ARTICLE 7

Business Profits

This Article provides rules for the taxation by a Contracting State of income from business activity carried on in that State by a resident of the other Contracting State.

Paragraph 1 provides that the business profits, as defined in paragraph 7, of an enterprise of a Contracting State shall be taxable only by that State unless the enterprise carries on business in the other Contracting State through a permanent establishment there. The term "permanent establishment" is defined in Article 5 (Permanent Establishment). If the enterprise does have a permanent establishment in the other Contracting State, that State may tax that portion of the enterprise's business profits which is attributable either to the permanent establishment itself, or to sales in that other State of goods or merchandise of the same or similar kind as those sold through the permanent establishment, or to other business activities carried on in that other State which are the same as or similar to the activities affected through the permanent establishment. Though this rule (which is taken from the U.N. Model Convention) gives the State in which the permanent establishment is situated a broader taxing right over the business profits of an enterprise of the other State than under the U.S. of OECD Model Conventions, it is narrower than the limited "force of attraction" rule of Code section 864(c)(3).

Paragraph 2 provides that the profits to be attributed to the permanent establishment itself are those which it might be expected to make if it were a distinct and independent enterprise engaged in the same or similar activities under the same or similar conditions. The term profits ''attributable to'' a permanent establishment means that, subject to the rules described above, the limited "force-of-attraction'' rule of Code section 864(c)(3) does not apply for U.S. tax purposes under the Convention. Profits may, however, be from sources within or without a Contracting State and be ''attributable to'' a permanent establishment. Thus, items of income described in section 864(c)(4)(B) of the Code which are attributable to a permanent establishment in the United States are subject to tax by the United States.

Paragraph 3 provides that there shall be allowed as deductions those expenses incurred for the purposes of the permanent establishment, whether incurred in the State where the permanent establishment is located or elsewhere. Deductible expenses include a reasonable allocation to the permanent establishment of administrative expenses, research and development expenses, interest, and other expenses incurred for the purposes of the enterprise.

Paragraph 4 provides that the mere purchase by a permanent establishment of goods or merchandise for the enterprise shall not result in profits being attributed to the permanent establishment.

Paragraph 5 is taken from the OECD Model and was included in the Convention at the request of Barbados. It provides that, in cases where it has been customary in a Contracting State to d so, that State may compute the profit attributable to a permanent establishment by apportioning the total profits of the single enterprise of which the permanent establishment is a part to its various parts, including the permanent establishment. The attribution of profits to the permanent establishment, however, must be consistent with the principle of the Article, i.e., the profits so apportioned must be consistent with the profits which would be attributed to the permanent establishment under the separate entity, arm's-length approach prescribed by

paragraph 2 of the Article.

Paragraph 6 provides that the same method for determining the profits attributable to a permanent establishment shall be used each year unless there is good and sufficient reason to change. In the United States, such a change may be a change of accounting method requiring the approval of the Internal Revenue Service.

Paragraph 7 provides that where business profits include items of income dealt with separately in other Articles of the Convention, then the provisions of those separate Articles override the provisions of Article 7. Thus, for example, the taxation of income from international shipping and transport dealt within Article 8 (Shipping and Air Transport) is governed by that Article and not by Article 7. Similarly the taxation of dividends, interest, and royalties is controlled by Articles 10 (Dividends), 11 (Interest), and 12 (Royalties); however, those Articles provide that where dividends, interest, or royalties derived by a resident of a Contracting State are attributable to a permanent establishment or regular base of that resident in the other Contracting State, then the provisions of this Article, or Article 14 (Independent Personal Services), shall apply.

Paragraph 8 provides a definition of "business profits.'' Such profits are defined to mean income derived from the conduct of any trade or business, including the rental of tangible personal property. Thus, as a general matter, income from the rental of such property derived by a resident of one Contracting State may not be taxed by the other Contracting State except to the extent attributable to a permanent establishment in the latter State. Note that under paragraph 2(l) of Article 5 (Permanent Establishment), a permanent establishment will exist in a State if substantial equipment or machinery is maintained there for more than 120 consecutive days, and, for a permanent establishment to exist in any taxable year, the property must be maintained in the State for 30 days or more in that year.