to a resident or citizen of the United States as a credit against the United States income tax :

(a) the income tax paid to Luxembourg by or on behalf of such citizen or resident; and

(b) in the case of a United States company owning at least 10 percent of the voting power of a company which is a resident of Luxembourg and from which the United States company receives dividends, the income tax paid to Luxembourg by or on behalf of the distributing company with respect to the profits out of which the dividends are paid.

For the purposes of this paragraph, the taxes referred to in subparagraph 1(b) and paragraph 2 of Article 2 (Taxes covered), other than the capital tax and that portion of the communal trade tax computed on a basis other than profits, shall be considered income taxes.

2. In Luxembourg double taxation shall be eliminated as follows :

(a) where a resident of Luxembourg derives income or owns capital which, in accordance with the provisions of this Convention, may be taxed in the United States, Luxembourg shall, subject to the provisions of subparagraphs (b) and (c), exempt such income or capital from tax, but may, in order to calculate the amount of tax on the remaining income or capital of the resident, apply the same rates of tax as if the income or capital had not been exempted;

(b) where a resident of Luxembourg derives income which, in accordance with the provisions of Article 10 (Dividends) and subparagraph 6(b) of Article 12 (Interest) may be taxed in the United States, Luxembourg shall allow as a deduction from the tax on the income of that resident an amount equal to the tax paid in the United States. Such deduction shall not, however, exceed that part of the tax, as computed before the deduction is given, which is attributable to such items of income derived from the United States; and

(c) where a company that is a resident of Luxembourg derives dividends from United States sources, Luxembourg shall exempt such dividends from tax, provided that the company that is a resident of Luxembourg has held directly since the beginning of its accounting year at least 10 percent of the capital of the company paying the dividends, and if this company is subject in the United States to an income tax corresponding to the Luxembourg corporation tax. The above-mentioned shares in the United States company are, under the same conditions, exempt from the Luxembourg capital tax.

3. Where a United States citizen is a resident of Luxembourg :

(a) with respect to items of income not exempt from Luxembourg tax under paragraph 2 and that under the provisions of this Convention are exempt from United States tax or that are subject to a reduced rate of United States tax when derived by a resident of Luxembourg who is not a United States citizen, Luxembourg shall allow as a credit against Luxembourg tax, only the tax paid, if any, that the United States may impose under the provisions of this Convention, other than taxes that may be imposed solely by reason of citizenship under the saving clause of paragraph 3 of Article 1 (General scope);

(b) for purposes of computing United States tax on those items of income referred to in subparagraph (a), the United States shall allow as a credit against United States tax the income tax paid to Luxembourg determined after reduction by the credit referred to in subparagraph (a); the credit so allowed shall not reduce the portion of the United States tax that is creditable against Luxembourg tax in accordance with subparagraph (a); and

(c) for the exclusive purpose of relieving double taxation in the United States under subparagraph (b), items of income referred to in subparagraph (a) shall be deemed to arise in Luxembourg to the extent necessary to avoid double taxation of such income under subparagraph (b).

4. Except as provided in subparagraph (c) of paragraph 3, for the purposes of allowing relief from double taxation pursuant to this Article, and subject to such source rules in the domestic laws of the Contracting States as apply for purposes of limiting the foreign tax credit, income derived by a resident of a Contracting State that may be taxed in the other Contracting State in accordance with this Convention (other than solely by reason of citizenship in accordance with paragraph 3 of Article 1 (General scope)) shall be deemed to arise in that other State.

Article 26

Non-discrimination

1. Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances are or may be subjected. This provision shall also apply to persons who are not residents of one or both of the Contracting States. However, for the purposes of United States tax, a United States national who is not a resident of the United States and a Luxembourg national who is not a resident of the United States are not in the same circumstances.

2. The taxation on a permanent establishment that an enterprise of a Contracting State has in the other Contracting State, or of remuneration of an individual resident of a Contracting State attributable to a fixed base in the other Contracting State regularly available to that resident, shall not be less favourably levied in that other State than the taxation levied on enterprises or residents of that other State carrying on the same activities. The provisions of this paragraph shall not be construed as obliging a Contracting State to grant to residents of the other Contracting State any personal allowances, reliefs, and reductions for taxation purposes on account of civil status or family responsibilities which it grants to its own residents.

3. Except where the provisions of paragraph 1 of Article 9 (Associated enterprises), paragraph 5 of Article 12 (Interest), or paragraph 5 of Article 13 (Royalties) apply, interest, royalties, and other disbursements paid by a resident of a Contracting State to a resident of the other Contracting State shall, for the purposes of determining the taxable profits of the first-mentioned resident, be deductible under the same conditions as if they had been paid to a resident of the first-mentioned State. Similarly, any debts of an enterprise of a Contracting State to a resident of the other Contracting State shall, for the purpose of determining the taxable capital of such enterprise, be deductible under the same conditions as if they had been contracted to a resident of the first-mentioned State.

4.Enterprises of a Contracting State, the capital of which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected in the first-mentioned State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which other similar enterprises of the first-mentioned State are or may be subjected.

5. Nothing in this Article shall be construed as preventing the United States from imposing a tax as described in Article 11 (Branch tax).

6. The provisions of this Article shall, notwithstanding the provisions of Article 2 (Taxes covered), apply to taxes of every kind and description imposed by a Contracting State or a political subdivision or local authority thereof.

Article 27

Mutual agreement procedure

1. Where a person considers that the actions of one or both of the Contracting States result or will result for him in taxation not in accordance with the provisions of this Convention, he may, irrespective of the remedies provided by the domestic law of those States, present his case to the competent authority of the Contracting State of which he is a resident or national.

2. The competent authority shall endeavour, if the objection appears to it to be justified and if it is not itself able to arrive at a satisfactory solution, to resolve the case by mutual agreement with the competent authorities of the other Contracting State, with a view to the avoidance of taxation which is not in accordance with the Convention. Any agreement reached shall be implemented notwithstanding any time limits in the domestic law of the Contracting States.

3. The competent authorities of the Contracting States shall endeavour to resolve by mutual agreement any difficulties or doubts arising as to the interpretation or application of the Convention. In particular, the competent authorities of the Contracting States may agree :

(a) to the same attribution of income, deductions, credits, or allowances of an enterprise of a Contracting State to its permanent establishment situated in the other Contracting State;

(b) to the same allocation of income, deductions, credits, or allowances between persons;

(c) to the same characterization of particular items of income;

(d) to a common determination of the State in which an item of income arises; and

(e) to a common meaning of a term.

They may also consult together for the elimination of double taxation in cases not provided for in the Convention.

4. The competent authorities of the Contracting States may communicate with each other directly for the purpose of reaching an agreement in the sense of the preceding paragraphs.

5. The competent authorities of the Contracting States shall consult together with a view to developing a commonly agreed application of the provisions of this Convention, including the provisions of Article 24 (Limitation on benefits). The competent authorities of the Contracting States may each prescribe regulations to carry out the purposes of this Convention.

Article 28

Exchange of information

1. The competent authorities of the Contracting States shall exchange such information as is necessary for carrying out the provisions of this Convention or of the domestic laws of the Contracting States concerning taxes covered by this Convention insofar as the taxation thereunder is not contrary to this Convention. The exchange of information is not restricted by Article 1 (General scope). Any information received by the competent authority of a Contracting State from the competent authority of the other Contracting State shall be treated as secret in the same manner as information obtained under the domestic law of that State and shall be disclosed only to persons or authorities (including courts and administrative bodies) involved in the assessment, collection, or administration of, the enforcement or prosecution in respect of, or the determination of appeals in relation to, the taxes covered by the Convention. Such persons or authorities shall use the information only for such purposes. They may disclose the information in public court proceedings or in judicial decisions.

2. In no case shall the provisions of paragraph 1 be construed so as to impose on a Contracting State the obligation :

(a) to carry out administrative measures at variance with the laws and administrative practice of that State or of the other Contracting State;

(b) to supply information which is not obtainable under the laws or in the normal course of the administration of that State or of the other Contracting State;

(c) to supply information which would disclose any trade, business, industrial, commercial, or professional secret or trade process, or information the disclosure of which would be contrary to public policy (ordre public).

3. Where information is requested by a Contracting State through competent authorities, the competent authority of the other Contracting State shall obtain the information to which the request relates in the same manner and to the same extent as if the tax of the first-mentioned State were the tax of that other State and were being imposed by that other State. If specifically requested by the competent authority of a Contracting State, the competent authority of the other Contracting State shall provide information under this Article in the form of depositions of witnesses and authenticated copies of unedited original documents (including books, papers, statements, records, accounts, and writing) to the same extent that the competent authority of the other Contracting State can obtain such depositions and documents for an investigation or proceeding under its laws and administrative practice.

4. The Contracting States undertake to lend each other support and assistance in the collection of taxes to the extent necessary to ensure that relief granted by the present Convention from taxation imposed by a Contracting State does not inure to the benefit of persons not entitled thereto. With respect to a specific request for collection assistance :

(a) the requesting State must produce a copy of a document certified by its competent authority specifying that the sums referred to it for the collection of which it is requesting the intervention of the other State, are finally due and enforceable;

(b) a document produced in accordance with the provisions of this paragraph shall be rendered enforceable in accordance with the laws of the requested State;

(c) the requested State shall effect recovery in accordance with the rules governing the recovery of similar tax debts of its own; however, tax debts to be recovered shall not be regarded as privileged debts in the requested State; and

(d) appeals concerning the existence or amount of the debt shall lie only to the competent tribunal of the requesting State.

The provisions of this paragraph shall not impose upon either Contracting State the obligation to carry out administrative measures that would be contrary to its sovereignty, security, public policy or its essential interests.

Article 29

Diplomatic agents and consular officers

Nothing in this Convention shall affect the fiscal privileges of diplomatic agents or consular officers under the general rules of international law or under the provisions of special agreements.

Article 30

Entry into force

1. This Convention shall be subject to ratification. The instruments of ratification shall be exchanged as soon as possible.

2. The Convention shall enter into force on the day of the exchange of instruments of ratification. Its provisions allocating taxation rights shall have effect, in respect of taxes withheld at source, for amounts paid or credited on or after the first day of January next following, and in respect of taxes on other income and on capital, for fiscal periods beginning on or after the first day of January next following, the date on which the Convention enters into force.

3. Where any greater relief from tax would have been afforded to a person entitled to the benefits of the Convention between the United States of America and the Grand Duchy of Luxembourg with respect to taxes on income and property, signed in Washington on 18 December 1962 (hereinafter referred to as “the 1962 Convention”), under that Convention than under this Convention, the 1962 Convention shall, at the election of such person, continue to have effect in its entirety for the first assessment period or taxable year following the date on which this Convention would other wise have effect under the provisions of paragraph 2.

4. The 1962 Convention shall cease to have effect in respect of income and capital to which this Convention applies in accordance with paragraphs 2 or 3 of this Article. The 1962 Convention shall terminate on the last date on which it has effect in accordance with the foregoing provisions of this Article.

Article 31

Termination

This Convention shall remain in force until terminated by a Contracting State. Either Contracting State may terminate the Convention, through diplomatic channels, by giving notice of termination at least six months before the end of any calendar year after the year of entry into force. In such event, the Convention shall cease to have effect in respect of tax withheld at the source, for amounts paid or credited on or after, and in respect of other taxes, to fiscal periods beginning on or after, the first day of January next following the expiration of the six-month period.

In witness thereof the undersigned, being duly authorized thereto, have signed the present Convention.

Done at Luxembourg in duplicate, in the French and English languages, the two texts having equal authenticity, this 3rd day of April, 1996.

EXCHANGE OF NOTES

I

3 April 1996

Excellency,

I have the honour to refer to the Convention between the Government of the United States of America and the Government of the Grand Duchy of Luxembourg for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with respect to taxes on Income and Capital (the “Convention”) and to propose on behalf of the Government of the United States the following :

In the course of the negotiations leading to the conclusion of the Convention, the negotiators developed and agreed upon a common understanding and interpretation of the following provisions. These understandings and interpretations are intended to give guidance both to the taxpayers and the authorities of our two countries in interpreting various provisions contained in the Convention.

I. With reference to Article 11 (Branch tax) :

The term “dividend equivalent amount” shall have the meaning it has under the law of the United States, as it may be amended from time to time without changing the general principle thereof.

II. With reference to Article 19 (Pensions, social security, and annuities)

It is understood that the term “other similar legislation” as used in Article 19 (Pensions, social security, and annuities) is intended to refer to United States tier 1 Railroad Retirement benefits.

III. With reference to Article 24 (Limitation on benefits)

A. It is understood that the term “any other securities exchange” includes the principal stock exchanges of Amsterdam, Brussels, Frankfurt, Hamburg, London, Madrid, Milan, Paris, Sydney, Tokyo and Toronto.

B. It is understood that the term “such other companies which enjoy a similar special fiscal treatment by virtue of the laws of Luxembourg” includes investment companies within the meaning of the Act dated 30 March 1988.

C. For purposes of determining under subparagraph 4(c) if a comprehensive income tax Convention between one of the Contracting States and a third State provides with respect to dividends a rate of tax that is equal to or less than the rate of tax provided under the Convention, it is understood that the following two tax rates must be compared :

(a) the rate of tax to which each of the persons described in subparagraph 4(a) would be entitled if they directly held their proportionate share of the shares that gave rise to the dividends; and

(b) the rate of tax to which the same persons, if they would be residents of the Contracting State of which the recipient is a resident, would be entitled if they directly held their proportionate share of the shares that gave rise to the dividends.

D. With respect to subparagraphs 2(c) and 2(d) and paragraph 4, it is understood that a Contracting State may consider a person not to be a qualified resident, unless such person demonstrates that a percentage of its shares (including shares not issued in registered form) necessary to satisfy the ownership threshold specified in subparagraphs 2(c) and 2(d) or paragraph 4 is beneficially owned by qualified residents, or, where relevant, residents of a member State of the European Union or a State that is a party to NAFTA.

IV. With reference to Article 28 (Exchange of information)

Paragraph 1 of Article 28 requires that each Contracting State provide to the other the broadest possible measure of assistance with respect to matters covered by the Convention. The Contracting States expect that the authorities in each State, including judicial authorities to the extent that they become involved in executing a request, will use their best efforts to provide the assistance requested.

Also, under paragraph 3, upon request the competent authority of a Contracting State will obtain and provide information, other than information of financial institutions, for any matter relating to the assessment, collection, or administration of, the enforcement or prosecution in respect of, or the determination of appeals in relation to, the taxes covered by the Convention, but only in the same manner and to the same extent as if the competent authority of the requested State were obtaining the information for an investigation or a public court proceeding under its laws and practices. Thus, upon request the competent authority of the requested State shall obtain and provide authenticated copies of third-party books and records located in the requested State for any tax investigation or proceeding in the requesting State, so long as the laws and practices of the requested State would allow its tax authorities to obtain such information for an investigation or a public court proceeding under its laws.

Finally, it is understood that certain information of financial institutions may be obtained and provided to certain U.S. authorities only in accordance with the terms of the Treaty between the United States of America and the Grand Duchy of Luxembourg on Mutual Legal Assistance in Criminal Matters. The scope of this obligation is set forth in that agreement. Further, if the laws and practices in Luxembourg change in a way that permits the Luxembourg competent authority to obtain such information for purposes of enforcing and administering its tax laws or the tax laws of member States of the European Union, it is understood that such information will be obtained and provided to the U.S. competent authority to the same extent that it is obtained and provided for the enforcement and administration of such tax laws.

If the foregoing understandings and interpretations of the various provisions meet with the approval of the Government of the Grand Duchy of Luxembourg, this Note and your Note in reply thereto will constitute a common and binding understanding by our Governments of the Convention.

Accept, Your Excellency, the expression of my highest considerations.

Clay Constantinou

Ambassador

II

Excellency,

I have the honour to acknowledge the receipt of Your Excellency’s Note of April 3rd, which reads as follows :

[see I]

I have further the honour to confirm the understandings and interpretations contained in Your Excellency’s Note, on behalf of the Government of the Grand Duchy of Luxembourg.

Accept, Your Excellency, the expression of my highest considerations.

Jacques F. Poos

Minister of Foreign Affairs

Foreign Trade and Cooperation of

the Grand Duchy of Luxembourg

 

TECHNICAL EXPLANATION TO THE 1996 TREATY (1996)

Date of Conclusion : 19 September 1996.

Entry into Force : Not applicable.

Effective Date : Not applicable.

TREASURY DEPARTMENT TECHNICAL EXPLANATION

OF THE CONVENTION BETWEEN THE GOVERNMENT OF THE UNITED STATES OF AMERICA AND

THE GOVERNMENT OF THE GRAND DUCHY OF LUXEMBOURG FOR THE AVOIDANCE OF DOUBLE TAXATION AND THE PREVENTION OF FISCAL EVASION

WITH RESPECT TO TAXES ON INCOME AND CAPITAL

SIGNED AT LUXEMBOURG, APRIL 3, 1996

INTRODUCTION

This document is a technical explanation of the Convention between the United States of America and the Grand Duchy of Luxembourg signed at Luxembourg, April 3, 1996 (“the Convention”). References are made to the Convention between the United States of America and the Grand Duchy of Luxembourg for the Avoidance of Double Taxation with Respect to Taxes on Income, signed at Washington on December 18, 1962 (“the 1962 Convention”). This Convention replaces the 1962 Convention. Negotiations took into account the U.S. Treasury Department’s current tax treaty policy, the Model Double Taxation Convention on Income and Capital published by the Organization for Economic Cooperation and Development (“the OECD Model”), and recent United States and Luxembourg treaties concluded with third countries.

The Convention is supplemented by an exchange of notes. The exchange of notes presents agreed understandings as to the proper interpretation of certain of the provisions of the Convention. The explanations of each article include explanations of any provisions in the exchange of notes relating to that article.

The technical explanation is an official guide to the Convention. It reflects the policies behind particular Convention provisions, as well as understandings reached with respect to the application and interpretation of the Convention. This technical explanation has been provided to Luxembourg. References in the technical explanation to “he” or “his” should be read to mean “he or she” or “his or her”.

Article 1

General scope

Article 1 provides that the Convention applies to persons who are residents of the United States or Luxembourg, except where the Convention otherwise provides. Under Article 4 (Residence) a person is generally treated as a resident of a Contracting State if that person is, under the laws of that State, liable to tax therein by reason of his domicile or other similar criteria, subject to certain limitations, as described in Article 4. These definitions govern for all provisions of the Convention.

Certain provisions are applicable to persons who may not be residents of either Contracting State. For example, Article 20 (Government service) may apply to an employee of a Contracting State who is resident in neither State. Paragraph 1 of Article 26 (Non- discrimination) applies to nationals of the Contracting States. Under Article 28 (Exchange of information), information may be exchanged with respect to residents of third states. Residents of a Contracting State are not, however, automatically entitled to benefits under the Convention; they must also satisfy one of the tests under Article 24 (Limitation on benefits) establishing the right to obtain treaty benefits.

Paragraph 2 makes explicit, on a reciprocal basis, the generally accepted principle that no provision in the Convention may restrict any exclusion, exemption, deduction, credit or other benefit now or hereafter accorded by the laws of either Contracting State, or by any other agreement between the Contracting States. For example, subparagraph 2(a) provides that if a deduction would be allowed under the U.S. Internal Revenue Code (the “Code”) in computing the taxable income of a resident of Luxembourg, the deduction will remain available to that person in computing taxable income under the Convention. Paragraph 2 also means that the treaty may not increase the tax burden on residents of the Contracting States beyond the burden determined under domestic law. Thus, a right to tax given by the treaty cannot be exercised unless that right also exists under internal law.

A taxpayer may always rely on the Code treatment rather than the treaty if the Code would produce a more favorable result. This does not mean, however, that a taxpayer may pick and choose among Code and treaty provisions in an inconsistent manner in order to minimize tax. For example, assume a resident of Luxembourg has three separate businesses in the United States. One is a profitable permanent establishment and the other two are trades of businesses that would earn taxable income under the Code, but that do not meet the permanent establishment threshold tests of the Convention. One is profitable and the other incurs a loss. Under the Convention, the income of the permanent establishment is taxable, and both the profit and loss of the other two businesses are ignored. Under the Code, all three would be taxable. The loss would offset the profits of the two profitable ventures. The taxpayer may not invoke the Convention to exclude the profits of the profitable trade or business and invoke the Code to claim the loss of the unprofitable trade or business against the profit of the permanent establishment. (See Rev. Rul. 84-17 1984-1 C.B. 308.) However, if the taxpayer invokes the Code for the taxation of all three ventures, he would not be precluded from invoking the Convention with respect, for example, to any dividend income that is not effectively connected with any of his business activities in the United States.

Subject to the provisions of paragraph 5, subparagraph 2(b) establishes that nothing in the Convention can be used to deny any benefit granted by any other agreement between the United States and Luxembourg, regardless of any provisions to the contrary, or silence, in this Convention.

