have a permanent establishment in that other country. This rule does not apply, however, if the insurance is placed through a broker or agent of independent status acting in the ordinary course of his or her business.

ARTICLE 6. INCOME FROM REAL PROPERTY

The proposed treaty provides that income from real property, including income from the leasing or use in any form of real property and income from agriculture or forestry, may be taxed by the country in which the real property or natural resources are situated. Additional rules regarding the taxation of dispositions of real property are provided in the article on capital gains (Article 13). The term "real property" has the meaning which it has under the law of the country in which the property in question is located. The term in any case includes property accessory to real property, livestock and equipment used in agriculture and forestry, rights to which the provisions of general law respecting landed property apply, usufruct of immovable property, and rights to variable or fixed payments as consideration for the working of, or the right to work, mineral deposits, sources and other natural resources. Ships, boats, and aircraft are not real property.

Although an election to compute tax on income from real property on a net basis is often included in U.S. tax treaties (and is included in the U.S. model treaty), no such election is provided for in the proposed treaty. Though the proposed treaty does not contain this election, such treatment is provided for U.S. real property income under the Code (secs. 871(d) and 882(d)). The Committee understands that a form of net basis taxation of Tunisian real property income is also provided under Tunisian domestic law.

Real property income may also be taxed by the taxpayer's country of residence. In such a case, residence-country taxation is subject to relief from double taxation (Article 23).

ARTICLE 7. BUSINESS PROFITS

United States Code rules

U.S. law distinguishes between the business income and the investment income of a nonresident alien or foreign corporation. A nonresident alien or foreign corporation is subject to a flat 30-percent rate (or lower treaty rate) of tax on certain U.S. source income if that income is not effectively connected with the conduct of a trade or business within the United States. The regular individual or corporate tax rates apply to income (from any source) that is effectively connected with the conduct of a trade or business within the United States.

The taxation of income as business or investment income varies depending upon whether the income is U.S. or foreign. In general, U.S. source periodic income (such as interest, dividends, rents, and wages), and U.S. source capital gains are effectively connected with the conduct of a trade or business within the United States only if the asset generating the income is used in or held for use in the conduct of the trade or business, or if the activities of the trade or business were a material factor in the realization of the income. All other U.S. source income of a person engaged in a trade or

business in the United States is treated as effectively connected with the conduct of a trade or business in the United States (thus, it is said to be taxed as if it were business income under a limited "force of attraction" rule).

In the case of foreign persons other than insurance companies, foreign source income is effectively connected income only if the foreign person has an office or other fixed place of business in the United States and the income is attributable to that place of business. For such persons, only three types of foreign source income can be effectively connected income: rents and royalties on intangible property derived from the active conduct of a licensing business; dividends and interest, derived in the active conduct of a banking, financing, or similar business in the United States, (or received by a corporation the principal business of which is trading in stocks or securities for its own account); and certain sales income attributable to a U.S. sales office.

The foreign source income of a foreign corporation that is subject to tax under the insurance company provisions of the Code may be treated as U.S.-effectively connected without regard to the foregoing rules, so long as such income is attributable to the U.S. business of the foreign corporation. In addition, the net investment income of such a company which must be treated as effectively connected with the conduct of an insurance business within the United States is not less than an amount based on a combination of asset/liability ratios and rates of return on investments experienced by the foreign person in its worldwide operations and by the U.S. insurance industry.

Trading in stocks, securities, or commodities in the United States for one's own account generally does not constitute a trade or business in the United States, and accordingly, income from those activities is not taxed by the United States as business income. Thus, income from trading through a U.S.-based employee, a resident broker, commission agent, custodian, or other agent, or from trading by a foreign person physically present in the United States generally is not taxed as business income. However, this rule does not apply to a dealer or to a corporation the principal business of which is trading in stocks or securities for its own account.

The Code, as amended by the 1986 Act, provides that any income or gain of a foreign person for any taxable year that is attributable to a transaction in any other taxable year will be treated as effectively connected with the conduct of a U.S. trade or business if it would have been so treated had it been taken into account in that other taxable year (Code sec. 864(c)(6)). In addition, the Code provides that if any property ceases to be used or held for use in connection with the conduct of a trade or business within the United States, the determination of whether any income or gain attributable to a sale or exchange of that property occurring within 10 years after the cessation of business is effectively connected with the conduct of trade or business within the United States shall be made as if the sale or exchange occurred immediately before the cessation of business (Code sec. 864(c)(7)).

Proposed treaty rules

Under the proposed treaty, business profits of an enterprise of one country are taxable in the other country (the "source country") only if the enterprise carries on business through a permanent establishment situated in the other country, and only to the extent that the profits are attributable to that permanent establishment. This is one of the basic limitations on a source country's right to tax income of a resident of the other country.

Article III of the proposed protocol contains a provision that is relevant to the rules contained in this article, as well as in the articles on dividends (Article 10), interest (Article 11), royalties (Article 12), capital gains (Article 13), independent personal services (Article 14), and other income (Article 21). That provision, which is consistent with Code section 864(c)(6), states that for the implementation of those articles, profits and income attributable to a permanent establishment or fixed base during its existence are taxable in the country in which the permanent establishment or fixed base is located, even if the payments of such profits and income are deferred until the permanent establishment or fixed base has ceased to exist.

