Internal taxation rules United States
Under the same system that applies to dividends and interest, the United States imposes a 30-percent withholding tax on U.S.- source royalties paid to foreign persons. U.S.-source royalties in- clude royalties for the use of or right to use intangible property in the United States.
Japan
Royalties paid to nonresidents are generally subject to a 20-per- cent withholding rate.
Proposed treaty limitations on internal law
The proposed treaty provides that royalties arising in a country (the source country) and beneficially owned by a resident of the other country are exempt from tax in the source country. This ex- emption from source country tax is similar to that provided in the U.S. model.
The term ‘‘royalties’’ means any consideration for the use of, or the right to use, any copyright of literary, artistic or scientific work (including cinematographic films and films or tapes for radio or tel- evision broadcasting). The term also includes consideration 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 information concerning industrial, commercial, or scientific ex- perience. Unlike the U.S. model, the term does not include gain from the alienation of any right or property described in the pre- ceding two sentences, regardless of whether the amount of such gain is contingent on the productivity, use, or disposition of the right or property. Such gains are dealt with under Article 13 (Gains) and, as the Technical Explanation states, generally are subject to the same treatment under the proposed treaty as royal-
ties. The Technical Explanation also states that the term royalties does not include income from leasing personal property.
The exemption from source country tax does not apply if the ben- eficial owner of the royalties carries on a business through a per- manent establishment in the source country, and the royalties are attributable to the permanent establishment. In that event, the royalties are taxed as business profits (Article 7). According to the Technical Explanation, royalties attributable to a permanent estab- lishment but received after the permanent establishment is no longer in existence are taxable in the country where the permanent establishment existed.
The proposed treaty addresses the issue of non-arm’s-length roy- alties between related parties (or parties otherwise having a special relationship) by providing that this article applies only to the amount of arm’s-length royalties. Any amount of royalties paid in excess of the arm’s-length interest is taxable in the country in which it arises at a rate not to exceed five percent. This provision is found in the U.S. model and other U.S. tax treaties, but the rule that limits the withholding rate to a specified percentage has not been included in the U.S. model or other U.S. tax treaties. The Technical Explanation states that the proposed treaty’s treatment of such excess amounts is consistent in most circumstances with the results under the U.S. model and U.S. domestic law. Absent this rule, the United States would treat such excess amounts as a dividend or as a contribution to capital, depending on the relation- ship between the parties, and tax such amounts accordingly. Under the proposed treaty, a maximum five percent withholding tax rate generally applies to dividends where the beneficial owner is a com- pany owning directly or indirectly at least 10 percent of the voting stock of the company paying the dividends. This rule is similar to rules provided in paragraph 8 of Article 11 (Interest) and para- graph 3 of Article 21 (Other Income.)
The proposed treaty also includes an anti-conduit rule that states that a resident of the United States or Japan shall not be consid- ered the beneficial owner of royalties in certain ‘‘back-to-back’’ ar- rangements. This rule is similar to other anti-conduit rules in- cluded in the proposed treaty dealing with interest, dividends, and other income, which can be found in paragraph 11 of Article 10 (Dividends), paragraph 11 of Article 11 (Interest), and paragraph 4 of Article 21 (Other Income). These anti-conduit rules are signifi- cantly narrower than similar rules that are provided under U.S. domestic law. The Technical Explanation notes that the limited anti-conduit rules provided in the proposed treaty are not included in the U.S. model, but are included at the request of Japan in order to ensure that Japan can prevent residents of third countries from improperly obtaining the benefits of the proposed treaty in certain limited circumstances. The Technical Explanation also states the United States does not intend the inclusion of such anti-conduit rules in the proposed treaty to create a negative inference regard- ing the application of U.S. domestic anti-abuse rules, other articles of the proposed treaty, or other U.S. tax treaties.
The royalty rule specifically provides that a resident of the United States or Japan shall not be considered the beneficial owner of royalties in respect of intangible property if such royalties would
72
36See Foreign Investment in Real Property Tax Act, Pub. L. No. 96–499, sec. 1125(c)(1) (1980).
not have been paid unless the resident pays royalties in respect of the same intangible property to a person that is not entitled to the same or more favorable treaty benefits and that is not a resident of either the United States or Japan.
The Technical Explanation notes that this article is subject to the saving clause of paragraph 4 of Article 1 (General Scope), as well as Article 22 (Limitation on Benefits).