Paragraph 3 contains the traditional saving clause, while paragraph 4 provides exceptions to the saving clause. Since the provisions apply only for the United States they are drafted unilaterally. The United States reserves its rights, except as provided in paragraph 4, to tax its residents and citizens as provided in its internal laws as if the Convention had not come into effect and notwithstanding any Convention provisions to the contrary. If, for example, a Luxembourg resident performs independent personal services in the United States and the income from the services is not attributable to a fixed base in the United States, Article 15 (Independent personal services) would normally prevent the United States from taxing the income. If, however, the Luxembourg resident is also a citizen of the United States, the saving clause permits the United States to include the remuneration in the worldwide income of the citizen and subject it to tax under the normal Code rules (i.e. without regard to Code section 894(a)). For special foreign tax credit rules applicable to the U.S. taxation of certain U.S. income of its citizens resident in Luxembourg see paragraph 3 of Article 25 (Relief from double taxation).

For purposes of the saving clause, “residence” is determined under Article 4 (Residence). Thus, if an individual who is not a U.S. citizen is a resident of the United States under the Code and is also a resident of Luxembourg under Luxembourg law, and that individual has a permanent home available to him in Luxembourg and not in the United States, he would be treated as a resident of Luxembourg under Article 4 and for purposes of the saving clause. The United States would not be permitted to apply any statutory rules to that person that are inconsistent with the treaty.

Under paragraph 3 the United States also reserves its right to tax former citizens whose loss of citizenship had as one of its principal purposes the avoidance of tax, but only for a period of 10 years after the loss of citizenship. Such former citizens of the United States are taxable in accordance with the provisions of section 877 of the Code.

Some provisions are intended to provide benefits to citizens and residents that do not exist under internal law. Paragraph 4 sets forth certain exceptions to the saving clause that preserve these benefits for citizens and residents of the United States.

Subparagraph 4(a) lists certain provisions that will apply to all citizens and residents of the United States, despite the general saving clause rule of paragraph 3 :

(1) Paragraph 2 of Article 9 (Associated enterprises) grants the right to a correlative adjustment under the conditions specified in that provision.

(2) Subparagraph 1(b) of Article 19 (Pensions, social security, and annuities) deals with social security and similar benefits. Its inclusion in the exceptions to the saving clause means that such payments will be exempt from tax in the country of residence of the recipient, notwithstanding a statutory right of the residence country to tax the recipient on the income.

(3) Article 25 (Relief from double taxation) confirms the benefits of U.S. double taxation relief on its citizens and residents.

(4) Article 26 (Non- discrimination) prohibits discriminatory taxation by one Contracting State of the citizens and residents of the other. These prohibitions are intended to apply even if the citizen or resident is also a citizen or resident of the taxing State.

(5) Article 27 (Mutual agreement procedure) may confer U.S. benefits on U.S. citizens and residents and Luxembourg benefits on its residents. For example, the statute of limitations may be waived for refunds and the competent authorities are permitted to agree to use a definition of a term that differs from the statutory definition in one or both countries. As with the foreign tax credit, these benefits are intended to be granted by a Contracting State to its citizens and residents.

Subparagraph 4(b) provides an additional set of exceptions to the saving clause. The benefits referred to are all intended to be granted by the United States to temporary residents, but not to permanent residents (i.e., those with immigrant status) or citizens. If, for example, beneficiaries of these provisions come to the United States from Luxembourg and remain in the United States long enough to become residents under the Code, but do not acquire permanent residence status (i.e., they do not become “green card” holders) and are not citizens of the United States, the United States will continue to grant these benefits even if they conflict with the Code rules. The benefits preserved by this paragraph are the United States exemptions for the following items of income : Government service remuneration, other than a pension, under Article 20 (Government service); certain income of visiting students and trainees under Article 21 (Students, trainees, teachers and researchers); and the income of diplomatic and consular officers under Article 29 (Diplomatic agents and consular officers).

Paragraph 5 modifies the rule of subparagraph 2(b) with respect to certain obligations undertaken by the Contracting States under other agreements. Subparagraph 5(a) provides that, notwithstanding any other agreement to which the Contracting States may be parties, a dispute concerning whether a measure falls within the scope of this Convention shall be considered only by the competent authorities of the Contracting States, and the procedures under this Convention exclusively shall apply to the dispute. Thus, dispute resolution procedures that may be incorporated into trade, investment, or other agreements between the United States and Luxembourg shall not apply for the purpose of determining the scope of this Convention.

Subparagraph 5(b) provides that, unless the competent authorities determine that a taxation measure is not within the scope of this Convention, the non-discrimination obligations of this Convention exclusively shall apply with respect to that measure, except for such national treatment or most-favored-nation (“MFN”) obligations as may apply to trade in goods under the General Agreement on Tariffs and Trade (“GATT”). No national treatment or MFN obligation under any other agreement shall apply with respect to that measure. Thus, unless the competent authorities agree otherwise, any national treatment and MFN obligations undertaken by the Contracting States under agreements other than the Convention shall not apply to a taxation measure, with the exception of GATT as applicable to trade in goods.

Subparagraph 5(c) defines a “measure” as a law, regulation, rule, procedure, decision, administrative action, or any similar provision or action.

Article 2

Taxes covered

Article 2 specifies the existing U.S. and Luxembourg taxes to which the Convention applies. With one exception, the taxes specified in this Article are the covered taxes for all purposes of the Convention. A broader coverage applies, however, for purposes of Article 26 (Non-discrimination). Article 26 applies with respect to all taxes, including those imposed by state and local governments.

Paragraph 1 identifies the specific taxes covered by the Convention. Subparagraph 1(a)(i) specifies that the United States covered taxes are the Federal income taxes imposed by the Code. Social security taxes (Code sections 1401, 3101, and 3111) are specifically excluded from coverage. U.S. and Luxembourg social security taxes are dealt with in the bilateral Social Security Totalization Agreement, which was signed on February 12, 1992, and entered into force on November 1, 1993. Except with respect to Article 26, state and local income taxes in the United States are not covered by the Convention.

Subparagraph 1(a)(ii) specifies that the Federal excise taxes imposed on insurance premiums paid to foreign insurers (Code section 4371) are also covered taxes. With respect to the tax on insurance premiums, the Convention shall not apply to the excise taxes imposed on premiums paid to foreign insurers for reinsurance. The Convention shall apply to the excise taxes imposed on premiums paid to foreign insurers for insurance other than reinsurance only to the extent that the risks covered by such premiums are not reinsured, directly or indirectly, with a person not entitled to exemption from such taxes under an income tax convention that applies to such taxes. Covering the U.S. insurance premiums excise tax effectively exempts Luxembourg companies that directly insure U.S. risks from the tax, subject to the anti-conduit rule which provides that the Convention will provide exemption with respect to direct insurance only to the extent that the risk is not reinsured with a person, including a resident of Luxembourg, that is not entitled to exemption from the taxes on both direct insurance and reinsurance premiums.

Under the Code, the tax applies only to premiums that are not effectively connected with a trade or business in the United States. Under Article 7 (Business profits), the United States does not subject the business profits of a Luxembourg enterprise to tax if the income of the enterprise is not attributable to a permanent establishment the enterprise has in the United States.

In contrast with this Convention, the 1962 Convention does not cover the insurance excise tax, thus allowing it to be imposed on premiums paid to Luxembourg insurers that were not attributable to a permanent establishment of the Luxembourg insurer in the United States.

Subparagraph 1(b) identifies the Luxembourg taxes covered by the Convention. Subparagraph 1(b)(i) covers the income tax on individuals, including the surcharge thereon for the benefit of the employment fund (l’impôt sur le revenue des personnes physiques, y comprise la contribution au fonds pour l’emploi); subparagraph 1(b)(ii) covers the corporation tax including the surcharge thereon for the benefit of the employment fund (l’impôt sur le revenue des collectivités, y compris la contribution au fonds pour l’emploi); subparagraph 1(b)(iii) covers the tax on the fees of directors of companies (l’impôt spécial sur les tantièmes); subparagraph 1(b)(iv) covers the capital tax (l’impôt sur la fortune); and, subparagraph 1(b)(v) covers the communal trade tax (l’impôt commercial communal). The official French terms used by Luxembourg for the corporation tax are “l’impôt sur le revenue des collectivités” and Luxembourg translates “collectivités” as “corporations”. Except for the employment fund surcharge, the listed Luxembourg taxes are also covered in the 1962 Convention.

Paragraph 2 states that the Convention shall apply to any taxes that are identical, or substantially similar, to those enumerated in paragraph 1, and which are imposed in addition to, or in place of, the existing taxes after the date of signature of the Convention. The paragraph also provides that the U.S. and Luxembourg competent authorities shall notify each other of any changes in their taxation laws that are significant to the operation of the Convention. They are also to notify each other of any official published materials concerning the application of the Convention. Such materials include explanations, regulations, rulings or judicial decisions.

Article 3

General definitions

Article 3 defines terms used in the Convention. Paragraph 1 defines a number of basic terms used in the Convention, while paragraph 2 addresses terms that are not defined in the Convention. Other articles define certain other terms. For example, the term “resident of a Contracting State” is defined in Article 4 (Residence). The term “permanent establishment” is defined in Article 5 (Permanent establishment). The terms “dividends”, “interest” and “royalties” are defined in Articles 10, 12 and 13, respectively. The introduction to paragraph 1 makes clear that these definitions apply for all purposes of the Convention, unless the context requires otherwise.

Subparagraph 1(a) defines the term “person” to include an individual, an estate, a trust, a partnership, a company and any other body of persons.

Subparagraph 1(b) defines the term “company” as any body corporate or any entity that is treated as a body corporate for tax purposes.

Subparagraph 1(c) defines the terms “enterprise of a Contracting State” and “enterprise of the other Contracting State” as, respectively, an enterprise carried on by a resident of a Contracting State and an enterprise carried on by a resident of the other Contracting State. Since the Convention does not define the terms “body corporate” and “enterprise” in accordance with paragraph 2 of this Article, the terms have the meaning they have under the laws of the Contracting State whose tax is being applied.

Subparagraph 1(d) defines the term “international traffic” as any transport by a ship or aircraft, except when such transport is operated solely between places within a Contracting State. This definition is applicable principally in the context of Article 8 (Shipping and air transport).

The exclusion from international traffic of transport solely between places within a Contracting State means, for example, that a carriage of goods or passengers solely between New York and Chicago would not be treated as international traffic, whether carried by a U.S. or a Luxembourg carrier. The substantive taxing rules of the Convention relating to the taxation of income from transport, principally Article 8, therefore, would not apply to income from such carriage. Thus, if the carrier engaged in internal U.S. traffic were a resident of Luxembourg (assuming that were possible under U.S. law), the United States would not be required to exempt the income under Article 8. The income would, however, be treated as business profits under Article 7 (Business profits) and would, therefore, be taxable in the United States only if attributable to a U.S. permanent establishment, and then only on a net basis. The gross basis U.S. tax imposed by section 887 never would apply under the circumstances described. If, however, goods or passengers are carried by a Luxembourg carrier from Luxembourg City to New York, with some of the goods or passengers carried only to New York, and the rest taken to Chicago, the entire transport would be international traffic.

Subparagraphs 1(e)(i) and 1(e)(ii) define the term “competent authority” for the United States and Luxembourg, respectively. The U.S. competent authority is the Secretary of the Treasury or his delegate. The Secretary of the Treasury has delegated the competent authority function to the Commissioner of Internal Revenue, who has, in turn, re-delegated the authority to the Assistant Commissioner (International). With respect to interpretative issues, the Assistant Commissioner acts with the concurrence of the Associate Chief Counsel (International) of the Internal Revenue Service. In Luxembourg, the competent authority is the Minister of Finance or his authorized representative.

Subparagraphs 1(f) and 1(g) define he terms “United States” and “Luxembourg”, respectively. The term “United States” means the United States of America, including the states of the United States and the District of Columbia. The definition of the United States does not include Puerto Rico, the Virgin Islands, Guam or any other U.S. possession or territory, since these areas impose their own income taxes and so are not included in tax treaties. Although the Convention does not explicitly include the continental shelf in the definition of the United States, by virtue of Code section 638, which treats the continental shelf as part of the United States, the continental shelf is considered to be included within the definition of the United States for purposes of the Convention. The term “Luxembourg” means the Grand Duchy of Luxembourg.

Subparagraph 1(h) defines the term “national” of a Contracting State. This term is relevant for purposes of Articles 20 (Government service) and 26 (Non-discrimination). A national is any individual possessing the nationality or citizenship of a Contracting State, and any legal person, partnership or association deriving its status, as such, from the laws in force in a Contracting State.

Subparagraph 1(i) defines the term “beneficial owner” for income, profit or gain derived by persons that are treated as fiscally transparent under the laws of the Contracting State where the owners of those persons are resident. The beneficial owners of income, profit or gain derived by such persons are the persons subject to tax on the income, profit or gain derived by the fiscally transparent person. Since this paragraph is drafted from the point of view of the source State, the reference to “other Contracting State” refers to the State where the persons claiming benefits are resident.

Paragraph 2 provides that in applying the Convention, any term used but not defined in the Convention shall, unless the context otherwise requires, have the meaning it has under the law of the Contracting State whose tax is being applied. Under the U.S. interpretation, any meaning under the applicable tax laws of that State prevails over a meaning given to the term under other laws of that State. If the meaning of a term cannot be readily determined under the laws of a Contracting State, or if there is a conflict in meaning under the laws of the two States that creates problems in the application of the Convention, the competent authorities, as indicated in paragraph 3(e) of Article 27 (Mutual agreement procedure), may establish a common meaning in order to prevent double taxation or to further any other purpose of the Convention. This common meaning need not conform to the meaning of the term under the laws of either Contracting State.

It is understood that the reference in paragraph 2 to the law of a Contracting State means the law in effect at the time the treaty is being applied, not the law as in effect at the time the treaty was signed. This use of “ambulatory definitions” is generally accepted within the OECD. The use of an ambulatory definition, however, may lead to results that are at variance with the intentions of the negotiators and of the Contracting States when the treaty was negotiated and ratified. The reference in paragraph 2 to the context otherwise requires “a definition different from” unless the internal law definition of the Contracting State whose tax is being imposed refers to a circumstance where the result intended by the Contracting States is different from the result that would obtain under the statutory definition.

Article 4

Residence

Article 4 sets forth rules for determining whether a person is a resident of a Contracting State for purposes of the Convention. As a general matter only residents of the Contracting States may claim the benefits of the Convention. The Article 4 definition of residence is used for all purposes of the Convention, including the “saving” clause of paragraph 3 of Article 1 (General scope). The treaty definition of residence is to be used only for purposes of the Convention. Any entitlement to the benefits of a resident of a Contracting State is, however, subject to the requirements of Article 24 (Limitation on benefits). The 1962 Convention does not contain a comprehensive definition of residence.

The determination of residence looks first to a person’s liability to tax as a resident under the laws of the Contracting States. Generally, a person who, under those laws, is a resident of one Contracting State and not of the other need look no further. That person will be treated as a resident of the State in which he is resident under internal law. If, however, a person is resident in both Contracting States under their respective taxation laws, the tie-breaker rules assign one State of residence to such a person.

Paragraph 1 generally incorporates the definitions of residence in U.S. and Luxembourg law, by defining a resident as a person who, under the laws of a Contracting State, is subject to tax there by reason of his domicile, residence, citizenship, place of management, place of incorporation, or any other similar criterion. Thus, as a general matter, residents of the United States include U.S. citizens as well as aliens who are considered U.S. residents under U.S. law (Code section 7701(b)).

Paragraph 1 provides certain exceptions to this general rule. Under subparagraph 1(a), if a person is liable to tax in a Contracting State only in respect of income from sources within State or capital situated therein, the person will not be treated as a resident of that Contracting State for purposes of the Convention. Thus, for example, a Luxembourg consular official posted in the United States, who may be subject to U.S. tax on U.S. source investment income, but who is not taxable in the United States on non-U.S. source income, would not be considered a resident of the United States for purposes of the Convention (see Code section 7701(b)(5)(B)). Similarly, a Luxembourg enterprise with a permanent establishment in the United States is not a resident of the United States by virtue of that permanent establishment. The enterprise generally is subject to U.S. tax only with respect to its income that is attributable to the U.S. permanent establishment, not with respect to its worldwide income.

Along with subparagraph 1(i) of Article 3 (General definitions), subparagraph 1(b) addresses special problems presented by fiscally transparent entities that are not subject to tax at the entity level, and, therefore, are not residents under paragraph 1. It provides that the income of a partnership, estate or trust will be treated as the income of a resident of a Contracting State only to the extent that the income derived by such person is subject to tax in that State as the income of a resident, either in the hands of the person deriving the income or in the hands of its partners, beneficiaries or grantor. Under U.S. law, a partnership is not, and an estate or trust is often not, a taxable entity. Thus, for U.S. tax purposes, whether income received by a partnership is received by a resident will be determined by the residence of its partners (looking through any partnerships which are themselves partners) rather than by the residence of the partnership itself. To the extent the partners are subject to U.S. tax as residents of the United States, the income received by a partnership will be treated as income received by a U.S. resident. Similarly, income received by a trust or estate will be determined by the residence for taxation purposes of the person subject to tax on such income, which may be the grantor, the beneficiaries or the estate or trust itself, depending on the circumstances. The classification of the entity under the laws of the source state is not relevant for purposes of this provision.

Subparagraph 1(c) specifies additional conditions for determining whether a U.S. citizen or an alien lawfully admitted for permanent residence in the United States (a “green-card” holder) will be treated as a U.S. resident for purposes of the Convention. If such an individual is not also a resident of Luxembourg under this paragraph, he will be treated as a resident of the United States only if he has a substantial presence, permanent home or habitual abode in the United States. Thus, for example, an individual resident of Mexico who is a U.S. citizen by birth, or who is a Mexican citizen and holds a U.S. green card, but who, in either case, does not live in the United States, would not be entitled to benefits under the treaty. On the other hand, a U.S. citizen who is transferred to Mexico for two years but who maintains a permanent home or habitual abode in the United States would be entitled to treaty benefits. However, the residence of a U.S. citizen or green card holder who is also a resident of Luxembourg under Luxembourg law will be determined by application of the tie-breaker rules of paragraph 2.

Subparagraph 1(d) clarifies that a Contracting State, and its political subdivisions or local authorities, or agencies or instrumentalities of such governments, subdivisions, etc., will be treated as residents of that State. Thus, such governmental entities are entitled to treaty benefits as residents of a Contracting State. This definition is the same as that used in Article 24 (Limitation on benefits).

Subparagraph 1(e) deals with the residence of a wholly or partially tax-exempt organization. These organizations include those organized and operated exclusively either for a religious, charitable, educational, scientific, or other purpose, or to provide pensions or other benefits to employees pursuant to a plan. Such an organization is considered to be established under the laws of a Contracting State, and is, therefore, a resident of that State under its law, and is to be treated as a resident of that State for purposes of the Convention as well. Thus, the fact that a charitable organization or pension fund is exempt from tax in its resident country is not to be construed to deny such organization or fund resident status under the Convention. In cases where a pension is organized as a trust, the more specific provisions of this subparagraph 1(e) would operate in lieu of the more general provisions applicable to trusts in subparagraph 1(b).

Paragraph 2 provides tie-breaker rules for determining a single State of residence for an individual who, under paragraph 1, would be a resident of both countries. Subparagraph 2(a) tests where the individual has a permanent home available. If that test is inconclusive because the individual has a permanent home available in both States, his residence is in the Contracting State where his personal and economic relations are closest, i.e., his “center of vital interests”.

If the center of vital interests test is also inconclusive, subparagraph 2(b) assigns residence in the Contracting State where he maintains an habitual abode. If he has an habitual abode in both States or in neither of them, subparagraph 2(c) treats him as a resident of his State of nationality. Finally, according to subparagraph 2(d), if he is a national of both States or of neither of them, the competent authorities shall assign a single State of residence by mutual agreement.

Paragraph 3 resolves dual-residence issues for persons other than individuals. Under U.S. law, a corporation is treated as resident in the United States if it is created or organized under the laws of the United States or a political subdivision. Under Luxembourg law a corporation is treated as a resident of Luxembourg if either its statutory seat or its principal place of day-to-day management is located in Luxembourg. Both countries tax resident companies on their worldwide income. Dual residence, therefore, can arise if a corporation organized in the U.S. is managed in Luxembourg. In such a case, the competent authorities shall attempt to settle the question by mutual agreement, taking into account the persons’ place of effective management, or the place where it is incorporated or constituted, and any other relevant factors. In the absence of such an agreement, the person shall not be considered a resident of either Contracting State for purposes of enjoying benefits under this Convention. Such dual residents may be treated as residents of a Contracting State for other purposes of the Convention. For example, if a dual resident corporation pays a dividend to a resident of Luxembourg, the U.S. paying agent would withhold on that dividend at the appropriate treaty rate, since reduced withholding is a benefit enjoyed by the resident of Luxembourg, not by the dual resident corporation. The purpose of the rule is to encourage taxpayers to organize their affairs so as to minimize the possibility of dual residence.

Article 5

Permanent establishment

This Article defines the term “permanent establishment”, a term that is significant for several articles of the Convention. The existence of a permanent establishment in a Contracting State is necessary under Article 7 (Business profits) for taxation by that State of the business profits of a resident of the other Contracting State. Since the term “fixed base” in Article 15 (Independent personal services) is understood by reference to the definition of “permanent establishment”, this Article is also relevant for purposes of Article 15. Articles 10, 12 and 13 (dealing with dividends, interest, and royalties, respectively) provide for reduced rates of tax at source on payments of these items of income to a resident of the other State only when the income is not attributable to a permanent establishment or fixed base that the recipient has in the source State. The concept is also relevant in determining which Contracting State may tax certain gains under Article 14 (Gains) and certain “other income” under Article 22 (Other income).

