SERVICE RULES THAT NETHERLANDS COMPANY'S PROFITS ON LEASE PAYMENTS FROM U.S. SUBSIDIARY ARE TAX-EXEMPT

Rev. Rul. 86-156

ISSUE

Whether photocopy machines are "other like property" within the meaning of Article IX of the United States--Netherlands Income Tax Convention (the Treaty), 1950-1 C.B. 92, as amended by the Protocol of December 30, 1965 (1965 Protocol), 1967-2 C.B. 472, and, if not, whether payments for the lease thereof constitute industrial or commercial profits within the meaning of Article III of the Treaty.

FACTS

P, a corporation organized under the laws of the Netherlands, owns 100 percent of the stock of S, a corporation organized under the laws of the United States. P manufactures photocopy machines and leases them to S, and S makes periodic rental payments to P. P carries on a portion of its manufacturing operations in the Netherlands. P is not engaged in a trade or business within the United States through a permanent establishment. S subleases the photocopy machines to its United States customers.

LAW AND ANALYSIS

Article IX of the Treaty, prior to the 1965 Protocol, specifically exempted United States source royalties paid to a Netherlands corporation for the use of industrial, commercial, or scientific equipment, provided that the Netherlands corporation was not engaged in a trade or business within the United States through a permanent establishment.

Article IX(2), as amended by the 1965 Protocol, exempts United States source royalties, rentals, or amounts paid as consideration for the use of, or right to use, copyrights, artistic or scientific works, patents, designs, plans, secret processes or fumulae, trademarks, motion picture films, films or tapes for radio or television broadcasting, or other like property or rights, or information concerning industrial, commercial or scientific knowledge, experience or skill, provided that the Netherlands corporation does not have a permanent establishment within the United States to which such amounts are attributable.

Article III(1) of the Treaty, as amended by the 1965 Protocol, exempts industrial or commercial profits derived by a Netherlands enterprise to the extent not attributable to a permanent establishment in the United States. Article II(1)(g) defines a Netherlands enterprise as an industrial or commercial enterprise or undertaking carried on in the Netherlands by the taxpayer. Article III(5) of the Treaty, as amended by the 1965 Protocol, provides that industrial or commercial profits means income derived from the active conduct of a trade or business, but does not include income described in Article IX(2).

Other treaties use the phrase "other like property or rights" in relation to intangibles such as patents and copyrights, and use independently the phrase "industrial, commercial or scientific equipment." For example, Article XII(4)(a)(i) of the United States- Australia Income Tax Convention, T.I.A.S. No. 10773, exempts payments and credits for the use of any "copyright, patent . . . or other like property or right." Article XII(4)(a)(ii) separately exempts payments for the use of, or the right to use, "industrial, commercial or scientific equipment. . . ."

Where payments for the use of industrial, commercial or scientific equipment are to be exempted by the royalties article in a treaty, that article specifically states that such property is included within its scope. Therefore, the phrase "other like property or rights" contained in Article IX(2) of the Treaty, as amended by the 1965 Protocol, modifies only the items specifically enumerated in Article IX(2). The items of tangible property included in Article IX(2) are tapes, films, and artistic or scientific works. None of the items enumerated could possibly incorporate equipment. Consequently, the phrase "other like property or rights" cannot be interpreted to refer to industrial, commercial, or scientific equipment. Payments for the use of industrial, commercial or scientific equipment, therefore, are not covered by Article IX(2) and are exempt, if at all, under the business profits article (Article III) of the Treaty.

Article III(5) of the Treaty defines "industrial or commercial profits" as "income derived from the active conduct of a trade or business." Article III(1) provides that the exemption for industrial or commercial profits derived by a Netherlands enterprise is applicable only to income that is not attributable to a permanent establishment in the United States.

The phrases "industrial or commercial profits" and "income derived from the active conduct of a trade or business" do not require such profits or income of the Netherlands enterprise be derived by an active trade or business within the United States, but merely require that the income be derived from the active conduct of a trade or business conducted in whole or in part in the Netherlands by the Netherlands enterprise.

Article III of the Treaty, therefore, exempts United States source rentals or other payments for the use of industrial, commercial, or scientific equipment, provided that such amounts are attributable to a trade or business actively conducted in whole or in part in the Netherlands by the Netherlands enterprise and are not attributable to a permanent esttblishment in the United States.

HOLDING

Under the facts of this case, the rentals for photocopy machines derived by P from S constitute industrial or commercial profits derived by a Netherlands enterprise. Furthermore, the rentals are not attributable to a permanent establishment of P in the United States. Therefore, the rentals are exempt from United States tax under Article III of the Treaty.