This Article follows closely recent U.S. treaties and the OECD Model provisions. It does not differ in substance from the definition of a permanent establishment in the 1962 Convention. Like other recent U.S. income tax conventions, it adds a rule that treats drilling rigs or ships in the same manner as building sites or construction or installation projects.

Paragraph 1 defines the term “permanent establishment”. As used in the Convention, the term means a fixed place of business through which the business of an enterprise is wholly or partly carried on.

Paragraph 2 lists examples of fixed places of business that constitute a permanent establishment. The list is illustrative and non-exclusive and includes a place of management, a branch, an office, a factory, a workshop, and a mine, an oil or gas well, a quarry or any other place of extraction of natural resources.

Paragraph 3 provides rules to determine whether a building site, a construction, assembly or installation project, or a drilling rig or ship used to explore or develop natural resources constitutes a permanent establishment. The site, project, etc., constitutes a permanent establishment only if it lasts for more than twelve months. The twelve-month test applies separately to each individual site or project, and the period begins when work (including preparatory work carried on by the enterprise) physically begins in a Contracting State. A series of contracts or projects that are interdependent, both commercially and geographically, are to be treated as a single project for purposes of applying the twelve- month threshold test. For example, the construction of a housing development would be considered as a single project even if each house is constructed for a different purchaser. If the twelve-month threshold is exceeded, the site or project constitutes a permanent establishment from its first day of activity. Paragraph 3 applies the same twelve-month threshold test to drilling rigs, both onshore and offshore. Rigs must, therefore, be present in a Contracting State for twelve months to constitute a permanent establishment.

This interpretation is based on the Commentaries to paragraph 3 of Article 5 (Permanent establishment) of the OECD Model, which contains language almost identical to that in this Convention with respect to construction activities, and, therefore, conforms to the generally accepted international interpretation of the language in paragraph 3 of this Article with respect to such activities.

Paragraph 4 contains exceptions to the general rule of paragraph 1, listing a number of activities that may be carried on through a fixed place of business, but that, nevertheless, do not create a permanent establishment. The use of facilities solely to store, display or deliver merchandise belonging to an enterprise does not constitute a permanent establishment of that enterprise. The maintenance of a stock of goods belonging to an enterprise solely for the purpose of storage, display or delivery, or solely for the purpose of processing by another enterprise, does not give rise to a permanent establishment of the first-mentioned enterprise. The maintenance of a fixed place of business solely for activities that have a preparatory or auxiliary character for the enterprise, such as advertising or the supply of information (but not including the carrying on of scientific research), does not constitute a permanent establishment of the enterprise. The paragraph also provides that a combination of these activities does not give rise to a permanent establishment.

Paragraphs 5 and 6 specify when activities carried on by an agent on behalf of an enterprise create a permanent establishment of that enterprise. Under paragraph 5, a dependent agent of an enterprise is deemed to be a permanent establishment of the enterprise if the agent has and habitually exercises an authority to conclude contracts in the name of that enterprise. If, however, the agent’s activities are limited to those activities specified in paragraph 4 that would not constitute a permanent establishment if carried on by the enterprise through a fixed place of business, that agent is not a permanent establishment of the enterprise. The contracts referred to are those relating to the essential business operations of the enterprise, not those relating to ancillary activities.

Paragraph 6 provides that an enterprise is not deemed to have a permanent establishment in a Contracting State merely because it carries on business in that State through an independent agent, including brokers or general commission agents, if the agent is acting in the ordinary course of his business. Thus, two conditions must be satisfied for a person to fall within the description set forth in paragraph 6 : the agent must be both legally and economically independent of the enterprise, and the agent must be acting in the ordinary course of its business in carrying out activities on behalf of the enterprise.

Whether the agent and the enterprise are independent is a factual determination. Among the questions to be considered are the extent to which the agent operates on the basis of instructions from the enterprise and whether the agent or the enterprise bears the business risk inherent in the activities carried on by the agent on behalf of the enterprise. Furthermore, even an otherwise independent commission agent would be deemed to be a dependent agent under paragraph 5 if the agent habitually exercises authority to conclude contracts in the name of the enterprise (as described above in connection with paragraph 5), because in such a case the agent would not be acting in the ordinary course of its trade or business as an independent commission agent.

Paragraph 7 clarifies that a company that is a resident of a Contracting State is not deemed to have a permanent establishment in the other Contracting State merely because it controls, or is controlled by, a company that is a resident of that other Contracting State, or that carries on business in that other Contracting State. The existence of a subsidiary company does not, of itself, make that subsidiary company a permanent establishment of its parent company. The determination of whether or not a permanent establishment exists will be made solely on the basis of the factors described in paragraphs 1 through 6 of the Article and not on the ownership or control relationship between the companies.

Article 6

Income from real property (immovable property)

Article 6 describes the treatment of income of a resident of a Contracting State derived from real (immovable) property situated in the other Contracting State. Income from immovable property situated in a third state is dealt with in Article 22 (Other Income).

Paragraph 1 provides the general rule that a Contracting State may tax the income of a resident of the other Contracting State derived from real property situated in the first-mentioned Contracting State. Like the OECD Model, the paragraph specifies that income from real property includes income from agriculture or forestry. This Article does not grant an exclusive taxing right to the situs State, but assigns it the primary taxing right. The Article does not impose any limitation in terms of rate or form of tax on the situs State, although, as provided in paragraph 5, it does allow the taxpayer the right to elect to be taxed on a net basis.

Paragraph 2 defines the term “real property” as having the meaning that it has under the laws of the situs State. In the case of the United States, the term has the meaning given to it by Treas. Reg. Sec. 1.897-1(b).

Paragraph 3 makes clear that the income referred to in paragraph 1 means income derived from any use of real property, including, but not limited to, income from direct use by the owner and rental income from the letting or sub-letting of real property. Thus, all forms of income derived from the exploitation of real property are taxable in the Contracting State where the property is situated. Income from the disposition of an interest in real property, however, is not considered “derived” from real property and is not dealt with in this Article, but in Article 14 (Gains).

Paragraph 4 specifies that the basic rule of paragraph 1 (as elaborated in paragraph 3) applies to income from real property of an enterprise and to income from real property used for the performance of independent personal services. This provision clarifies that the situs country may tax the real property income (including rental income) of a resident of the other Contracting State in the absence of attribution to a permanent establishment or fixed base in the situs State. This provision is an exception to the general rules of Articles 7 (Business profits) and 15 (Independent personal services) that to be taxable by the situs country, income must be attributable to a permanent establishment or fixed base, respectively.

Paragraph 5 permits a resident of either Contracting State to elect to be taxed on income from real property situated in the other Contracting State as if such income were attributable to a permanent establishment in the other State, that is, to elect to be taxed on a net basis. The election may be terminated with the consent of the competent authority of the situs State. In the United States, revocation of such an election will be granted in accordance with Treas. Reg. section 1.871-10(d)(2).

Article 7

Business profits

This Article provides rules for taxation by a Contracting State of the business profits of an enterprise of the other Contracting State. It updates the corresponding Article in the 1962 Convention to conform more closely to current U.S. treaty policy and to the OECD Model.

Paragraph 1 states the general rule that business profits of an enterprise of one Contracting State may be taxed by the other Contracting State only if the enterprise carries on business in that other Contracting State through a permanent establishment (as defined in Article 5 (Permanent establishment)) situated there. Where that condition is met, the State where the permanent establishment is situated may tax the enterprise, but only on a net basis and only on the income that is attributable to the permanent establishment. This rule differs from the comparable rule in the 1962 Convention, which contained a limited force of attraction rule. That rule permitted the State in which the permanent establishment was located to tax income of the enterprise even if not attributable to the permanent establishment, but only to the extent that the income was derived from sources in that State.

Paragraph 2 provides rules for attributing business profits to a permanent establishment. The Contracting States will attribute to a permanent establishment the profits that it would have been expected to earn had it been a distinct and separate entity engaged in the same or similar activities under the same or similar circumstances and dealing wholly independently with the enterprise of which it is a permanent establishment. The computation of the business profits attributable to a permanent establishment under this paragraph is subject to the rules of paragraph 3 regarding deductions for expenses incurred for the purposes of earning the income.

The concept of “attributable to” in the Convention is analogous to the concept of “effectively connected” in Code section 864(c). For example, profits attributable to a permanent establishment may be from sources within or without a Contracting State. Thus, items of foreign source income described in Code section 864(c)(4)(B) may be attributed to a U.S. permanent establishment of a Luxembourg enterprise and subject to tax in the United States. The “asset use” and “business activities” tests of Code section 864(c)(2) are also consistent with the “attributable to” concept. The two concepts are not identical, however, in that the limited “force of attraction” rule in Code section 864(c)(3) is not applicable under the Convention.

Paragraph 3 provides that in determining the business profits of a permanent establishment, deductions shall be allowed for a reasonable allocation of the expenses incurred for the purposes of the permanent establishment, regardless of where the expenses are incurred. This rule ensures that business profits will be taxed on a net basis. Such expenses include executive and general administrative expenses and expenses for research and development, interest and other similar expenses, to the extent that they are attributable to the permanent establishment. The allocation of the enumerated expenses made in determining the profits attributable to the permanent establishment must be “reasonable”, and each country may apply its own rules in calculating such expenses as long as those rules are designed to identify the profits the permanent establishment would make if it were a distinct and separate enterprise. This language permits (but does not require) each state to apply the types of expense allocation rules found in U.S. law, for example, in Treasury Regulations sections 1.861-8 and 1.882-5.

This rule is not limited to expenses incurred exclusively for the purposes of the permanent establishment, but includes expenses incurred for the purposes of the enterprise as a whole, or that part of the enterprise that includes the permanent establishment. Deductions are to be allowed regardless of which accounting unit of the enterprise books the expenses, so long as they are incurred for the purposes of the permanent establishment. Thus, a portion of the interest expense recorded on the books of the home office in one State may be deducted by a permanent establishment in the other (or vice versa) if properly allocable thereto.

Paragraph 4 provides that no business profits can be attributed to a permanent establishment merely because it purchases goods or merchandise for the enterprise of which it is a part. This rule refers to a permanent establishment that performs more than one function for the enterprise. For example, a permanent establishment may purchase raw materials for the enterprise’s manufacturing operation and sell the manufactured output. While business profits may be attributable to the permanent establishment with respect to its sales activities, no profits are attributable to it with respect to its purchasing activities.

Under paragraph 5, the business profits attributed to a permanent establishment shall include only the profits derived from its assets or activities. This clarifies the fact, as noted in connection with paragraph 2 of the Article, that the Convention does not incorporate the Code’s concept of effective connection, with its limited “force of attraction” concept. Paragraph 5 also states that, to assure continuous and consistent tax treatment, the same method for determining the profits of a permanent establishment is to be used from year to year, unless there is good and sufficient reason to change. In conformity with current U.S. treaty policy and the OECD Model, the paragraph applies for the purposes of this Convention.

Paragraph 6 coordinates the provisions of this Article and other provisions of the Convention. Under this paragraph, when business profits include items of income that are dealt with separately under other articles of the Convention, the provisions of those articles will, except where they specifically provide to the contrary, take precedence over the provisions of this Article. Thus, for example, the taxation of interest generally will be determined by the rules of Article 12 (Interest), and not by Article 7. However, as provided in paragraph 3 of Article 12, if the interest is attributable to a permanent establishment, the provisions of Article 7 apply instead.

Under paragraph 6, income derived from shipping and air transport activities that is described in Article 8 (Shipping and Air Transport) is taxable only in the country of residence of the enterprise regardless of whether it is attributable to a permanent establishment situated in the source State. For example, an airline ticket office situated in the United States that constitutes a permanent establishment of an airline of Luxembourg will not be subject to tax in the United States with respect to the profits attributable to that office, because such income is encompassed by Article 8.

Paragraph 7 incorporates into the Convention the rule of Code section 864(c)(6) regarding the treatment of certain deferred payments. It provides that any income or gain attributable to a permanent establishment or a fixed base during its existence is taxable in the Contracting State where the permanent establishment or fixed base is or was situated, even if the payments are deferred until after the permanent establishment (or fixed base) no longer exists. This rule applies with respect to paragraphs 1 and 2 of Article 7 (Business profits), paragraph 4 of Article 10 (Dividends), paragraph 3 of Article 12 (Interest), paragraph 3 of Article 13 (Royalties), paragraph 3 of Article 14 (Gains), Article 15 (Independent personal services) and paragraph 2 of Article 22 (Other income).

Business profits are not explicitly defined; however, it is understood that the term means income derived from any trade or business, including income from the performance of personal services by an enterprise and income from the rental of tangible personal property.

This Article is subject to the saving clause of paragraph 3 of Article 1 (Personal scope). Thus, for example, if a citizen of the United States who is a resident of Luxembourg under the Convention derives business profits from the United States that are not attributable to a permanent establishment in the United States, the United States may, subject to the special foreign tax credit rules of paragraph 3 of Article 25 (Relief from double taxation), tax those profits, notwithstanding the provisions of paragraph 1 of this Article which would exempt such income derived by a Luxembourg resident from U.S. tax. The benefits of this Article are also subject to the provisions of Article 24 (Limitation on benefits). For example, assume a Luxembourg company is doing business in the United States and is earning income effectively connected with a trade or business in the United States, but does not have a permanent establishment in the United States. Under the provisions of Article 7, that company would not be subject to U.S. tax on its business profits. If, however, the company does not qualify for U.S. benefits under Article 24, the income that is effectively connected with its U.S. trade or business would be subject to U.S. tax.

Article 8

Shipping and air transport

Article 8 provides rules governing the taxation of profits from the operation of ships and aircraft in international traffic. Subparagraph 1(d) of Article 3 (General definitions) defines the term “international traffic” as any transport by a ship or aircraft, except where such transport is solely between places in a Contracting State.

Paragraph 1 provides that profits of an enterprise of a Contracting State derived from the operation of ships or aircraft in international traffic shall be taxable only in that State. This rule is the same as the rule under the 1962 Convention. Because paragraph 6 of Article 7 (Business profits) defers to Article 8 with respect to shipping income, such income derived by a resident of one of the Contracting States may not be taxed in the other State even if the enterprise has a permanent establishment in that other State.

Paragraph 2 extends the definition of profits from the operation of ships or aircraft in international traffic to include profits from the rental of ships or aircraft on a full (i.e., equipped with crew and supplies) basis. Profits also include profits from the rental of ships or aircraft on a bareboat (i.e., without crew and supplies) basis if the lessee operates the ships or aircraft in international traffic, or if the rental profits are incidental to profits from the operation of ships or aircraft in international traffic (as described in paragraph 1).

It is understood, consistent with the Commentary to Article 8 of the OECD Model, that income derived from the inland transport of property or passengers within either Contracting State shall be treated as profits from international traffic if such transport is undertaken as part of international traffic by the enterprise. Thus, if a U.S. shipping company contracts to carry property from Luxembourg to a U.S. city and, as part of that contract, it transports the property by truck from its point of origin to an airport in Luxembourg (or it contracts with a trucking company to carry the property to the airport) the income earned by the U.S. shipping company from the overland leg of the journey would be taxable only in the United States.

In addition, certain non-transport activities that are an integral part of the services performed by a transport company are understood, consistent with the Commentary to Article 8 of the OECD Model, to be covered in paragraph 1, although they are not specified in paragraph 2. These include, for example, the performance of some maintenance or catering services by one airline for another airline, if these services are incidental to the provision of those services by the airline for itself. Income earned by concessionaires, however, is not covered by this Article.

Paragraph 3 provides that the profits of an enterprise of a Contracting State from the use, rental, or maintenance of containers and related equipment used to transport goods in international traffic are exempt from tax in the other Contracting State. This result obtains regardless of whether the recipient of the income is engaged in the operation of ships or aircraft in international traffic, and regardless of whether the enterprise has a permanent establishment in the other Contracting State.

Paragraph 4 clarifies that the provisions of paragraphs 1 and 3 apply equally to profits derived from participation in a pool, joint business, or international operating agency.

The taxation of gains from the alienation of ships, aircraft or containers is not dealt with in this Article, but is dealt with in paragraph 4 of Article 14 (Gains).

This Article is subject to the saving clause of paragraph 3 of Article 1 (Personal scope). The United States, therefore, may, subject to the special foreign tax credit rules of paragraph 3 of Article 25 (Relief from double taxation), tax the shipping or air transport profits of a resident of Luxembourg if that Luxembourg resident is a citizen of the United States. As with any benefit of the Convention, the enterprise claiming the benefit must be entitled to the benefit under the provisions of Article 24 (Limitation on benefits).

Article 9

Associated enterprises

Article 9 incorporates into the Convention the general principles of section 482 of the Code. It provides that when associated enterprises engage in transactions that are not at arm’s length, the Contracting States may make appropriate adjustments to the taxable income and tax liability of such enterprises to reflect what the income or tax of these enterprises with respect to these transactions would have been had an arm’s-length relationship existed between them.

Paragraph 1 deals with circumstances where an enterprise of a Contracting State is related to an enterprise of the other Contracting State and those related enterprises make arrangements or impose conditions between themselves in their commercial or financial relations that differ from those that would be made between independent persons. Under these circumstances, the Contracting States may adjust the income (or loss) of the enterprises to reflect the income that would have been taken into account in the absence of such a relationship.

The paragraph specifies the meaning of the term “related enterprises” in this context. The necessary element in these relationships is effective control, which is also the standard for purposes of section 482. An enterprise of one Contracting State is related to an enterprise of the other Contracting State if either enterprise participates, directly or indirectly, in the management, control, or capital of the other enterprise. The enterprises are also related if the same persons participate, directly or indirectly, in the management, control, or capital of both enterprises. The term “control” includes any kind of control, whether or not legally enforceable and however exercised or exercisable.

Paragraph 2 provides that where a Contracting State has made an adjustment to profits and taxes those profits accordingly under provisions of paragraph 1 and the other Contracting State agrees that the adjustment was appropriate to reflect arm’s-length conditions, that other Contracting State is obligated to make a correlative adjustment to the tax liability of the related person in that other Contracting State. Where relevant, the Contracting State making such an adjustment will take the other provisions of the Convention into account. For example, if the effect of a correlative adjustment is to treat a Luxembourg corporation as having made a distribution of profits to its U.S. parent corporation, the provisions of Article 10 (Dividends) will apply, and Luxembourg may impose a 5 percent withholding tax on the dividend. The competent authorities are authorized to consult to resolve any differences in the application of these provisions.

If a correlative adjustment is made under paragraph 2, it is to be implemented, pursuant to paragraph 2 of Article 27 (Mutual agreement procedure), notwithstanding any time limits or other procedural limitations in the law of the Contracting State making the adjustment. The saving clause of paragraph 3 of Article 1 (General scope) does not apply to paragraph 2 of Article 9 by virtue of the exceptions to the saving clause in subparagraphs 4(a) of Article 1. Thus, even if the statute of limitations has run, a tax refund can be made in order to implement a correlative adjustment. Statutory or procedural limitations, however, cannot be overridden to impose additional tax, because, under subparagraph 2(a) of Article 1, the Convention cannot restrict any statutory benefit.

Article 9 of this Convention does not contain a counterpart to the paragraph 3 found in Article 9 of many other U.S. income tax treaties. That paragraph is intended to clarify that the rights of the Contracting States to apply internal law provisions relating to adjustments between related parties are fully preserved. The negotiators understood that both countries would apply internal law and that the paragraph was, therefore, unnecessary. The absence of paragraph 3 does not limit either State’s right to implement its own statutory rules related to adjustments intended to reflect transactions between unrelated parties.

It is understood that the “commensurate with income” standard for finding appropriate transfer prices for intangibles, which was added by the Tax Reform Act of 1986, was designed to operate in such a way that it does not represent a departure in U.S. practice or policy from the arm’s-length standard. It merely suggests alternative approaches, beyond those spelled out in current regulations, for achieving appropriate transfer prices; it is anticipated, therefore, that the application of this standard by the Internal Revenue Service will be in accordance with the general principles of this Article.

Article 10

Dividends

Article 10 provides rules for the taxation of dividends and similar amounts paid by a company resident in one Contracting State to a resident of the other. The article provides for full residence country taxation of such dividends and a limited source State right to tax.

Under paragraph 1, dividends paid by a company that is a resident of one Contracting State to a shareholder resident in the other Contracting State may be taxed in the State of residence of the recipient. Thus, paragraph 1 preserves the residence country’s general right to tax dividends arising in the source country. In the case of the United States, this provision is consistent with the saving clause of paragraph 4 of Article 1 (General scope).

Subparagraph 2(a) limits the right of the source State to tax dividends paid by a company that is a resident of that State if the beneficial owner of the dividends is a resident of the other Contracting State, except as otherwise provided in paragraph 6. Generally, under subparagraph 2(b)(ii), the source State tax is limited to 15 percent of the gross amount of the dividend paid. If, however, the beneficial owner of the dividends is a company resident in the other State holding at least 10 percent of the voting shares of the company paying the dividend, then under subparagraph 2(a)(i), the source State tax is limited to 5 percent of the gross amount of the dividend. Indirect ownership of voting shares (e.g., through tiers of corporations) and direct ownership of non-voting shares are not taken into account for purposes of determining eligibility for the 5 percent direct dividend rate. Shares are considered voting shares if they provide the power to elect, appoint or replace any person, vested with the powers ordinarily exercised by the board of directors of a U.S. corporation. The Convention does not require that the 10 percent voting interest be held for a minimum period prior to the dividend payment date.

Subparagraph 2(b) provides an additional exception to the 15 percent rate on gross dividends for dividends paid by companies resident in Luxembourg. Notwithstanding the provisions of subparagraph 2(a)(i), subparagraph 2(b) provides that Luxembourg shall exempt from tax the dividends paid by a company resident in Luxembourg if the beneficial owner of the dividends is a company resident in the United States that has held directly, during an uninterrupted period of two years preceding the date of payment of the dividends, at least 25 percent of the voting stock of the company paying the dividends. The provision applies only to the dividends attributable to that part of the shareholding that has been owned without interruption by the beneficial owner during such two-year period and only if the distributed dividend is derived from the active conduct of a trade or business in Luxembourg (other than the business of making or managing investments, unless such business is carried on by a banking or insurance company). Therefore, dividends paid out of profits generated in a subsidiary or branch outside of Luxembourg will not qualify for the exemption. However, it is not relevant for purposes of the exemption whether or not the earnings were earned before or after the establishment of the qualifying stockholding. In addition, distributions qualify for the exemption to the extent of undistributed earnings from an active Luxembourg trade or business. Stockholdings of at least 25 percent held for at least two years qualify for a 100 percent exemption.

Under the 1962 Convention, direct investment dividends are also taxable by the source State at a maximum rate of 5 percent, but the 1962 Convention requires an ownership threshold of 50 percent and that not more than 25 percent of the gross income of the payer corporation be derived from interest and dividends (unless received from its subsidiary corporations) for the 5 percent rate to apply. Portfolio dividends are subject to source State tax under the 1962 Convention at a rate that is one-half of the rate otherwise applicable, which, in the case of the United States, results in the application of a 15 percent rate.

Subparagraph 2(c) clarifies that paragraph 2 does not affect the taxation of the profits of the company from which the dividends are paid.

The “beneficial owner” of a dividend is understood generally to refer to any person resident in a Contracting State to whom that State attributes the dividend for purposes of its tax. Subparagraph 1(i) of Article 3 (General definitions) makes this point explicitly with regard to income derived by fiscally transparent persons. Further, in accordance with paragraph 12 of the OECD Commentaries to Article 10, the source State may disregard as beneficial owner certain intermediaries that nominally may receive a dividend but in substance do not control it. See also, paragraph 24 of the OECD Commentaries to Article 1 (General scope).

Subparagraph 3(a) defines “dividends” to mean income from shares, “jouissance” shares, or “jouissance” rights, mining shares, founders’ shares, or other rights that are not treated as debt under the law of the source State, that participate in profits of the company, as well as income derived from other rights that is subjected to the same tax treatment as income from shares by the laws of the source State. The term “dividends” also includes income from arrangements, including debt obligations, that carry the right to participate in, or that are determined by reference to, profits of the issuer or one of its associated enterprises, to the extent that such income is characterized as a dividend under the laws of the Contracting State in which the income arises. Income that is treated as a distribution by the tax laws of the resident state of the company making a distribution that is not necessarily called a dividend is also included in the dividend. The purpose of this language is to ensure that such payments are not classified as “other income” and thus become free from withholding taxes.

Subparagraph 3(b) extends the provisions of this Article to beneficial owners of dividends that hold depository receipts in place of the shares themselves.

Paragraph 4 excludes from the general source State limitations of paragraph 2 the dividends attributable to a permanent establishment or fixed base of the beneficial owner in the source State. Such dividends will be included in the taxable income of the permanent establishment and taxed on a net basis under the rules of Article 7 (Business profits) or Article 15 (Independent personal services). This rule conforms to the OECD Model. The rule in paragraph 7 of Article 7 (Business profits) applies to this paragraph as well, so that dividends attributable to a permanent establishment or fixed base, but received after the permanent establishment or fixed base no longer exists, nevertheless will be taxable in the Contracting State in which the permanent establishment or fixed base existed.

Paragraph 5 bars one Contracting State from imposing any tax on dividends paid by a company resident in the other Contracting State. Exceptions to this rule apply insofar as such dividends are paid to a resident of the first-mentioned Contracting State, or if the holding in respect of which the dividends are paid forms part of the business property of a permanent establishment or pertains to a fixed base situated in such first-mentioned State. Except as provided in Article 11 (Branch profits), a Contracting State may not subject the undistributed profits of a company resident in the other State to a tax, even if the dividends paid or the undistributed profits consist wholly or partly of profits or income arising in such other State.

Paragraph 6 imposes special limits on the rate of source State taxation for dividends paid by U.S. Regulated Investment Companies and Real Estate Investment Trusts (“RICs” and “REITs”). Dividends paid by RICs and REITs are denied the 5 percent direct dividend rate. Dividends paid by RICs are subject to the 15 percent portfolio dividend rate of subparagraph 2(a)(ii), regardless of the percentage of voting shares held directly by a Luxembourg corporate recipient of the dividend. Dividends paid by REITs are generally taxed at source at full statutory rates. Thus, the United States may tax most REIT dividends at its statutory 30 percent rate. However, dividends paid by REITs are taxed at source at the 15 percent portfolio dividend rate if the beneficial owner of the dividend is a Luxembourg individual who owns less than a 10 percent interest in the REIT.

The denial of the 5 percent withholding rate at source to all RIC and REIT shareholders, and the denial of the 15 percent rate to most shareholders of REITs, is intended to prevent the use of these conduit entities to gain unjustifiable benefits for certain shareholders. For example, a Luxembourg corporation that wishes to hold a diversified portfolio of U.S. corporate shares may hold the portfolio directly and pay a U.S. withholding tax of 15 percent on all of the dividends that it receives. Alternatively, it may place the portfolio of U.S. stocks in a RIC in which the Luxembourg corporation owns more than 10 percent of the shares, but in which the corporation has arranged to have a sufficient number of small shareholders to satisfy the RIC diversified ownership requirements. Since the RIC usually is a pure conduit, there are no U.S. tax costs to the Luxembourg corporation from interposing the RIC as an intermediary in the chain of ownership. In the absence of the special rules in paragraph 6, however, the interposition would transform portfolio dividends into direct investment dividends, which are taxable at source by the United States at only 5 percent.

Similarly, a resident of Luxembourg may hold U.S. real property directly and pay U.S. tax either at a 30 percent rate on the gross income or at the ordinary income tax rates specified in Code sections 1 or 11 on net income. As in the preceding example, by placing the real estate holding in a REIT, the Luxembourg investor could transform real estate income into dividend income, and in the process, absent the special rule, transform, at no tax cost, high- taxed income into much lower-taxed income. In the absence of the special rule, if the REIT shareholder is a Luxembourg corporation that owns at least a 10 percent interest in the REIT, the withholding rate would be 5 percent; in all other cases it would be 15 percent. In either event, with one exception, a tax of 30 percent or more would be significantly reduced. A possible exception is the relatively small individual investor who might be subject to a U.S. tax of 15 percent of net income even if he earned the real estate income directly. Under the special rule in paragraph 6, such individuals, defined as those holding less that a 10 percent interest in the REIT, remain eligible for the 15 percent rate.

Notwithstanding the foregoing limitations on source State taxation of dividends, the saving clause of paragraph 3 of Article 1 (General scope) permits the United States to tax dividends received by its residents and citizens, subject to the special foreign tax credit rules of paragraph 3 of Article 25 (Relief from double taxation), as if the Convention had not come into effect. The benefits of this Article are available to a resident of a Contracting State only if that resident qualifies for benefits under the provisions of Article 24 (Limitation on benefits).

Article 11

Branch tax

Article 11 authorizes the imposition of a branch profits tax (in addition to the income tax) by the United States. This tax is imposed on branch profits similar to, and at the same rate as, the tax that may be imposed under Article 10 (Dividends) paid by a subsidiary corporation in one Contracting State to its parent company in the other Contracting State. As Luxembourg does not have a branch tax, the article is drafted unilaterally in favor of the United States.

The United States may impose its branch profits tax (Code section 884(a)) on a company resident in Luxembourg that has income attributable to a permanent establishment in the United States, that derives income from real property in the U.S. that is taxed on a net basis in the U.S. under Article 6 (Income from real property), or that realizes gains taxable in the U.S. under paragraph 1 of Article 14 (Gains). This tax may be imposed only on the portion of the business profits of the Luxembourg company that represents the dividend equivalent amount.

The United States may impose its branch profits tax on a corporation resident in Luxembourg to the extent of the corporation’s

(i) business profits that are attributable to a permanent establishment in the United States;

(ii) income that is subject to taxation on a net basis because the Luxembourg corporation has elected under Code section 882(d) to treat income from real property not otherwise taxed on a net basis as effectively connected income; and

(iii) gain from the disposition of a United States Real Property Interest, other than an interest in a United States Real Property Holding corporation. The United States may not impose its branch tax on the business profits of a Luxembourg corporation that are effectively connected with a U.S. trade or business but that are not attributable to a permanent establishment and are not otherwise subject to U.S. taxation under Article 6 or paragraph 1 of Article 14.

Paragraph I of the exchange of notes clarifies that the term “dividend equivalent amount” shall have the same meaning it has under the Code (section 884), as amended from time to time without changing the general principle thereof. The dividend equivalent amount for any year approximates the portion of the income that a U.S. branch office would have paid during the year if the branch had been operated as a separate U.S. subsidiary of the Luxembourg company and distributed its earnings currently.

The branch profits tax shall not be imposed at a rate exceeding 5 percent of the “dividend equivalent amount” of the business profits of the company that are either attributable to a permanent establishment in the United States or are subject to tax on a net basis in the U.S. under Article 6 or paragraph 1 of Article 14.

Article 12

Interest

Article 12 deals with the taxation by one Contracting State of interest derived and beneficially owned by a resident of the other Contracting State.

Paragraph 1 grants to the residence State the exclusive right, subject to exceptions provided in paragraphs 3 and 6, to tax interest beneficially owned by its residents. Thus, this Convention generally preserves the exemption at source for interest provided in the 1962 Convention. As in the case of Article 10 (Dividends), the source State generally shall treat as the beneficial owner of such income a resident of the other State if the income is attributable to such resident for purposes of the tax laws of the other State. However, interest arising in a Contracting State and paid to a nominee or agent that is a resident of the other Contracting State may be taxed in the source State if the beneficial owners are not residents of the other Contracting State (subject to the provisions of any applicable treaty between the State of source and the State of residence of the beneficial owner).

Paragraph 2 defines the term “interest” as used in the Convention to include, inter alia, income from debt claims of every kind, whether or not secured by a mortgage, and whether or not carrying a right to participate in the debtor’s profits (unless described in paragraph 3 of Article 10 (Dividends)). The term “interest” includes, in particular, income from government securities and income from bonds or debentures, including premiums or prizes attaching to these instruments, and all other income that is treated as income from money lent by the taxation law of the Contracting State in which the income arises. Penalty charges for late payment are not defined as interest.

Interest does not include amounts, even if income from debt claims, that are treated as dividends in paragraph 3 of Article 10 (Dividends). Thus, for example, if under the domestic law of the source State, income from a debt obligation carrying the right to participate in profits is treated as a dividend, it is also treated as a dividend under paragraph 3 of Article 10 and is subject to tax at source at a rate not exceeding 15 percent. Thus, such interest will be taxed at the same rate as portfolio dividends, unless the domestic law of the source State provides a lower rate of tax. Such income that is not treated as a dividend under the law of the source State, however, remains within the definition of interest under Article 12.

Paragraph 3 provides an exception to the exclusive residence State taxation rule of paragraph 1 in cases where the beneficial owner of the interest carries on business through a permanent establishment in the source State or performs independent personal services from a fixed base situated in the source State and the debt claim in respect of which the interest is paid is effectively connected with the permanent establishment or fixed base. In such cases, the provisions of Article 7 (Business profits) or Article 15 (Independent personal services) will apply and the source State generally will retain the right to impose tax on a net basis on such interest income. This rule conforms to the OECD Model. The rule in paragraph 7 of Article 7 (Business profits) applies to this paragraph as well, so that interest attributable to a permanent establishment or fixed base, but received after the permanent establishment or fixed base no longer exists, nevertheless will be taxable in the Contracting State in which the permanent establishment or fixed base existed.

Paragraph 4 contains a source rule for interest. This rule provides that the source of an interest payment generally is the residence State of the payer. However, if the interest is borne by a permanent establishment or fixed base in the other State, the source of interest is assigned to that other State. A source rule is provided because paragraph 1 requires that each Contracting State exempt from tax income “arising in” that State and beneficially owned by a resident of the other State. This format follows the OECD Model.

Paragraph 5 limits the benefits of this Article to interest amounts that reflect arm’s-length transactions. If the interest paid exceeds an arm’s-length amount due to a special relationship between the debtor and creditor, then 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 to the rate limitations of paragraph 2 of Article 10 (Dividends).

Paragraph 6 provides anti-abuse exceptions to the source-State interest exemption in paragraph 1 for two classes of income.

The first exception, in subparagraphs 6(a) and 6(b), deals with so- called “contingent interest”. Under this provision, interest arising in one of the Contracting States that is determined with reference to the profits of the issuer or of one of its associated enterprises and paid to a resident of the other Contracting State may be taxed in that other Contracting State. Subparagraph 6(b) provides, however, that if the beneficial owner is a resident of the other Contracting State, the source State must limit the tax to a rate not above the rate prescribed in subparagraph 2(a)(ii) of Article 10 (Dividends), which is 15 percent. This provision permits the United States to impose a 15 percent withholding tax on payments of contingent interest described in section 871(h)(4).

The second exception, in subparagraph 6(c), allows each Contracting State to tax certain excess inclusions in accordance with its domestic law. Thus, the United States may impose its statutory rate of tax (currently 30 percent) on an excess inclusion with respect to a residual interest of a Luxembourg resident in a U.S. real estate mortgage investment conduit (REMIC), consistent with the policy of Code sections 860E(e) and 860G(b).

With respect to profit sharing bonds in Luxembourg, subparagraph 6(b) allows Luxembourg to impose a tax at the rate of 15 percent on distributions made to resident or non-resident holders.

Notwithstanding the foregoing limitations on source State taxation of interest, the saving clause of paragraph 3 of Article 1 (General Scope) permits the United States to tax its residents and citizens, subject to the special foreign tax credit rules of paragraph 3 of Article 25 (Relief from double taxation), as if the Convention had not come into force. As with all benefits under this Convention, the granting of benefits under this Article is subject to the requirement that the beneficial owner of the interest income qualify for benefits under the provisions of Article 24 (Limitation on benefits).

Article 13

Royalties

Article 13 provides rules for source and residence country taxation of royalties.

Paragraph 1 provides the general rule that royalties derived and beneficially owned by a resident of a Contracting State shall be taxable only in that State. Thus, the residence State has the exclusive right to tax royalties derived and beneficially owned by its residents. The source State generally shall regard a person as the beneficial owner of such royalties for purposes of this Article if the person is the person to which the income is attributable for tax purposes under the laws of the State in which that person is a resident. However, as in the case of dividends and interest payments, the source State may disregard an intermediary who is in substance a nominee of another person.

The source treatment for royalties in the 1962 Convention (i.e., exemption at source) carries forward to this Convention.

Paragraph 2 defines the term “royalties” as used in the Convention to cover three categories of rights or property. Royalties include payments of any kind received as a consideration for the use of, or the right to use, any copyright of literary, artistic, or scientific work (including cinematographic films, and audio and video tapes and disks and other means of reproduction); for the use of, or the right to use, any patent, trademark, design or model, plan, secret formula or process, or other like right or property; or for the use of, or the right to use, information concerning industrial, commercial, or scientific experience. This definition conforms with the OECD Model.

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. Payments received in connection with the transfer of so-called “shrink-wrap” computer software are treated as business profits.

Subparagraph 2(b) defines royalties also to include gains derived from the alienation (e.g., the sale, exchange, or other disposition) of any such right or property that are contingent on the productivity, use, or disposition of the property. Such income, therefore, is not subject to tax under Article 14 (Gains).

Paragraph 3 excludes from the scope of this Article royalties attributable to a permanent establishment or fixed base of the beneficial owner in the source State. In such cases the provisions of Article 7 (Business profits) or Article 15 (Independent personal services) will apply and the source State will generally retain the right to tax such royalties. The rule in paragraph 7 of Article 7 (Business Profits) applies to this paragraph as well, so that royalties attributable to a permanent establishment or fixed base, but received after the permanent establishment or fixed base no longer exists, will, nevertheless, be taxable in the Contracting State in which the permanent establishment or fixed base existed.

Paragraph 4 contains a source rule for royalty payments. Under this rule, a royalty arises in a Contracting State to the extent it is paid as consideration for the use of, or the right to use, property, information or experience in that State. Thus, if a U.S. resident licensor receives royalties from a resident of Luxembourg for the use of a patent in Luxembourg, the royalty will be deemed to arise in Luxembourg. If, however, the Luxembourg resident uses the patent in the United States, the royalty will be deemed to arise in the United States. Therefore, the United States will not be required to credit a Luxembourg tax on an item of income which, under U.S. law, would have a U.S. source.

Paragraph 5 limits the benefits of this Article to royalty amounts that reflect arm’s-length transactions. It provides that in cases involving special relationships between the payer and beneficial owner of a royalty, Article 12 applies only to the extent of royalty payments that would have been made absent such special relationships. Any excess amount of royalties paid 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 national law of the source State, such excess amount will be taxed as a dividend rather than as a royalty payment, and the tax imposed on the dividend will be subject to the rate provided in Article 10 (Dividends).

Notwithstanding the foregoing limitations on source State taxation of royalties, the saving clause of paragraph 3 of Article 1 (General scope) permits the United States to tax its citizens, subject to the special foreign tax credit rules of paragraph 3 of Article 25 (Relief from double taxation), and its residents as if the Convention had not come into effect. As with all benefits under this Convention, the granting of benefits under this Article is subject to the requirements that the beneficial owner of the royalty income qualify for benefits under the provisions of Article 24 (Limitation on benefits).

Article 14

Gains

Article 14 provides rules for source and residence State taxation of gains from the alienation of real property.

Paragraph 1 preserves the source State right to tax gains derived from the alienation of real property situated in that State. Thus, gains derived by a resident of one Contracting State from the alienation of real property situated in the other Contracting State may be taxed in that other Contracting State.

Paragraph 2 defines “real property situated in the other Contracting State”. Subparagraphs 2(a) defines the term to include real property referred to in Article 6 (i.e., an interest in the real property itself). The paragraph also covers certain indirect interests in real property. Indirect interests include shares or comparable interests in a company the assets of which consist or consisted wholly or principally of real property situated in the source State.

For the United States, paragraph 2(b) defines these interests to include a “United States real property interest”. Under section 897(c) of the Code the term “United States real property interest” includes shares in a U.S. corporation that owns sufficient U.S. real property interests to satisfy an asset-ratio test on certain testing dates. The term also includes certain foreign corporations that have elected to be treated as U.S. corporations for this purpose (section 897(i)). In applying paragraph 1, the United States will look through distributions made by a REIT. Accordingly, distributions made by a REIT are taxable under paragraph 1 of Article 14 (not under Article 10 (Dividends)) when they are attributable to gains derived from the alienation of real property.

For Luxembourg, subparagraph 2(c) defines the term to include shares or comparable corporate rights in a company that is a resident of Luxembourg, the assets of which company consist for the greater part of real property situated in Luxembourg. In Luxembourg, a real property interest is measured according to fair market value of the assets held by the entity. Under Luxembourg internal law, capital gains are taxed in the hands of resident shareholders under certain conditions. These conditions are more restrictive in the case of non-resident shareholders. Non-residents are exempt from tax on capital gains from shares unless, in the case of a shareholding of more than 25 percent in such a company whose registered office or principal place of business is in Luxembourg, (a) the period between acquisition and sale of the shareholding is not more than six months, or (b) if this period is more than six months , the seller had been a resident of Luxembourg for more than fifteen years and became a non-resident taxpayer less than five years before the alienation.

Because the definition of “real property situated in the other Contracting State” contained in paragraph 2 is specifically limited to the interpretation of this Article, such definition has no effect on the right to tax income covered in other articles. For example, the inclusion of interests in certain corporations in the definition of real property situated in the other Contracting State for purposes of permitting source country taxation of gains derived from dispositions of such interests under this Article does not affect the treatment of dividends paid by such corporations. Such dividends remain subject to the limitations on source country taxation contained in Article 10 (Dividends) and are not governed by the unlimited source country taxation right contained in Article 6 with respect to immovable property.

In the case of gains from the alienation of personal property (movable property), paragraph 3 preserves the source country right to tax in certain circumstances. It provides that gains from the alienation of such property forming part of the business property of a permanent establishment that an enterprise of a Contracting State has in the other Contracting State or of such property pertaining to a fixed base available to a resident of a Contracting State in the other Contracting State for the purpose of performing independent personal services, including such gains from the alienation of such a permanent establishment (alone or with the whole enterprise) or of such fixed base, may be taxed in that other State. The rule in paragraph 7 of Article 7 (Business profits) applies to this paragraph as well, so that gains from the alienation of personal property forming part of the business property of a permanent establishment or pertaining to a fixed base that are received after the permanent establishment or fixed base no longer exists, nevertheless will be taxable in the Contracting State in which the permanent establishment or fixed base existed.

Paragraph 4 provides that gains derived by an enterprise of a Contracting State from the alienation of ships, aircraft, or containers operated or used in international traffic or personal property (movable property) pertaining to the operation or use of such ships, aircraft or containers, shall be taxable only in that Contracting State. Thus, such gains are taxable on the same basis as income from the operation of ships or aircraft under Article 8 (Shipping and air transport).

Paragraph 5 grants to the State of residence of the alienator the exclusive right to tax gains from the alienation of property other than property referred to in paragraphs 1 through 4. Thus, gain from the sale of corporate securities or other tangible personal property not covered in paragraphs 3 and 4 is exempt from tax at source.

Notwithstanding the foregoing limitations on source State taxation of certain gains, the saving clause of paragraph 3 of Article 1 (General scope) permits the Contracting States to tax their citizens and residents as if the Convention had not come into effect. As with all benefits under this Convention, the granting of benefits under this Article is subject to the requirement that the beneficial owner of the income qualify for benefits under the provisions of Article 24 (Limitation on benefits).

Article 15

Independent personal services

The Convention provides separate articles dealing with different classes of income from personal services. Article 15 deals with the general class of income from independent personal services. Article 16 (Dependent personal services) deals with the general class of income from dependent personal services. Modifications to these general rules are provided for directors’ fees (Article 17), performance income of artistes and sportsmen (Article 18); pensions in respect of personal service income, social security benefits, and annuities (Article 19); government service salaries (Article 20); and income of students, business trainees, teachers, and researchers (Article 21). Generally, services rendered by those who perform personal services as sole proprietors or partners are independent personal services, whereas services performed as an employee or as an officer of a corporation constitute dependent personal services.

Paragraph 1 provides the general rule that income derived by an individual who is a resident of a Contracting State from the performance of personal services in an independent capacity shall generally be taxable only by that State. Such income may be taxed in the other Contracting State only if the income is attributable to a fixed base that is regularly available to the individual in that other State for the purpose of performing his activities.

The Convention does not define the term “fixed base”, but its meaning is understood to be analogous to that of the term “permanent establishment”, as defined in Article 5 (Permanent establishment).

The taxing rule in paragraph 1 of the Article differs significantly from that in the 1962 Convention. Under Article XII of that Convention the host State exempted from tax income from independent personal services (other than fees or directors of corporations) performed by a resident of the other State if the person performing the services was present in the host State for a period or periods aggregating not more than 180 days in the taxable year, and either the individual was performing his services under contract with a resident of the individual’s State of residence, and the compensation was borne by that person, or the compensation did not exceed $3,000. The new Convention does not examine the length of time or compensation received but, instead, considers whether the income received from independent personal services performed is attributable to a fixed base.

Paragraph 2 defines the term “personal services in an independent capacity” to include, especially, independent scientific, literary, artistic, educational, or teaching activities as well as the independent activities of physicians, lawyers, engineers, architects, dentists, and accountants. For example, teaching activities refer to any teaching done by a person who has gone to a Contracting State for, say, scientific research purposes and conducts a seminar while there. The taxation of income of an individual from those types of independent services that are covered by Articles 17 through 21 is governed by the provisions of those articles. Therefore, teachers would be generally covered by Article 21 rather than by this Article.

The rule in paragraph 7 of Article 7 (Business profits) applies to Article 15 as well. That rule clarifies, in the context of Article 15, that income that is attributable to a fixed base but is deferred and received after the fixed base no longer exists, may nevertheless be taxed by the State in which the fixed base was located. Thus, the tax cannot be avoided by deferring the payment.

Paragraph 3 provides that the principles of paragraph 3 of Article 7 (Business profits) for attributing income and expenses to a permanent establishment are relevant for attributing income to a fixed base. Thus, all relevant expenses, wherever incurred, must be allowed as deductions in computing the net income from services subject to tax in the Contracting State where the fixed base is located. However, the taxing right conferred by this Article with respect to income from independent personal services is somewhat more limited than that provided in Article 7 for the taxation of business profits. In both articles the income of a resident of one Contracting State must be attributable to a permanent establishment or fixed base in the other for that other State to have a taxing right. In Article 15, in addition, the income must be attributable to services performed in that other State, while Article 7 does not require that all of the income-generating activities be performed in the State where the permanent establishment is located.

If the individual is a Luxembourg resident and is also a U.S. citizen and performs independent personal services in the United States, the United States may, by virtue of the saving clause of paragraph 3 of Article 1 (Personal scope) tax the individual’s income without regard to the restrictions of this Article, subject to the special foreign tax credit rules of paragraph 3 of Article 25 (Relief from double taxation).

Article 16

Dependent personal services

Article 16 deals with the taxation of remuneration derived by a resident of a Contracting State as an employee.

Paragraph 1 provides the general rule that remuneration derived by a resident of a Contracting State in respect of employment may be taxed only in the State of residence. To the extent the remuneration is derived from an employment exercised in the other Contracting State (the “host country”), the remuneration may also be taxed by the host country, subject to the conditions specified in paragraph 2.

Paragraph 1 also provides that the more specific rules of Articles 17 (Directors’ fees), 19 (Pensions, social security, and annuities) and 20 (Government service) apply in the case of employment income described in one of those articles. Thus, if a person is exempt from tax in the host country under the provisions of Articles 17, 19 or 20 (e.g., the person is performing Government service on behalf of one State in the other) he cannot be subject to host country tax under paragraph 1 of this Article even though his employment is exercised in the host country. In addition, Article 18 (Artistes and sportsmen) specifies that its provisions apply notwithstanding the provisions of this Article. Thus, for example, a resident of one Contracting State, who is a member of a football team that plays in the other Contracting State, and who earns over $10,000 in a taxable year from performances in the other State will be subject to host country tax on his employment income even if he would otherwise be exempt under Article 16.

Paragraph 2 specifies the conditions under which, even where the remuneration of a resident of a Contracting State is derived from sources within the other Contracting State (i.e., the services are performed there), that other State may not tax the remuneration. The host country may not tax the remuneration if three conditions are satisfied :

(1) the individual is present there for a period or periods not exceeding, in the aggregate, 183 days in any twelve- month period beginning or ending in the taxable year concerned;

(2) the remuneration is paid by, or on behalf of, an employer who is not a resident of the host country; and

(3) the remuneration is not borne as a deductible expense by a permanent establishment or fixed base that the employer has in the host country. For the remuneration to be exempt from tax in the source State, all three conditions must be satisfied. This exception is identical to that set forth in the OECD Model.

The 183-day period in condition (a) is to be measured using the “days of physical presence” method. Under this method, the days that are counted include any day in which a part of the day is spent in the host country. These rules are consistent with the description of the 183-day period in the Commentary to Article 15 (Dependent personal services) in the OECD Model.

If condition (a) is met, the individual generally will become a resident of the State where the services are performed for purposes of its taxation. The individual may also continue to be a resident of the other State under its law, in which case the tie-breaker rules of Article 4 (Residence) will be applied. Even if Article 4 determines that the individual is not a resident for treaty purposes of the State where the services are performed, the length of time spent there is sufficient, under paragraph 2, to entitle that country to tax the income from those services.

Conditions (b) and (c) are intended to ensure that a Contracting State will not be required to allow a deduction to the employer for the salary paid and at the same time to exempt the employee on the amount received. Accordingly, if a foreign employer pays the salary of an employee who is employed in the host State, but a host-State corporation or permanent establishment reimburses the foreign employer in a deductible payment that can be identified as a reimbursement, neither condition (b) nor (c), as the case may be, will be considered to have been fulfilled.

Paragraph 3 contains a special rule applicable to remuneration in respect of an employment exercised continuously or predominantly aboard a ship or aircraft operated in international traffic by an enterprise of a Contracting State. Generally, such remuneration may be taxed in the State of residence of the enterprise. If that State fails to tax the income, the income will be taxable in the State of which the employee is a resident. Thus, for example, a U.S. resident working as an international pilot for a Luxembourg airline would be taxable in Luxembourg on income from the employment. Under the saving clause of Article 1 (General scope), the U.S. also would tax the pilot, but would have to provide a credit for the Luxembourg tax paid. In the reverse situation (i.e., a Luxembourg citizen working for a U.S. carrier), the last sentence of paragraph 3 would allow Luxembourg to tax the person to the extent the U.S. did not tax the individual. By allowing the residence State of the employee to tax the income if the resident State of the enterprise does not exercise its right to tax the income, the paragraph ensures that the income will not escape taxation in both countries.

A U.S. citizen resident in Luxembourg who performs dependent services in the United States and meets the conditions for U.S. exemption under paragraph 2, or a U.S. citizen or resident who is a crew member on a Luxembourg ship or airline, and would, therefore, be exempt from U.S. tax under paragraph 3 were he not a U.S. citizen or resident, nevertheless is taxable in the United States on his remuneration by virtue of the saving clause of paragraph 3 of Article 1 (Personal scope), subject to the special foreign tax credit rule of paragraph 3 of Article 25 (Relief from double taxation).

Article 17

Directors’ fees

Article 17 provides that a Contracting State may tax the fees and other similar payments paid by a company that is a resident of that State for services performed in that State by a resident of the other Contracting State in his capacity as a director of the company. This rule is an exception to the more general rules of Articles 15 (Independent personal services) and 16 (Dependent personal services). The State of residence of the corporation may tax non-resident directors without regard to the conditions of Articles 15 and 16, but only with respect to remuneration for services performed in that State and subject to the provisions of Article 26 (Non-discrimination).

No such provision was included in the 1962 Convention. The preferred U.S. policy has been to treat a corporate director in the same manner as any other individual performing personal services; outside directors would be subject to the provisions of Article 15 and inside directors would be subject to the provisions of Article 16. The preferred Luxembourg position, on the other hand, is that reflected in the OECD Model, in which a resident of one Contracting State who is a director of a corporation that is resident in the other Contracting State is subject to tax in that other State in respect of his directors’ fees regardless of where the services are performed. The United States has entered a reservation with respect to the OECD provision. The provision in this Article represents a compromise between the U.S. position and the Luxembourg position. Under this Article, the State of residence of the corporation may tax non-resident directors with no time or dollar threshold, but only with respect to remuneration for services performed in that State.

This Article is subject to the saving clause of paragraph 3 of Article 1 (General scope). Thus, if a U.S. citizen who is a Luxembourg resident is a director of a U.S. corporation, the United States may tax his full remuneration, regardless of where the services are performed, subject to the special rules of paragraph 3 of Article 25 (Relief from double taxation).

Article 18

Artistes and sportsmen

Article 18 deals with the taxation by a Contracting State of artistes (i.e., performing artists and entertainers) and sportsmen (e.g., athletes) resident in the other Contracting State from the performance of their services as such. The Article applies both to the income of an entertainer or sportsman who performs services on his own behalf and one who performs services on behalf of another person, either as an employee of that person, or pursuant to any other arrangement.

Paragraph 1 of the Article applies only with respect to the income of performing artists and sportsmen, themselves. Paragraph 2 applies in certain circumstances to income received by persons providing the services of the artists and sportsmen. Others involved in a performance or athletic event, such as producers, directors, technicians, managers, and coaches, remain subject to the provisions of Articles 15 (Independent personal services) and 16 (Dependent personal services).

Paragraph 1 describes the circumstances in which a Contracting State may tax the performance income of an entertainer or sportsman who is a resident of the other Contracting State. Notwithstanding Articles 15 and 16, the host State may tax the income derived by a resident of a Contracting State from personal activities as an entertainer or sportsman exercised in the host State if the amount of the gross receipts derived by the individual exceeds $10,000 (or its equivalent in Luxembourg francs) for the taxable year. The $10,000 includes expenses reimbursed to or borne on behalf of the individual. The $10,000 threshold is the same as in the 1962 Convention.

The OECD Model provides for taxation by the country of performance of the remuneration of entertainers or sportsmen with no dollar or time threshold. The United States introduces a dollar threshold test in its treaties to distinguish between two groups of entertainers and athletes — those who are paid very large sums of money for very short periods of service, and who would, therefore, normally be exempt from host country tax under the standard personal services income rules, and those who earn only modest amounts and are, therefore, not clearly distinguishable from those who earn other types of personal services income. The United States has entered a reservation to the OECD Model on this point.

Paragraph 1 applies notwithstanding the provisions of Articles 15 (Independent personal services) and 16 (Dependent personal services). Thus, tax may be imposed under paragraph 1 even if the individual would otherwise be exempt from tax under those Articles. On the other hand, an entertainer or sportsman who receives less that the $10,000 threshold amount, and who is, therefore, not subject to host-country tax under this Article, nevertheless may be subject to tax in that country under Articles 15 or 16 if the tests for taxability under those Articles are met. For example, if an entertainer who is an independent contractor earns only $9,000 of income for the taxable year, but the income is attributable to a fixed base regularly available to him in the State of performance, that State may tax that income under Article 15.

It may not be possible to know until the end of the year whether the income an entertainer or athlete derived from performance in a Contracting State exceeds $10,000. Thus, nothing in the Convention precludes that Contracting State from withholding tax at the time of payment and refunding the excess, if any.

This Article applies to all income directly connected with a performance by the entertainer, such as appearance fees, award or prize money, and a share of the gate receipts. Income derived from a Contracting State by a performer who is a resident of the other Contracting State from other than actual performance, such as royalties from record sales and payments for product endorsements, is not covered by this Article, but by other articles of the Convention, such as Article 12 (Royalties) or Article 15 (Independent personal services). For example, if an entertainer receives royalty income from the sale of recordings of a concert given in a State, the royalty income would be exempt from source country tax under Article 12, even if the remuneration from the concert itself may have been covered by this Article.

Paragraph 2 is intended to deal with the potential for abuse when a performer’s income does not accrue directly to the performer himself, but to another person. Foreign performers commonly perform in the United States as employees of, or under contract with, a company or other person.

The relationship may truly be one of employee and employer, with no abuse of the tax system either intended or realized. On the other hand, the “employer” may be a company established and owned by the performer, which is merely acting as the nominal income recipient in respect of the remuneration for the performance (a “star” company). The performer may act as an “employee”, receive a modest salary, and arrange to receive the remainder of the income from his performance in another form or at a later time. In such case, absent the provisions of paragraph 2, the company providing the entertainer’s services could escape host State tax because it earns business profits but has no permanent establishment in that State. The income could later be paid out to the performer at a time when he is not subject to host country tax, perhaps as salary payments, dividends or liquidating distributions.

Paragraph 2 seeks to prevent this type of abuse while at the same time protecting the taxpayers’ rights to the benefits of the Convention when a legitimate employee-employer relationship exists between the performer and the person providing services. Under paragraph 2, when the income accrues to a person other than the performer, resident in the same Contracting State as the performer, and the performer or related persons participate, directly or indirectly, in the profits of that other person, the income may be taxed in the Contracting State where the performer’s services are exercised, without regard to the provisions of the Convention concerning business profits (Article 7) or independent personal services (Article 15). Thus, even if the “employer” has no permanent establishment or fixed base in the host State, its income may be subject to tax there under the provisions of paragraph 2. If the “employer” is resident in a third State, the Convention does not apply to its income. It is, therefore, subject to the host country’s internal law, or to the provisions of a treaty, if one exists, between the host country and the country of residence of the “employer”.

Taxation under paragraph 2 is on the person providing the services of the performer. This paragraph does not affect the rules of paragraph 1, which apply to the entertainer or sportsman himself. However, wage or salary payments to the performer would reduce the income taxable to the person providing his services.

For purposes of paragraph 2, income is deemed to accrue to another person (i.e., the person providing the services of the performer) if that other person has control over, or the right to receive, gross income in respect of the services of the entertainer or sportsman. Direct or indirect participation in the profits of a person may include, but is not limited to, the accrual or receipt of deferred remuneration, bonuses, fees, dividends, partnership income, or other income or distributions.

The paragraph 2 override of the protection of Articles 7 (Business profits) and 15 (Independent personal services) does not apply if it is established that neither the performer, nor any persons related to the performer participates directly or indirectly in the profits of the person providing the services of the performer. Consider, for example, a circus owned by a U.S. corporation that performs in Luxembourg and the Luxembourg promoters of the performance pay the circus, which, in turn, pays salaries to the clowns. The circus has no permanent establishment in Luxembourg. Since the clowns do not participate in the profits of the circus, but merely receive their salaries from the circus’ gross receipts, the circus is protected by Article 7 and its income is not subject to Luxembourg tax. Whether the salaries of the clowns are subject to Luxembourg tax depends on whether the salaries exceed the $10,000 threshold. This exception for non-abusive cases is not in the OECD Model (to which the U.S. has entered a reservation), but reflects the U.S. position that the purpose of the paragraph is to prevent abuse of the provisions of Articles 7 and 15 in this context (see the U.S. reservation to the OECD Model in paragraph 16 of the Commentary to Article 17 of the OECD Model).

Since pursuant to Article 1 (General scope) the Convention applies only to persons who are a resident of one of the Contracting States, if the star company is not a resident of one of the Contracting States, each Contracting State may impose tax according to its domestic law.

The 1962 Convention contains no special rules for the taxation of the income of entertainers and sportsmen. Such income was subject to the general rules for the taxation of personal service income, which imposed, among others, a $3,000 threshold for taxation of personal services income.

This Article is subject to the provisions of the saving clause of paragraph 3 of Article 1 (General scope). Thus, if an entertainer or sportsman who is resident in Luxembourg is also a citizen of the United States, the United States may tax all of his or her income from performances in the United States without regard to the provisions of this Article, subject, however, to the special foreign tax credit provisions for U.S. citizens who are residents of Luxembourg found in paragraph 3 of Article 25 (Relief from double taxation). The benefits of this Article are available to a resident of a Contracting State only if that resident qualifies for benefits under the provisions of Article 24 (Limitation on benefits).

Article 19

Pensions, social security, and annuities

Article 19 deals with the taxation of private pensions, social security benefits, and annuities.

Subparagraph 1(a) provides that, except where the provisions of Article 20 (Government service) apply (i.e., where a pension is paid in respect of past government service), pensions and other similar remuneration derived and beneficially owned by a resident of a Contracting State in consideration of past employment are taxable only in the State of residence of the recipient. This rule applies to both periodic and lump-sum payments. The term “pensions and other similar remuneration” includes amounts paid by all private retirement plans and arrangements in consideration of past employment, whether to the employee or to his beneficiary, regardless of whether they are qualified plans under U.S. law, including an Individual Retirement Account. It does not include deferred compensation not paid pursuant to a pension plan. Treatment of such pensions under the 1962 Convention is essentially the same as under this Convention.

Subparagraph 1(b) provides that, notwithstanding the provisions of subparagraph 1(a) under which private pensions are taxable exclusively in the State of residence of the beneficial owner, payments made by a Contracting State, or a statutory body thereof, under the provisions of its social security or similar legislation to a resident of the other Contracting State or to a United States citizen are taxable only in the State making the payment. The reference to U.S. citizens is to ensure that a social security payment by Luxembourg to a U.S. citizen not resident in the United States will not be taxable by the United States. The reference to payments by a “statutory body” of a Contracting State is intended to cover Luxembourg social security payments, which are not paid by the State itself, but by what is called in French “établissement public”, which translates as “statutory body”.

Since these provisions are also subject to the provisions of Article 20, social security benefits paid in respect of past government service fall under the rules of that Article rather than Article 19.

The reference to “provisions of the social security” legislation is not restricted to old age pensions but refers to all sorts of social security benefits, e.g., to benefits granted in kind and to payments made in compensation for work-related diseases or accidents. Paragraph II of the exchange of notes clarifies that the term “other similar legislation” is intended to refer to United States tier 1 Railroad Retirement benefits.

Paragraph 2 provides that annuities derived and beneficially owned by a resident of a Contracting State are taxable only in that State. An annuity, as the term is used in this paragraph, means a stated sum paid periodically at stated times during a specified number of years, under an obligation to make the payment in return for adequate and full consideration (other than for services rendered). Deferred compensation does not constitute an annuity for this purpose. Annuities are similarly treated under the 1962 Convention.

Subparagraph 1(a) and paragraph 2 are subject to the saving clause of paragraph 3 of Article 1 (General Scope). Thus, a U.S. citizen who is a resident in Luxembourg, and receives a pension from the United States, may be subject to U.S. tax on the payment, notwithstanding the rules in those paragraphs that give the State of residence of the recipient the exclusive taxing right. Subparagraph 1(b) is an exception to the saving clause by virtue of subparagraph 4(a) of Article 1. Thus, the United States will not tax social security benefits paid by Luxembourg to a U.S. citizen.

Article 20

Government service

Article 20 deals with the taxation of compensation paid by a government in respect of government service performed in the discharge of governmental functions.

Paragraph 1 deals with the taxation of government compensation, other than a pension addressed in paragraph 2. Subparagraph 1(a) provides that, as a general rule, remuneration paid by a Contracting State or one of its political subdivisions or local authorities to an individual for services rendered to that State, subdivision, or local authority shall be taxable only in that State. However, under subparagraph 1(b), such payments are taxable exclusively in the other State (i.e., the host State) if the services are rendered in the host State by an individual who is a resident of the host State and who is either a national of that State or a person who did not become a resident of that State solely for purposes of rendering the services (for example, if the individual was already a local resident when hired by the first Contracting State).

The remuneration described in paragraph 1 is subject to the provisions of this paragraph and not to those of Articles 15 (Independent services), 16 (Dependent personal services), and 18 (Artistes and sportsmen). If, however, the conditions of paragraph 1 are not satisfied, those other Articles may apply. Thus, if a local government sponsors a basketball team in an international tournament and pays the athletes from public funds, the compensation of the players is covered by Article 18 and not Article 20, because the athletes are not engaging in a governmental function when they play basketball.

Paragraph 2 deals with the taxation of a pension paid from the public funds of a Contracting State or a political subdivision or a local authority thereof to any individual as consideration for services rendered to that Contracting State or subdivision or local authority. These provisions apply notwithstanding the provisions of Article 19 (Pensions, social security, and annuities). Subparagraph 2(a) provides that such a pension is taxable only in the payer State. Subparagraph 2(b), however, provides that pensions received by persons who are both nationals and residents of the other State may only be taxed by that other State.

Paragraph 3 specifies that paragraphs 1 and 2 do not apply to remuneration and pensions paid for services performed in connection with a business carried on by a Contracting State or one of its political subdivisions or local authorities. In such cases, the remuneration and pensions remain taxable under the ordinary rules provided in Articles 16 (Dependent personal services), 17 (Directors’ fees), and 19 (Pensions, social security, and annuities). This language conforms to the OECD Model.

Pursuant to paragraph 4(b) of Article 1 (General scope), the benefits of this Article are not subject to the saving clause of paragraph 3 of Article 1, with respect to individuals who are neither citizens of, nor lawful permanent residents in, that State. Thus, a Luxembourg national who comes to the United States for the purpose of performing functions of a governmental nature on behalf of the Luxembourg government would be exempt from U.S. tax under paragraph 1(a) on his salary, notwithstanding the fact that the person may become a U.S. resident under the Code. However, an individual who is a U.S. citizen or a lawful permanent resident of the U.S. and who is employed by the Government of Luxembourg in the United States, would, notwithstanding this Article, be fully subject to U.S. tax on the salary.

Article 21

Students, trainees, teachers, and researchers

Article 21 deals with the taxation of payments to students, trainees, teachers and researchers who are residents of one of the Contracting States who go to the other Contracting State (the host country) for purposes of studying, training, teaching, or research. Several conditions must be satisfied for the individual to be entitled to the benefits of this Article.

Paragraph 1 provides that a resident of one of the Contracting States who goes to the other Contracting State for the purpose of full-time education at a recognized educational institution or for full-time training shall be exempt from tax by that other Contracting State as long as payments are for the purpose of the individual’s maintenance, education, or training.

First, the visitor must have been, either at the time of his arrival in the host State or immediately before, a resident of the other Contracting State.

Second, the purpose of the visit must be for full-time education at a recognized educational institution or for full-time training. For example, a person who visits the host State for the purpose of obtaining business training and who also receives a salary from his employer for providing services would not be considered a trainee and would not be entitled to the benefits of this Article.

The exemption from host-country tax applies only to payments received by the student, apprentice or business trainee for the purpose of his maintenance, education or training. It is not necessary that the payments arise outside the host State.

For an apprentice or business trainee, the tax exemption applies for a maximum of two years from the day the apprentice or trainee first arrives in the host State. If the visit exceeds two years, the host State may tax the individual under its national law for the entire period of the visit, unless in a particular case the competent authorities of the States agree otherwise.

The 1962 Convention provides a similar exemption for students, but does not require full-time attendance at a recognized educational institution. As under this Convention, the 1962 Convention does not impose a time limit on the length of stay for students, researchers, or teachers for purposes of the tax exemption. For apprentices, the 1962 Convention provides an exemption from host country tax for persons present for a period not exceeding one year. The 1962 Convention also provides an exemption from host country tax if the stay is less than one year and if remuneration does not exceed $5,000 or its equivalent in Luxembourg francs.

Paragraph 2 provides a special two-year exemption for the compensation of certain teachers and researchers resident of one Contracting State who visit the other State to teach or to carry out research. As with students and trainees, certain conditions must be satisfied for the individual to qualify for the exemption from host- country tax.

First, the individual must be a resident of one of the Contracting States and be invited by a university, college, school, or other recognized educational institution for a temporary stay in the host State.

Second, the sole purpose of the visit must be for the purpose of teaching, engaging in research, or both, at that educational institution. If these conditions are satisfied, then the remuneration from such teaching or research is exempt from host country tax for a period not exceeding two years from the date of first arrival. If the visit exceeds two years, the host State may tax the individual under its national law for the entire period of the visit, unless in a particular case the competent authorities of the States agree otherwise.

Paragraph 3 denies the exemption granted under paragraph 2 with respect to any remuneration for research carried on for the benefit of any person other than the educational institution that hosts the individual.

The two-year period of tax exemption is subject to anti-abuse provisions. Where a person visits for two years and leaves for a brief time and returns, an additional exemption is not available if the two visits are in substance treated as a single visit.

By virtue of the exceptions to the saving clause in subparagraph 4(b) of Article 1 (General scope), the benefits conferred by the host State are not subject to the saving clause of paragraph 3 of Article 1 with respect to individuals who are neither citizens of nor lawful permanent residents in that State. The saving clause, however, does apply with respect to citizens and permanent residents of the host State. Thus, a U.S. citizen who is a resident of Luxembourg and who visits the United States as a full-time student to study at an accredited American university does not benefit from the U.S. tax exemption accorded by this Article. However, an individual who is not a citizen of the United States and who visits the U.S. as a student or teacher and remains long enough to become a resident under U.S. law, but does not become a permanent resident (i.e., does not acquire a green card), will be entitled to the full benefits of this Article.

Article 22

Other income

Article 22 provides the rules for the taxation of items of income that are not dealt with in the other articles of the Convention. An item of income is “dealt with” in another article if it is the type of income described in the article and it has its source in a Contracting State.

Paragraph 1 provides the general rule that any item of income beneficially owned by a resident of a Contracting State that is not covered by other articles of the Convention shall be taxable only in the State of residence. The scope of this Article is not confined to income having a source in the other Contracting State but extends, as well, to income from sources in third countries. Moreover, the exclusive right of taxation applies whether or not the residence State exercises its right to tax the income covered by the Article.

Items of income covered by this Article include classes of income not dealt with elsewhere in the Convention, such as, for example, lottery winnings. It also includes items of income that are not dealt with in the other articles because the income in question does not meet certain characteristics of the income covered by the other articles. For example, Article 10 (Dividends) deals with dividends paid by a company that is a resident of a Contracting State. A dividend paid by a third-country corporation would not be covered by Article 10, and therefore, would come within the scope of this Article.

Paragraph 2 provides an exception to the general rule of paragraph 1 for income, other than income from real property, that is attributable to a permanent establishment or fixed base maintained in a Contracting State by a resident of the other Contracting State. The taxation of such income is governed by the provisions of Articles 7 (Business profits) and 15 (Independent personal services). Thus, for example, income arising outside the United States that is attributable to a permanent establishment maintained in the United States by a resident of Luxembourg generally would be taxable by the United States under the provisions of Article 7, even if the income is sourced in a third state.

An exception to this general rule of paragraph 2 is provided for income that a resident of a Contracting State derives from real property located outside the other Contracting State (whether in the first-mentioned Contracting State or in a third state) that is attributable to the resident’s permanent establishment or fixed base in the other State. In that case, only the State of residence of the person deriving the income and not the host State of the permanent establishment or fixed base may tax that income. Thus, for example, even if such property is part of the property of a permanent establishment or fixed base in the United States, the U.S. may not tax income from the property since neither the situs of the property not the residence of the owner is in the United States. This special rule for foreign-situs real property is consistent with the general rule, also reflected in Article 6, that only the situs and residence States may tax real property and real property income.

This Article is subject to the saving clause of paragraph 3 of Article 1 (General scope). Thus, the United States may tax the income of a Luxembourg resident not dealt with elsewhere in the Convention, if that Luxembourg resident is a citizen of the United States. The benefits of this Article are also subject to the provisions of Article 24 (Limitation on benefits), which require that the beneficial owner of the income is qualified to receive treaty benefits under at least one of the tests of Article 24.

Article 23

Capital

Article 23 sets forth rules for the taxation by a Contracting State of various items of capital owned by a resident of the other Contracting State. Although the Article is written reciprocally, since there are no United States capital taxes covered by the Convention, the Article applies only with respect to Luxembourg taxation.

Luxembourg imposes a 0.5 percent capital tax on net worth. For residents of Luxembourg (individuals and corporations), the tax base is worldwide net worth. For non-residents, the tax base generally includes real property situated in Luxembourg, assets belonging to a permanent establishment or a fixed base in Luxembourg, certain other business assets, certain intangibles registered in Luxembourg, and debt claims secured by Luxembourg real property.

Paragraph 4 provides the general rule that capital owned by a resident of a Contracting State may be taxed only by that Contracting State. Paragraphs 1 through 3 provide exceptions to this general rule.

Paragraph 1 deals with capital represented by real property referred to in Article 6 (Income from real property (immovable property)). Property referred to in Article 6 which is owned by a resident of a Contracting State and situated in the other Contracting State may be taxed in the State in which the property is situated.

Under paragraph 2, capital represented by movable property that is part of the business property of a permanent establishment or fixed base maintained in one Contracting State by a resident of the other State may be taxed by the State where the permanent establishment or fixed base is located.

Under paragraph 3, ships and aircraft operated in international traffic by an enterprise of a Contracting State, and movable property related to such operations, such as containers and trailers, are taxable only by the State in which the operating enterprise is resident.

All other elements of capital owned by a resident of a Contracting State are exempt from tax by the other Contracting State. This includes capital represented by corporate shares owned by individuals, and shares owned by a corporation in a subsidiary or other corporation.

Article 24

Limitation on benefits

Article 24 addresses the problem of “treaty shopping”. The Article ensures that only those persons intended to benefit from the Convention — residents of the other Contracting State — do so, by not granting benefits that will ultimately be received by residents of third States that do not have a substantial business in, or business nexus with, that other Contracting State.

In a typical case of treaty shopping, a resident of a third State wants to derive treaty-favored income from one of the Contracting States, but has no treaty, or has an unfavorable treaty, with that State. The third-country resident would establish an entity resident in the other Contracting State for the purpose of deriving income from the first-mentioned Contracting State and claiming treaty benefits with respect to that income. Article 24 seeks to deny benefits to such persons by limiting the benefits of the Convention to those persons whose residence in a Contracting State is unlikely to have been motivated by the existence of the Convention.

Absent Article 24, the entity described in the preceding paragraph generally would be entitled to benefits as a resident of a Contracting State, subject, however, to anti-abuse provisions (e.g., business purpose, substance-over-form, step transaction or conduit principles) that may apply to the transaction or arrangement under the domestic law of the source State. The Limitation on benefits Article and the anti-abuse provisions of domestic law complement each other, as Article 24 generally determines whether an entity has sufficient nexus to the Contracting State to be treated as a resident for treaty purposes, while domestic anti-abuse provisions determine whether a particular transaction should recast in accordance with the substance of the transaction.

The structure of the Article is as follows : Paragraph 1 provides the general proposition of the Article. Paragraph 2 lists a series of six attributes of a qualified resident, any one of which will entitle a person who is a resident of a Contracting State to some or all of the benefits of the Convention in the other Contracting State. These tests are essentially objective tests. Paragraph 3 describes the active trade or business test. Paragraph 4 describes the “derivative benefits” test. Paragraph 5 addresses “triangular cases”. Paragraph 6 discusses restrictions on the granting of benefits. Paragraph 7 discusses the competent authorities’ discretionary powers. Paragraph 8 defines the term “recognized stock exchange”. Paragraph 9 authorizes the competent authorities to develop agreed applications and to exchange information necessary for carrying out the provisions of the Article. Paragraph 10 states that notwithstanding any other provisions of the article, Luxembourg “holding companies” are not residents.

The negotiators developed an exchange of notes indicating how certain provisions of the Article are to be understood both by the competent authorities and by taxpayers in the Contracting States. It is anticipated that as the competent authorities and taxpayers gain more experience with the concepts in this Article further guidance may be developed and made public.

Under subparagraphs 2(a) and 2(b), two categories of persons eligible for benefits from the other Contracting State are (1) individual residents of a Contracting State and (2) the Contracting States, political subdivisions or local authorities thereof, or any agency or instrumentality of any such government, subdivision or authority. It is unlikely that a person falling into one of these categories can be used to derive treaty-benefitted income as the beneficial owner of the income on behalf of a third-country person. If an individual receives income as a nominee on behalf of a third- country resident, benefits will be denied with respect to those items of income under the articles of the Convention that grant the benefit, because those articles require that the beneficial owner of the income be a resident of a Contracting State.

Subparagraph 2(c) provides a two-part test, ownership and base erosion, both of which must be met for benefits to be granted under this subparagraph. Under these tests, a company will be considered a qualified resident entitled to benefits if both

(i) at least 50 percent of the principal class of shares in the company is owned by persons who are either qualified residents or U.S. citizens under this paragraph, and

(ii) not more than 50 percent of the company’s gross income is used, directly or indirectly, to make deductible payments to persons who are neither qualified residents nor U.S. citizens.

The rationale for this two-part test is that since treaty benefits can be indirectly enjoyed not only by equity holders of an entity, but also by that entity’s various classes of obligees, such as lenders, licensors, service providers, insurers and reinsurers, and others, merely requiring substantial ownership of the entity by treaty country residents or U.S. citizens is not sufficient to prevent such benefits from flowing substantially to third-country residents. It is also necessary to require that the entity’s deductible payments be made to such treaty country residents or their equivalents. For example, a third-country resident could lend funds to a Luxembourg-owned Luxembourg corporation to be reloaned to the United States. The U.S.-source interest income of the Luxembourg corporation would be exempt from U.S. withholding tax under Article 12 (Interest). While the Luxembourg corporation would be subject to Luxembourg corporation income tax, its taxable income could be reduced to near zero by the deductible interest paid to the third-country resident. If, under Luxembourg law or a Convention between Luxembourg and the third country, that interest income is exempt from Luxembourg tax, the U.S. treaty benefit with respect to the U.S.-source interest income will have flowed to the third-country resident inappropriately, with no reciprocal benefit to the United States from the third country.

The term “principal class of shares” is not defined. It is understood, however, that the term refers generally to the ordinary or common shares of a company, provided that such class represents the majority of the voting power and value of the company. If more than one group of classes can be identified that accounts for more than 50 percent of the shares, it is only necessary that one such group satisfy the requirements of this subparagraph for the company to be entitled to benefits. If no single class represents the majority of the company’s voting power and value, the principal class of shares will be those classes that in the aggregate possess more than 50 percent of voting power and value.

Subparagraph 2(c)(i) refers to persons who “ultimately” own the company’s principal class of shares. In general, this test requires that any intermediate owners of the company be disregarded and that ownership be traced to a person that is a qualified resident without reference to its owners (such as a publicly-traded company under subparagraph 2(d)). Thus, for purposes of subparagraph 2(c)(i) an owner that satisfies this subparagraph includes qualified residents described in subparagraphs 2(a), (b), (d), and (f), because such persons are considered qualified residents without reference to their ownership (if any). Ownership traced to any other person would not count towards satisfying subparagraph 2(c)(i) ownership threshold. At least 50 percent of such owners must be qualified residents or U.S. citizens.

Subparagraph 2(d) provides that a company is a qualified resident if the company’s principal class of shares is substantially and regularly traded on one or more recognized stock exchanges (defined in paragraph 8) in a taxable year. Shares are considered to be “substantially and regularly traded” if the aggregate number of shares of that class traded on such exchanges during the previous taxable year is at least 6 percent of the average number of shares outstanding in that class during that previous year. It is understood that for purposes of this paragraph, the term “principal class of shares” will have the same meaning described under the explanation of subparagraph 2(c) above.

Subparagraph 2(e) applies the general base erosion test to all subsidiaries of publicly-traded companies. It grants benefits to a company that is controlled, directly or indirectly, by U.S. or Luxembourg publicly-traded corporations described in subparagraph (d), provided that its payments to persons who are not qualified residents or U.S. citizens satisfy the base-erosion requirements of subparagraph (c)(ii). This would allow a corporation to qualify for benefits if, for example, it is a wholly owned subsidiary of a publicly-traded company that satisfies the tests of subparagraph 2(d) and would, therefore, itself qualify for benefits if it received any income from the other Contracting State. The term control refers to the ability to influence the actions of the company, but does not require a majority ownership.

Subparagraph 2(f) provides that a not-for-profit organization will be considered a qualified resident if it satisfies two conditions :

(1) It must be generally exempt from income tax in its State of residence by virtue of its not-for-profit status, and

(2) more than half of the beneficiaries, members, or participants, if any, in the organization must be qualified residents entitled to the benefits of the Convention. Thus, a non-profit organization must meet its own qualification tests with respect to its beneficiaries, members, or participants.

Unlike in recent treaties with France and Austria, headquarters companies for a multinational corporate group are not considered to be qualified residents in Luxembourg.

The provisions of paragraph 2 are intended to be self executing. Unlike claiming benefits under paragraph 7, discussed below, claiming benefits under this paragraph does not require advance competent authority ruling or approval. The tax authorities may, on review, determine that the taxpayer has improperly interpreted the paragraph and is not entitled to the benefits claimed.

The exchange of notes deals with the issue of “bearer shares” and clarifies how the negotiators agreed to interpret certain terms used in subparagraphs 2(c) and 2(d) and paragraph 4 (discussed below). A Contracting State may consider a person not to be a qualified resident unless such person demonstrates that a percentage of its shares (including shares not issued in registered form, i.e., “bearer shares”) necessary to satisfy the specified ownership threshold is beneficially owned by qualified residents or, where relevant, by residents of a member State of the European Union or a State that is a party to NAFTA.

Paragraph 3 describes the “active trade or business” and the “substantiality” test for eligibility for benefits. This paragraph looks not at objective characteristics of the person deriving the income, but at the nature of the activity engaged in by that person and the connection between the income and that activity. As described in subparagraph 3(a), a resident of a Contracting State that is not a qualified resident shall be entitled to the benefits of the Convention with respect to an item of income derived from the other State if such resident person is engaged, directly or indirectly, in the active conduct of a trade or business in the State of residence and the item of income meets one of two tests. If the item of income in question is derived in connection with that trade or business, that trade or business must be substantial in relation to the resident’s proportionate interest in the activity in the other State that generated the interest. If the item of income is incidental to that trade or business, it need not be substantial in relation to the income generating activity in the other State. The substantiality test is needed to support the connection between the income and the active trade or business, while the test for incidental activity does not require substantiality. Income that is derived in connection with, or is incidental to, the business of making or managing investments will not qualify for benefits under this provision, unless the business is a bank or insurance company engaged in banking or insurance activities.

Subparagraph 3(b) provides that an item of income will be derived in connection with a trade or business if the item of income accrues in the ordinary course of the trade or business and the beneficial owner owns less than 5 percent of the shares in the payer of the item of income, or the activity in the other State that generated the item of income is part of the same line of business or is complementary to the trade or business conducted in the first- mentioned State by the person receiving the income.

Subparagraph 3(c) sets forth the “substantiality” test. Whether a trade or business is substantial will generally be determined based on all the facts and circumstances, including the proportionate share of the trade or business in the other State, the nature of the activities performed, and the relative contributions made to the conduct of the trade or business in both states.

In addition to this subjective facts and circumstances approach to interpreting substantiality, subparagraph 3(c) provides a safe harbor standard, which is intended to offer more certainty to taxpayers and the competent authorities. Under the safe harbor, an activity in a State will be deemed substantial in relation to the income-producing activity in the other State if the ratios of the assets used in the first-mentioned State, gross income derived from the active business in that State, and payroll expense for services performed in that State to the assets, gross income, and payroll expense for services performed in the other Contracting State each equals at least 7.5 percent and the average of the three ratios equals at least 10 percent. If the ratio for any factor fails the 7.5 percent test, the average ratio for the preceding three years may be used instead. If the entity paying the income is less than fully owned, only the resident’s proportionate interest in such activity will be taken into account for purposes of this test. For instance, if a U.S. corporation derives income from a corporation in Luxembourg in which it holds 80 percent of the shares, and unrelated parties hold the remaining shares, for purposes of this subparagraph, only 80 percent of the assets, payroll and gross income of the company in Luxembourg would be taken into account.

If neither the recipient nor a person related to the recipient has an ownership interest in the person from whom the income is derived, the substantiality test will always be satisfied (the denominator in each factor is zero and the numerators are positive). Of course, the other two prongs of this test under paragraph 3 would have to be satisfied for the recipient of the income to receive treaty benefits with respect to that income.

Since the term “gross income” is not defined in the Convention, in accordance with paragraph 2 of Article 3 (General definitions), in determining whether a person deriving income from U.S. sources is entitled to the benefits of the Convention, the United States will ascribe the meaning to the term that it has under U.S. law. Thus, in general, the term should be understood to mean gross receipts (net of returns and allowances) less the cost of goods sold. The cost of sales and operations, or cost of goods sold, includes the sum of the direct materials, direct labor, and overhead costs related to producing, acquiring, storing, and handling the inventories sold during a period. Overhead costs allocable to inventory include depreciation, property taxes paid, amortization, employee retirement plan expenses, or other supervisory, general, and administrative expenses, to the extent these costs directly benefit or are incurred by reason of inventory operations. The cost of goods sold does not include expenses associated with advertising, promotion, sales and marketing, or operating costs not related to inventory operations.

The substantiality requirement is intended to prevent an abuse of the active trade or business test. For example, a third-country resident may want to acquire a U.S. motion picture company. If its country of residence has no tax treaty with the United States, any dividends generated by the investment would be subject to a 30 percent U.S. withholding tax. Absent a substantiality test, the investor could set up a Luxembourg corporation that would operate a small video rental outlet in Luxembourg to rent a few videos of the movies produced by the U.S. company. That Luxembourg corporation would then acquire the U.S. manufacturer with capital provided by the third-country resident. It might be argued that the U.S.-source income is generated from business activities in the United States related to the video rental activity of the Luxembourg parent and that the dividend income should be subject to U.S. tax at the 5 percent rate provided in Article 10 (Dividends). However, the substantiality test would not be met in this example, so the dividends would remain subject to the 30 percent withholding tax in the United States.

Subparagraph 3(d) provides the meaning of an item of income that is “incidental” to a trade or business. Such an item will be considered incidental if the income is not described in subparagraph 3(b) and the production of such item of income facilitates the conduct of the trade or business in the first-mentioned State (e.g., the investment of working capital of such trade or business).

If a person qualifies for benefits under paragraph 2, no inquiry will be made into qualification for benefits under paragraph 3. Upon satisfaction of any of the other tests of paragraph 2, any income derived by the beneficial owner from the other Contracting State is entitled to treaty benefits. Under paragraph 3, however, the test is applied separately for each item of income.

Paragraph 4 provides that a company resident in a Contracting State shall also be entitled to all the benefits of the Convention if it meets certain tests. Subparagraph 4(a) specifies that a resident of a Contracting State shall be granted all benefits of the Convention if seven or fewer residents of member States of the European Union or of NAFTA own at least 95 percent of the company’s shares and the other State has a comprehensive tax treaty with such member state of the EU or NAFTA. The ownership percentage requirement is less than 100 percent to avoid denying benefits simply because there is a small non-qualified shareholder, while the limitation on the number of shareholders is set at seven in recognition of the fact that most of the companies that would want to use this provision will be subsidiaries of E owners, i.e., in most cases there will be a single owner. The seven residents can reside in different countries.

Subparagraph 4(b) grants benefits to a company that is a resident of a Contracting State if deductible amounts paid or accrued by the company during its taxable year to persons that are not residents of a member State of the E or of NAFTA or U.S. citizens do not exceed 50 percent of the gross income of the company for that year. This provision incorporates the definitions of “resident of a member State of the European Union and “resident of a state that is a party to NAFTA” in subparagraphs 4(d)(i) and (ii), respectively. Therefore, recipients of payments that are residents of such a state are excluded for purposes of subparagraph 4(b)(i) only if the recipients fall within the definitions set forth in subparagraphs 4(d)(i) or (ii).

Notwithstanding subparagraph 4(a), subparagraph 4(c) sets forth an additional requirement that must be satisfied in order for a resident of a Contracting State to be entitled to the benefits of the Convention with respect to dividends, the branch tax, interest or royalties. This provision requires a comparison of the rate of tax imposed on a particular payment under the Convention to the rate of tax that would be imposed under the income tax convention between the source State and any third E or NAFTA member state in which the resident’s owner or owners that account for the 95 percent ownership interest described in subparagraph 4(a) are resident. Benefits will be extended with respect to such payments under this provision only if the rate (or rates) of withholding tax provided in such convention (or conventions) is less than or equal to the rate or rates imposed under the Convention. If any of the owners accounting for the 95 percent interest in the resident claiming treaty benefits would not be so entitled, then paragraph 4 does not apply to that payment (although it may apply to other payments and would apply to items of income, profit or gain other than those enumerated in subparagraph 4(c)).

Paragraph III.C. of the exchange of notes clarifies how this rate comparison is to be made in the case of dividend payments. The rate of tax to be compared are the rate of withholding tax that the source State would impose had the E or NAFTA resident directly received its proportionate share of the dividend payment and the rates of withholding tax that the source State would have imposed had that person been a resident of the other State and the person’s proportionate share of the dividend were paid directly to that person. For example, assume that a U.S. company pays a dividend to LuxCo, a company resident in Luxembourg. LuxCo has two equal shareholders, a corporation resident in the United Kingdom and an individual resident in the United Kingdom. Both are residents of a member State of the European Union within the meaning of subparagraph 4(d)(i). Each person’s proportionate share of the dividend payment is 50 percent of the dividend. If the UK corporation had received this portion of the dividend directly, it would be subject to a withholding tax of 5 percent under the income tax treaty between the United States and the United Kingdom. If the individual had received his portion of the dividend directly, it would be subject to a withholding tax of 15 percent under the U.S.- U.K. treaty. These rates are the same rates that would apply if they were residents of Luxembourg. Therefore, the test under subparagraph 4(c) is satisfied with respect to this dividend payment.

Subparagraph 4(d) defines the terms “resident of a member State of the European Union” and “resident of a state that is a party to NAFTA.” It also places a condition on the contents of the comprehensive income tax treaty. In general, residents of a member state of the E or NAFTA are entitled to benefits of this Convention if that state has in place a convention with a comprehensive limitation on benefits Article and they are entitled to the benefits of that convention. If that income tax treaty does not contain a comprehensive limitation on benefits Article, however, then the person must qualify for benefits under the principles of paragraphs 2 or 3 as a resident under the Article of this Convention. In that case Article 24 is applied to the third state resident as if that person were resident of the other Contracting State (i.e., the residence State).

Subparagraphs 4(d)(i) and (ii) provide that a resident of an E or NAFTA member state may be considered a “resident of a member state of the European Union” or a “resident of a state that is a party to NAFTA” if, inter alia, it is entitled to benefits under an active trade or business test analogous to that set forth under paragraph 3. In such a case, subparagraph 4(d) limits the items of income for which treaty benefits may be claimed to items of income that are derived in connection with an active trade or business conducted by the third state resident in that third state. This rule effectively means that a resident of a Contracting State that seeks treaty benefits for dividends, interest or royalties under paragraph 4 and that is owned by a resident of a member state of the European Union” or a “resident of a state that is a party to NAFTA” only may receive treaty benefits for income that would be derived in connection with the trade or business connected in the third state, assuming that the third state resident would not qualify for benefits under any provision other than an active trade or business provision.

Paragraph 5 addresses the so-called “triangular case” in which a Luxembourg enterprise derives income from the United States and that income is attributable to a permanent establishment located in a third jurisdiction that imposes little or no income tax liability on those profits. The paragraph is drafted reciprocally, but has no application with respect to the United States because the U.S. does not exempt the profits of a U.S. company attributable to its foreign permanent establishments. This provision is necessary to prevent triangular case abuse since Luxembourg exempts from tax profits attributable to a permanent establishment of its residents located in certain countries, although it would tax the income, subject to a foreign tax credit, if the income were earned directly by the Luxembourg resident entity.

The Contracting States agreed that it would be inappropriate to grant treaty benefits with respect to such income. Therefore, paragraph 5 generally denies any treaty benefit with respect to any item of income beneficially owned by a Luxembourg resident and attributable to a permanent establishment in a third jurisdiction if the combined tax in Luxembourg and the third jurisdiction is less than 50 percent of the tax that normally would be imposed in Luxembourg if the income were earned there and were not attributable to the permanent establishment in the third jurisdiction. The 50 percent test is also used in the U.S.-Netherlands treaty. Paragraph 5 further provides that any dividends, interest or royalties to which this paragraph apply shall be subject to tax at source under domestic law, but at a rate not exceeding 15 percent of the gross amount.

Paragraph 5 provides an exception for certain types of income. The provisions of paragraph 5 do not apply to interest derived in connection with or incidental to an active trade or business carried on by the permanent establishment in the third jurisdiction. The business of making or managing investments is not an active trade or business for this purpose unless the activities are banking or insurance activities carried on by a bank or insurance company.

Notwithstanding other provisions of Article 24, paragraph 6 denies the benefits of the Convention with respect to certain income attributable to a “disproportionate” class of shares if a majority of the class is held by persons other than qualified residents or of a State that is a party to NAFTA or a member State of the European Union. This provision applies to a company, or to a company that controls that company. Control does not require majority ownership. In general, the shares subject to this paragraph are shares that entitle the shareholder to a disproportionately higher participation in the earnings that the company generates in the other State through particular assets or activities of the company. Such participation may take any form, including dividends or redemption payments. Such a class of shares would include so-called alphabet stock that entitles the holder to earnings in the source State produced by a particular division or subsidiary of the company.

If a company has such a class of shares and 50 percent or more of its owners are not qualified residents or of a State that is a party to NAFTA or a member State of the European Union, the benefits of the Convention are not available to the “disproportionate part” of the income derived from the source State by the distributing company. The disproportionate part of the income is defined as that part of the total income derived by a shareholder that exceeds the portion of the income that the shareholder would have received absent the special terms that gave the shareholder a disproportionate entitlement to income derived from the source State.

Paragraph 7 provides that a resident of a Contracting State that does not qualify for benefits of the Convention under the other provisions of Article 24 may be granted benefits at the discretion of the competent authority of the Contracting State in which the income arises. The competent authority of the State requested to give benefits shall consult with the competent authority of the other State before denying benefits under this paragraph.

The competent authority of a State will base a determination under this paragraph on whether the establishment, acquisition, or maintenance of the person seeking benefits under the Convention, or the conduct of such person’s operations, has or had as one of its principal purposes the obtaining of benefits under the Convention. Thus, persons that establish operations in one of the States with the principal purpose of obtaining the benefits of the Convention ordinarily will not be granted relief under paragraph 7.

In making determinations under paragraph 7, it is understood that the competent authorities will take into account all relevant facts and circumstances. The factual criteria the competent authorities are expected to take into account include the existence of a clear business purpose for the structure and location of the income earning entity in question; the conduct of an active trade or business (as opposed to a mere investment activity) by such entity; a valid business nexus between that entity and the activity giving rise to the income and the extent to which the entity, if it is a corporation, would be entitled to treaty benefits comparable to those afforded by the Convention if it had been incorporated in the country of residence of the majority shareholders.

The competent authority may determine to grant all benefits of the Convention, or it may determine to grant only certain benefits. For instance, it may determine to grant benefits only with respect to a particular item of income in a manner similar to paragraph 3. Relief under paragraph 3 may be for a single year or for multiple years.

Paragraph 7 also provides the competent authority with authority to unilaterally address so-called “triangular” cases arising under paragraph 5. An example where U.S. competent authority would grant relief would include triangular structures under which U.S.-source income subject to the provision is ultimately included in a U.S. shareholder’s income under the provisions of subpart F of part III of subchapter N of chapter 1 of subtitle A (“Subpart F”) of the Code. In such a case, it is anticipated that relief from U.S. tax under paragraph 5 would be granted to the extent the income is recognized under Subpart F.

Paragraph 8 defines certain terms used in this article. Subparagraph 8(a) defines a “recognized stock exchange” as any stock exchange registered with the U.S. Securities and Exchange Commission, the Luxembourg stock exchange, the NASDAQ system, and any other stock exchange agreed upon by the competent authorities. Companies whose shares are listed on the Luxembourg stock exchange or on the NASDAQ would normally be entitled to treaty benefits, unless they are considered to be closely held by persons who are not residents of member states of the E or NAFTA.

Paragraph III.A. of the exchange of notes provides the understanding that the principal stock exchanges of Amsterdam, Brussels, Frankfurt, Hamburg, London, Madrid, Milan, Paris, Sydney, Tokyo and Toronto also will be considered recognized stock exchanges.

Subparagraph 8(b) defines the term “closely-held company” as a company of which at least 50 percent of the principal class of shares is owned by persons other than qualified residents, residents of a member State of the European Union, or residents of a State that is a party to NAFTA and each of whom beneficially owns, directly or indirectly, alone or together with related persons, more than 5 percent of such shares for more than 30 days during a taxable year. If a class of shares traded on the Luxembourg stock exchange or on the NASDAQ System is owned in this manner, it will not be considered to be substantially and regularly traded on a recognized stock exchange. If such shares constitute the principal class of shares of the company, the company could not qualify for treaty benefits under subparagraph 2(d).

Paragraph 9 provides additional authority to the competent authorities (in addition to that of Article 27 (Mutual agreement procedure)) to consult together to develop a common application of the provisions of this Article, including the publication of regulations or other public guidance. The competent authorities shall exchange such information as is necessary to carry out the provisions of the Article.

Paragraph 10 provides that Luxembourg holding companies, and such other companies that enjoy a similar special fiscal treatment by virtue of the laws of Luxembourg are not residents. Luxembourg holding companies are those described in the Act (loi) of July 31, 1929 and the Decree (arrêté grand-ducal) of December 17, 1938, and any subsequent revision thereof. The 1962 Convention contained a similar provision.

Paragraph III.B of the exchange of notes clarifies that the term “such other companies which enjoy a similar special fiscal treatment by virtue of the laws of Luxembourg” includes investment companies within the meaning of the Act dated March 30, 1988.

Article 25

Relief from double taxation

Article 25 describes the manner in which each Contracting State undertakes to relieve double taxation. The United States uses the foreign tax credit method under its internal law and by treaty. Luxembourg uses a combination of foreign tax credit and exemption methods, depending on the nature of the income involved.

In paragraph 1, the United States agrees to allow its citizens and residents to credit against their U.S. income tax the income taxes paid or accrued to Luxembourg. Subparagraph 1(b) provides for a deemed-paid credit, consistent with section 902 of the Code, to a U.S. corporation in respect of dividends received from a Luxembourg corporation in which the U.S. corporation owns at least 10 percent of the voting power. This credit is for the tax paid by the Luxembourg corporation on the earnings out of which the dividends are considered paid.

The credit under the Convention is allowed in accordance with the provisions and subject to the limitations of U.S. law, as that law may be amended over time, so long as the general principle of this Article, i.e., the allowance of a credit, is retained. Thus, although the Convention provides for a foreign tax credit, the terms of the credit are determined by the provisions, at the time a credit is given, of the U.S. statutory credit. U.S. law generally limits the credit against U.S. tax to the amount of U.S. tax due with respect to net foreign source income within the relevant foreign tax credit limitation category (see Code section 904(a)). Nothing in the Convention prevents the limitation of the U.S. credit from being applied on a per-country or overall basis or on some variation thereof. Paragraph 4 adds rules for determining the source of income for credit purposes under the Convention.

Paragraph 1 also identifies which Luxembourg taxes may be credited under this article. Except for the capital tax and the portion of the communal trade tax computed on a basis other than profits, the Luxembourg income taxes specified in paragraphs 1(b) and 2 of Article 2 (Taxes covered) are to be treated as income taxes for purposes of allowing a credit under the Convention. Thus, the United States will only credit Luxembourg’s income taxes, and not the Luxembourg capital tax and the portion of the communal trade tax computed on a basis other than profits.

Paragraph 2 describes how Luxembourg will avoid double taxation under the Convention. Subparagraph 2(a) provides that where a Luxembourg resident derives income or owns capital that may be taxed in the United States, Luxembourg will exempt such income or capital from tax. Luxembourg, however, may, when calculating the amount of tax on the remaining income or capital of the resident, apply the same rates of tax as if the income or capital had not been exempted (i.e., Luxembourg may apply exemption with progression).

Subparagraph 2(b) provides that where a Luxembourg resident derives income that may be taxed in the United States in accordance with the provisions of Article 10 (Dividends) and subparagraph 6(b) of Article 12 (Interest), Luxembourg will allow a deduction from Luxembourg tax (i.e., a credit) of an amount equal to the tax paid on that income in the United States. The credit, however, may not exceed that part of the Luxembourg income tax (computed before the credit) that is attributable to the income that the United States may tax. The amounts in subparagraph 6(b) of Article 12 are certain distributions that are determined with reference to profits and that may not be taxed at a rate above the rate for portfolio dividends.

Subparagraph 2(c) provides that Luxembourg will exempt certain dividends received from U.S. sources by a Luxembourg resident company. This exemption will be granted only if the Luxembourg resident company has held directly since the beginning of its accounting year at least 10 percent of the capital of the U.S. company paying the dividends, and only if this U.S. company is subject to tax in the United States to an income tax corresponding to the Luxembourg corporation tax. Under the same conditions, the above-mentioned shares in the U.S. company are also exempt from the Luxembourg capital tax.

Paragraph 3 sets out special rules for the tax treatment in both the United States and Luxembourg of certain types of income derived from U.S. sources by U.S. citizens who are residents of Luxembourg. Since U.S. citizens are subject to U.S. tax at ordinary progressive rates on their worldwide income, the U.S. tax on the U.S. source income of a U.S. citizen resident in Luxembourg may exceed the U.S. tax allowable under the Convention on an item of U.S. source income derived by a resident of Luxembourg who is not a U.S. citizen.

Subparagraph 3(a) provides special credit rules for Luxembourg with respect to certain items of income that are not exempt from Luxembourg tax under paragraph 2 and are either exempt from U.S. tax or subject to reduced rates of U.S. tax under the provisions of the Convention when received by Luxembourg residents who are not U.S. citizens. The purpose of this provision is to ensure that U.S. citizens resident in Luxembourg are not taxed more heavily in Luxembourg than Luxembourg’s own citizens and residents. The tax credit of Luxembourg allowed under these circumstances, to the extent consistent with Luxembourg law, need not exceed the U.S. tax that may be imposed under the provisions of the Convention, other than tax imposed solely by reason of the U.S. citizenship of the taxpayer under the provisions of the saving clause of paragraph 3 of Article 1 (General scope). Thus, if a U.S. citizen resident in Luxembourg receives U.S. source portfolio dividends, the foreign tax credit granted by Luxembourg would be limited to 15 percent of the dividend — the U.S. tax that may be imposed under subparagraph 2(a)(ii) of Article 10 (Dividends) — even if the shareholder is subject to U.S. net income tax because of his U.S. citizenship.

Subparagraph 3(b) deals with the potential for double taxation which can arise as a result of the absence, because of subparagraph 3(a), of a full foreign tax credit by Luxembourg for the U.S. tax imposed on its citizens resident in Luxembourg. The subparagraph provides that the United States will credit the Luxembourg income tax paid, after allowance of the credit provided for in subparagraph 3(a). It further provides that in allowing the credit, the United States will not reduce its tax below the amount allowed as a creditable tax in Luxembourg under subparagraph 3(a). Since the income described in this paragraph is U.S. source income, special rules are required to re-source some of the income to Luxembourg in order for the United States to be able to credit the Luxembourg tax.

Subparagraph 3(c) provides for this re-sourcing. It deems the items of income referred to in subparagraph 3(a) to be from Luxembourg sources to the extent necessary to avoid double taxation under subparagraph 3(b). This re-sourcing is for the exclusive purpose of relieving double taxation in the United States with respect to certain U.S. source income of its citizens who are resident in Luxembourg.

In general, where a Contracting State is given the right to tax an item of income under the Convention (except where that right is solely on the basis of citizenship under the saving clause of paragraph 3 of Article 1 (General scope)), paragraph 4 provides that the item of income is treated as arising in the other Contracting State for purposes of computing the Convention’s foreign tax credit, subject to the exception provided in subparagraph 3(c) in the case of a U.S. citizen resident in Luxembourg. As a general matter, such source rules provided in the Convention for purposes of determining the taxing rights of the Contracting States are consistent with the Code source rules for purposes of computing the foreign tax credit. If however, the Convention and Code source rules are inconsistent, paragraph 4 provides that the Code source rules (e.g., Code section 904(g)) will be used to determine the limits for the allowance of a credit under the Convention. Because paragraph 4 resolves any such conflict in treaty and Code source rules, the election under section 904(g)(10) is unavailable. That election is available only to the extent that treaty and Code source rules conflict.

By virtue of the exceptions in subparagraph 4(a) of Article 1, this Article is not subject to the saving clause of paragraph 3 of Article 1 (General scope). Thus, the United States will allow a credit to its citizens and residents in accordance with the Article, even if such credit were to provide a benefit not available under U.S. law.

Article 26

Non-discrimination

Article 26 assures that nationals of a Contracting State, in the case of paragraph 1, and residents of a Contracting State, in the case of paragraphs 2 through 4, will not be subject, directly or indirectly, to discriminatory taxation in the other Contracting State. It also provides for non-discriminatory taxation of residents of the taxing State with respect to deductions for amounts paid to residents of the other State. It also prohibits a State from imposing discriminatory taxation upon its resident companies that are owned, partly or wholly, by residents of the other State. Non- discrimination, in the context of this Article, means providing national treatment.

Paragraph 1 provides that a national of one Contracting State may not be subject to taxation or connected requirements in the other Contracting State that are other or more burdensome than the taxes and connected requirements imposed upon a national of that other State in the same circumstances. A national of a Contracting State is afforded protection under this paragraph even if the national is not a resident of either Contracting State. Thus, a U.S. citizen who is resident in a third country is entitled, under this paragraph, to the same treatment in Luxembourg as a Luxembourg national who is in similar circumstances (i.e., who is also resident in the third country). The term “national” is defined in subparagraph 1(h) of Article 3 (General definitions) as any individual possessing the nationality or citizenship of that Contracting State and any legal person, partnership or association deriving its status as such from the laws in force in that Contracting State.

The United States is not obligated, by virtue of paragraph 1, to apply the same taxing regime to a Luxembourg national who is not resident in the United States and a U.S. national who is not resident in the United States since that paragraph applies only when the nationals of the two Contracting States are in the same circumstances. United States citizens who are not residents of the United States but who are, nevertheless, subject to United States tax on their worldwide income are not in the same circumstances with respect to United States taxation as citizens of Luxembourg who are not United States residents. Thus, for example, Article 26 would not entitle a Luxembourg national not resident in the United States to the net basis taxation of U.S. source dividends or other investment income that applies to a U.S. citizen not resident in the United States.

Paragraph 2 provides that a permanent establishment in a Contracting State of an enterprise of the other Contracting State may not be less favorably taxed in the first-mentioned State than an enterprise of that first-mentioned State which is carrying on the same activities. This provision does not prevent either Contracting State from imposing the branch profits tax described in Article 11 (Branch tax). Nor does it obligate a Contracting State to grant to a resident of the other Contracting State any tax allowances, reliefs, etc., which it grants to its own residents on account of their civil status or family responsibilities. Thus, if a sole proprietor who is a resident of Luxembourg owns a Luxembourg enterprise that has a permanent establishment in the United States, in assessing income tax on the profits attributable to the permanent establishment, the United States is not obligated to allow to the Luxembourg resident the personal allowances for himself and his family that he would be permitted to take if the permanent establishment were a sole proprietorship owned and operated by a U.S. resident.

Section 1446 of the Code imposes on any partnership with income effectively connected with a U.S. trade or business the obligation to withhold tax on amounts allocable to a foreign partner. In the context of the Convention, this obligation applies with respect to a Luxembourg resident partner’s share of the partnership income attributable to a U.S. permanent establishment. There is no similar obligation with respect to the distributive shares of U.S. resident partners. It is understood, however, that this distinction is not a form of discrimination within the meaning of paragraph 2 of the Article, but, like other withholding on payments to non-resident aliens or foreign entities, is merely a reasonable method for the collection of tax from persons who are not continually present in the United States, and as to whom it may otherwise be difficult for the United States to enforce its tax jurisdiction. No distinction is made between U.S. and Luxembourg partnerships, since the law requires that partnerships of both domiciles withhold tax in respect of the partnership shares of non-U.S. partners. The tax withheld under section 1446 is a tentative tax and, if it exceeds the final liability, the partner can, as in other cases of over-withholding, file for a refund.

Paragraph 3 prohibits discrimination in the allowance of deductions. When an enterprise of a Contracting State pays interest, royalties, or other disbursements to a resident of the other Contracting State, the first-mentioned Contracting State must allow a deduction for those payments in computing the taxable profits of the enterprise as if the payment had been made under the same conditions to a resident of the first-mentioned Contracting State. An exception to this rule is provided for cases where the provisions of paragraph 1 of Article 9 (Associated enterprises), paragraph 5 of Article 12 (Interest) or paragraph 5 of Article 13 (Royalties) apply, because all of these provisions permit deductions to be denied in certain circumstances in respect of transactions between related persons. This exception would include the denial or deferral of certain deductions under Code section 163(j).

The term “other disbursements” is understood to include a reasonable allocation of executive and general administrative expenses, research and development expenses and other expenses incurred for the benefit of a group of related persons which includes the person incurring the expense.

Paragraph 3 also provides that any debts of an enterprise of a Contracting State to a resident of the other Contracting State are deductible in the first Contracting State in computing the capital tax of the enterprise under the same conditions as if the debt had been contracted to a resident of the first-mentioned Contracting State. Even though the United States does not now impose a national tax on capital, because the non-discrimination provisions apply to all taxes levied at all levels of government in the U.S. and Luxembourg, this provision may be relevant for U.S. as well as Luxembourg tax purposes, because of taxes on capital, such as real property taxes, levied by local governments.

Paragraph 4 prohibits a Contracting State from subjecting an enterprise of that State the capital of which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other Contracting State to taxation or connected requirements that are other or more burdensome than the taxation or connected requirements imposed on other similar enterprises in the first State.

As in the case of its other treaties, it is understood that the provisions of Code section 367(e)(2) regarding the taxation of corporations on certain distributions in liquidation to foreign parent corporations are not contrary to paragraph 4 of the Article. The U.S. rules providing that a corporation with non-resident alien shareholders is not eligible to make an election to be an “S” corporation also is consistent with paragraph 4. In both cases, corporations eligible for these benefits are not similarly situated. In the first case, a foreign parent corporation will not be subject to U.S. tax on a subsequent alienation, as would a U.S. corporation. In the second case, a foreign shareholder is not subject to U.S. tax on worldwide income, as are U.S. resident shareholders.

For the reasons given above in connection with the discussion of paragraph 2, it is also understood that the provision in section 1446 of the Code for withholding tax on non-U.S. partners does not violate paragraph 4 of the Article.

Paragraph 5 specifies that no provision of the Article will prevent the United States from imposing the branch tax described in Article 11 (Branch tax). Since imposition of the branch tax is specifically sanctioned by Article 11, its imposition could not be precluded by Article 26, even without this paragraph. Under the generally accepted rule of construction that the specific takes precedence over the more general, the specific branch tax provision of Article 11 would take precedence over the more general national treatment provision of this Article.

As noted above, paragraph 6 provides that notwithstanding the specification of taxes covered by the Convention in Article 2 (Taxes covered), for purposes of providing non-discrimination protection this Article applies to taxes of every kind and description imposed by a Contracting State or a political subdivision or local authority thereof. Customs duties are not considered to be taxes for this purpose.

The saving clause of paragraph 3 of Article 1 (General scope) does not apply to this Article, by virtue of the exceptions in subparagraph 4(b) of that Article. Thus, for example, a U.S. citizen who is resident in Luxembourg may claim benefits in the United States under this Article. As with all benefits under this Convention, the granting of benefits under this Article generally is subject to the requirement that the beneficial owner of the income qualify for benefits under the provisions of Article 24 (Limitation on benefits). However, a national of a Contracting State is entitled to the benefits of paragraph 1 regardless of whether he is entitled to benefits under Article 24, because a person need not be a resident of a Contracting State in order to receive the benefits of paragraph 1.

Article 27

Mutual agreement procedure

Article 27 provides for cooperation between the competent authorities of the Contracting States to resolve disputes which may arise under the Convention and to resolve cases of double taxation not provided for in the Convention. The competent authorities of the two Contracting States are defined in subparagraph 1(e) of Article 3 (General definitions).

Paragraph 1 provides that where a person considers that the actions of one or both Contracting States will result for him in taxation which is not in accordance with the Convention he may present his case to the competent authority of his State of residence or nationality. It is not necessary for a person bringing a complaint first to have exhausted the remedies provided under the national laws of the Contracting States before presenting a case to the competent authorities.

Paragraph 2 instructs the competent authorities in dealing with cases brought by taxpayers under paragraph 1. It provides that if the competent authority of the Contracting State to which the case is presented judges the case to have merit but cannot reach a unilateral solution, it shall seek agreement with the competent authority of the other Contracting State so as to avoid taxation not in accordance with the Convention. If agreement is reached under this provision, it is to be implemented even if implementation is otherwise barred by the statute of limitations or by some other procedural limitation, such as a closing agreement. In a case where the taxpayer has entered into a closing agreement (or other written settlement) with the United States prior to bringing a case to the competent authorities, the U.S. competent authority will endeavor only to obtain the correlative adjustment from the other Contracting State. See Rev. Proc. 96-13, 1996-3 I.R.B. 31, Sec. 7.05. Because, under paragraph 2 of Article 1 (General scope), the Convention cannot operate to increase a taxpayer’s liability, time or other procedural limitations can be overridden only for the purpose of making refunds and not to impose additional tax.

Paragraph 3 authorizes the competent authorities to resolve difficulties or doubts that may arise as to the application or interpretation of the Convention. The paragraph includes a non- exhaustive list of examples of the matters about which the competent authorities may reach agreement. They may agree to the same attribution of income, deductions, credits or allowances between an enterprise in one Contracting State and its permanent establishment in the other State or between related persons. The competent authorities may also agree to settle a variety of conflicting applications of the Convention, including those regarding the characterization of items of income, the application of source rules to particular items of income, and to a common meaning of a term.

The paragraph also authorizes the competent authorities to consult for purposes of eliminating double taxation in cases not provided for in the Convention. This provision is intended to permit the competent authorities to implement the Convention in particular cases in a manner that is consistent with its expressed general purposes, even though the cases are not specifically covered by the Convention. An example of such a case might be double taxation arising from a transfer pricing adjustment between two permanent establishments of a third-country resident, one in the United States and one in Luxembourg. Since no resident of a Contracting State is involved in the case (both permanent establishments being operated by residents of a third State), the Convention does not, by its terms, apply, but the competent authorities may, nevertheless, use the authority of the Convention to seek to prevent the double taxation. Paragraph 3 is not, however, intended to authorize the competent authorities to resolve problems of major policy significance that normally would be the subject of negotiations between the Contracting States themselves.

Paragraph 4 provides that the competent authorities may communicate with each other directly for the purpose of reaching an agreement. This makes clear that the competent authorities may communicate without going through diplomatic channels.

Paragraph 5 directs the competent authorities to consult with each other to develop an agreed application of the provisions of the Convention, including Article 24 (Limitation on benefits). It also allows the competent authorities to prescribe regulations to carry out the purposes of the Convention.

This Article is not subject to the saving clause of paragraph 3 of Article 1 (General scope), by virtue of the exceptions to the saving clause in subparagraph 4(a) of that Article. Thus, rules, definitions, procedures, etc., that are agreed upon by the competent authorities under this Article, may be applied by the United States with respect to its citizens and residents even if they differ from the comparable Code provisions. Similarly, as indicated above, U.S. law may be overridden to provide tax refunds to U.S. citizens or residents. A person may seek relief under Article 27 regardless of whether he is generally entitled to benefits under Article 24 (Limitation on benefits). As in all other cases, the competent authority is vested with the discretion to decide whether the claim for relief is justified.

Article 28

Exchange of information

This Article provides for the exchange of information between the competent authorities of the Contracting States and for the provision of certain assistance in the collection of taxes. The memorandum of understanding provides that each Contracting State provide the other the broadest possible measure of assistance with respect to matters covered by the Convention, and the Contracting States expect that the authorities in each State, including judicial authorities to the extent they become involved in executing a request, will use their best efforts to provide the assistance requested.

Paragraphs 1 through 3 provide for the exchange of information. Paragraph 1 provides that the information to be exchanged is that necessary for carrying out the provisions of the Convention or the domestic laws of the United States or Luxembourg concerning the taxes covered by this Convention. Paragraph 1, Article 2, specifies that, for the United States, the Convention shall apply to all federal income taxes, except for social security taxes, and federal excise taxes imposed on insurance premiums paid to foreign insurers, except for excise taxes imposed on premiums paid to foreign insurers for reinsurance.

The exchange of notes makes clear that upon request the Luxembourg competent authority will obtain and provide information, other than information of Luxembourg financial institutions, for any matter relating to the assessment, collection, or administration of, the enforcement or prosecution in respect of, or the determination of appeals in relation to, the taxes covered by the Convention. Thus, under Article 28 U.S. tax authorities can obtain such information for both civil and criminal tax matters. Although the exchange of notes limits the latter obligation to the same manner and to the same extent as if the Luxembourg competent authority were obtaining the information for an investigation or public court proceeding under its laws and practices, the Luxembourg competent authority has adequate authority to compel the production of a wide variety of information, whether in the form of statements of individuals or documents, such as the books and records of a business, located in Luxembourg, pursuant to a request for information from the U.S. competent authority.

On the other hand, because Luxembourg tax authorities are prohibited under Luxembourg law from obtaining information from Luxembourg financial institutions for their own tax investigations and proceedings, Luxembourg was unable to agree to any provision in the Tax Convention which would obligate the Luxembourg competent authority to obtain such information upon the request of U.S. competent authority for use in U.S. tax investigations or proceedings. To allow U.S. authorities another channel for obtaining information of Luxembourg financial institutions, the exchange of notes makes clear that information of Luxembourg financial institutions may be provided to U.S. authorities only in accordance with the terms of the Treaty between the United States of America and the Grand Duchy of Luxembourg on Mutual Legal Assistance in Criminal Matters (hereinafter “MLAT”).

Paragraph 1 states that information exchange is not restricted by Article 1 (General scope). This means that information may be requested and provided under this Article with respect to persons who are not residents of either Contracting State. For example, if a third-country resident has a permanent establishment in Luxembourg which engages in transactions with a U.S. enterprise, the United States could request information with respect to that permanent establishment, even though it is not a resident of either Contracting State. Similarly, if a third-country resident maintains a bank account in Luxembourg, the United States could request and obtain information under the MLAT with respect to that person’s account to the same extent that it could request the information regarding a resident of Luxembourg or the United States.

Paragraph 1 also provides assurances that any information exchanged will be treated as secret, subject to the same disclosure constraints as information obtained under the laws of the requesting State. Information received may be disclosed only to persons or authorities, including courts and administrative bodies, involved in the assessment, collection, or administration of, the enforcement or prosecution in respect of, or the determination of appeals in relation to, the taxes covered by this Article. The information may be used by these persons or authorities only in connection with these designated functions, but may disclose information exchanged in public court proceedings or in judicial proceedings.

It is understood that the reference in Paragraph 1 to administration includes persons involved in the oversight of the administration of taxes in the United States, i.e., the appropriate committees of the U.S. Congress as well as the U.S. General Accounting Office, where such access is necessary to carry out their oversight responsibilities. Information received by these bodies is for use in the performance of their role in overseeing the administration of U.S. tax laws.

Paragraph 2 explains that the obligations undertaken in paragraph 1 to exchange information do not require a Contracting State to carry out administrative measures which are at variance with the laws or administrative practice of either State. Nor does that paragraph require a Contracting State to supply information not obtainable under the laws or administrative practice of either State, or to disclose any trade, business, industrial, commercial or professional secret or trade process, or other information, the disclosure of which would be contrary to public policy.

Paragraph 3 and the exchange of notes provide that when information is requested by a competent authority of Contracting State in accordance with this Article, the competent authority of the other Contracting State is obligated to obtain the requested information as if the competent authority of that Contracting State were obtaining the requested information for an investigation or public court proceeding under its own laws and practices. The paragraph further provides that the requesting State may specify the form in which information is to be provided (e.g., depositions of witnesses and authenticated copies of original documents) so that the information can be usable in the judicial proceedings of the requesting State. The requested State should, if possible, provide the information in the form requested to the same extent that it can obtain the requested information in that form for an investigation or public court proceeding under its own laws and practices.

Paragraph 4 provides for assistance in collection of taxes to the extent necessary to ensure that treaty benefits are enjoyed only by persons entitled to those benefits under the terms of the Convention. Under this paragraph, a Contracting State will endeavor to collect on behalf of the other State only those amounts necessary to ensure that any exemption or reduced rate of tax at source granted under the Convention by that other State is not enjoyed by persons not entitled to those benefits.

Subparagraphs (a), (b), (c) and (d) of paragraph 4 impose conditions on collection assistance. Under subparagraph (a), the requesting State must produce a copy of a document certified by its competent authority specifying that the sums referred for collection assistance are finally due and enforceable. The tax of a requesting State shall be considered “finally due and enforceable” when the requesting State has the right under its internal law to collect the tax and all administrative and judicial rights of the taxpayer to restrain collection in the requesting State have lapsed or been exhausted. Thus, the concept of “finally due and enforceable” is equivalent to “finally determined” in the U.S. income tax treaties with Canada and the Netherlands.

Under subparagraph (b), a document described in subparagraph (a) shall be rendered enforceable in accordance with the laws of the requested State. For example, where the U.S. Competent Authority accepts a request for collection assistance, the Luxembourg tax claim shall be treated by the United States as an assessment under United States laws against the taxpayer as of the time the request is received.

Under subparagraph (c), the requested State shall effect recovery in accordance with the rules governing the recovery of similar tax debts of its own; however, tax debts to be recovered shall not be regarded as privileged debts in the requested State. This provision establishes the rule that a tax for which collection assistance is provided shall not have in the requested State any priority specially accorded to the taxes of the requested State. Thus, the priority enjoyed by the requested State for collection of its own taxes in relation to conflicting creditor claims (e.g., in bankruptcy) are not automatically extended to the tax claims of the requesting state.

Where the U.S. competent authority accepts a request for collection assistance, and judicial enforcement is required to effect such assistance, judicial enforcement will be requested and the matter will be referred to the Department of Justice as if the Luxembourg tax claim were a U.S. tax assessment.

Under subparagraph (d), appeals concerning the existence or amount of the debt shall lie only to the competent tribunal of the requesting State. Finally, paragraph 7 provides that the Contracting State asked to collect the tax is not obligated, in the process, to carry out administrative measures that would be contrary to its sovereignty, security, public policy or essential interests. Essential interests are not defined in the Convention, but bank secrecy is understood not to be an essential interest.

The exchange of notes provides that if the laws and practices in Luxembourg change in a way that permits the Luxembourg competent authority to obtain information from Luxembourg financial institutions for the purposes of enforcing and administering its tax laws or the tax laws of member states of the European Union, it is understood that such information will be obtained and provided to the U.S. competent authority to the same extent that it is obtained and provided for the enforcement and administration of the former laws.

Article 29

Diplomatic agents and consular officers

This Article confirms that any fiscal privileges to which diplomatic or consular officials are entitled under general provisions of international law or under special agreements will apply, notwithstanding any provisions to the contrary in the Convention. The text of this article is identical to the corresponding provision of the OECD Model. The agreements referred to include any bilateral agreements, such as consular conventions, that affect the taxation of diplomats and consular officials and any multilateral agreements dealing with these issues, such as the Vienna Convention on Diplomatic Relations and the Vienna Convention on Consular Relations.

The saving clause of paragraph 3 of Article 1 (General scope) does not apply, by virtue of the exceptions in subparagraph 4(b) of that Article, to override any benefits of this Article available to an individual who is neither a citizen of the United States nor has immigrant status there.

Article 30

Entry into force

Article 30 contains the rules for bringing the Convention into force and giving effect to its provisions.

Paragraph 1 provides for the ratification of the Convention by both Contracting States and the prompt exchange of instruments of ratification.

Paragraph 2 provides that the Convention will enter into force on the day when the instruments of ratification are exchanged. The Convention will have effect with respect to taxes withheld at source for amounts paid or credited on or after the first day of January next following the date on which the Convention enters into force. For all other income and capital taxes, the Convention will have effect for fiscal periods beginning on or after the first day of January next following the date on which the Convention enters into force. Thus, all provisions of the Convention become effective on January 1 of the year following the exchange of instruments of ratification.

Paragraph 3 provides a general exception to the effective date rules of paragraph 2. Under this paragraph, if the 1962 Convention would have afforded greater relief from tax with respect to taxes on income and property to a person entitled to its benefits than would be the case under this Convention, that person may elect to remain subject to all of the provisions of the 1962 Convention for the first assessment period or taxable year with respect to which this Convention would have had effect under the provisions of paragraph 2 of this Article.

Thus, paragraph 3 allows the taxpayer to elect to extend the benefits of the old Convention for one year from the date on which the relevant provision of the new Convention would first take effect. For example, suppose the instruments of ratification are exchanged on February 1 of year 1 and the Convention thus enters into force on that date. The new Convention would take effect with respect to taxes withheld at source for amounts paid or credited on or after January 1 of the following year. If the election is made, the provisions of the old Convention regarding withholding would continue to have effect for amounts paid or credited at any time prior to January 1 of the second year. With regard to assessed taxes, the new Convention is applicable for fiscal periods beginning on or after January 1 of the following year (year 2). Therefore, with respect to the branch tax, which is imposed on an assessment basis, an election would allow the old Convention to continue, thus preventing the imposition of the branch tax until the first taxable year beginning on or after January 1 of year 3.

Paragraph 4 provides that the 1962 Convention will cease to have effect in respect of income and capital at the time this Convention takes effect under the provisions of paragraphs 2 and 3 of this Article. The 1962 Convention shall terminate on the last date on which it has effect in accordance with the foregoing provisions of this Article.

Article 31

Termination

The Convention is to remain in effect indefinitely, unless terminated by a Contracting State. The Convention may be terminated by either Contracting State, through diplomatic channels, by giving notice of termination at least six months before the end of any calendar year after the year of entry into force. Unlike many other U.S. treaties, this treaty does not contain the five year period that must pass before the treaty can be terminated.

The termination will have effect in respect of tax withheld at source, for amounts paid or credited on or after, and in respect of other taxes, to fiscal periods beginning on or after, the first day of January next following the expiration of the six-month period. Thus, if notice is given prior to June 30 of any calendar year after the Convention enters into force, the provisions of the Convention will cease to have effect for withholding purposes with respect to any payment made or credited on or after January 1 of the following year, and for other purposes for taxable years beginning on or after January 1 of the following year.

 

 

 

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