The taxation of business profits under the proposed treaty differs from the U.S. rules for taxing business profits primarily by requiring more than merely being engaged in a trade or business before a country can tax business profits, and by substituting an "attributable to" standard for the Code's "effectively connected" standard. Under the Code, all that is necessary for effectively connected business profits to be taxed is that a trade or business be carried on in the United States. Under the proposed treaty, on the other hand, some level of fixed place of business must be present and the business profits must be attributable to that fixed place of business.

The business profits of a permanent establishment are determined on an arm's-length basis. Thus, there is attributed to a permanent establishment the business profits which might be expected to have been derived by it if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing at arm's length with the enterprise of which it is a permanent establishment, or with any other associated enterprise. For example, this arm's-length rule applies to transactions between a permanent establishment and a branch of the resident enterprise located in a third country. Amounts may be attributed whether they are from sources within or without the country in which the permanent establishment is located.

In computing taxable business profits, deductions generally are allowed under paragraph 3 of Article 7 for expenses, wherever incurred, that are incurred for the purposes of the business of the permanent establishment. These deductions include executive and general administrative expenses. Thus, for example, a U.S. company that has a branch office in Tunisia and its head office in the United States is, in computing the Tunisian tax liability of the branch, entitled to deduct a portion of the executive and general administrative expenses incurred in the United States by the head office for purposes of administering the branch. No such deduction is allowed, however, in respect of amounts paid (other than in re

imbursement of actual expenses) by the permanent establishment to the head office of the enterprise (or any other of its offices) by way of royalties, fees or other similar payments as consideration for the use of patents or other rights, or as commissions for specific services performed or for management, or as interest on moneys lent to the permanent establishment. A reciprocal rule applies for specified payments from the head office (or other office) to the permanent establishment.

Business profits are not attributed to a permanent establishment merely by reason of the purchase of merchandise by the permanent establishment for the account of the enterprise. Thus, if a permanent establishment purchases goods for its head office, the business profits attributed to the permanent establishment with respect to its other activities are not increased by a profit element in its purchasing activities. The method of determining profits attributable to a permanent establishment must be applied consistently from year to year, unless there is good and sufficient reason for using an inconsistent method.

Where business profits include items of income that are dealt with separately in other articles of the proposed treaty, those other articles, and not Article 7, generally govern the treatment of those items of income.

The proposed treaty provides that a partner's share of the business profits of a partnership is taxable in the country where the partnership has a permanent establishment.

Finally, the proposed treaty contains a provision designed to permit the tax authorities of either the United States or Tunisia to apply the provisions of the respective country's internal law in determining tax liability in cases where the information available to the competent authority is inadequate to accurately compute the profits of a permanent establishment. Such a determination must be done in a manner which, based on the available information, is consistent with the principles of Article 7 (e.g., allocation of profits on an arm's length basis). In accordance with the Technical Explanation, the Committee understands that the Internal Revenue Service has this authority notwithstanding this special provision.

ARTICLE 8. SHIPPING AND AIR TRANSPORT

As a general rule, the United States taxes the U.S. source income of a foreign person from the operation of ships or aircraft to or from the United States. An exemption from U.S. tax is provided if the income is earned by a corporation that is organized in, or an alien individual who is resident in, a foreign country that grants an equivalent exemption to U.S. corporations and residents. The United States has entered into agreements with a number of countries providing reciprocal tax exemptions for shipping and aircraft income.

Under the proposed treaty, the rights of the two countries to tax income that is derived from the operation of ships or aircraft in international traffic is limited to certain cases. Tunisia is permitted to tax such income only if the place of effective management of the enterprise is in Tunisia, or is aboard a ship whose home harbor is Tunisia or whose operator is a resident of Tunisia. The United

States is permitted to tax this income only if the enterprise is created under the laws of the United States or any State. It is the Committee's understanding that, in effect, each country is permitted to tax income from international shipping or air transport only if the enterprise is a resident of that country for domestic tax purposes. As explained in the Technical Explanation, both countries are permitted to tax such income of a dual resident company, subject to the provisions of the article providing relief from double taxation (Article 23).

These rules also apply to profits derived from the participation in a pool, joint business, or international operating agency.

Article 8 takes precedence over the article on business profits (Article 7). Thus, each country is required to exempt the shipping income of a resident of the other country, even if the income is attributable to a permanent establishment in the first country.

International traffic is any transportation by ship or aircraft, except where the transportation is solely between places in one of the countries (Article 3(1)(g) (General Definitions)).

Profits from the operation of ships or aircraft in international traffic include profits derived from the rental of ships or aircraft, if operated in international traffic by the lessee or if such rental profits are occasional and accessory to the actual operation of ships or aircraft in international traffic. In addition, those profits include income derived from the use, maintenance, or rental of containers, or other related equipment where the containers, equipment, etc. are used in international traffic, if such income is occasional and accessory to the actual operation of ships or aircraft in international traffic. As explained in the Technical Explanation, income derived from container leasing by companies not engaged in international shipping or air transport is covered by the article on business profits (Article 7) or independent personal services (Article 14), as appropriate. Thus, source-country taxation of container leasing income is permitted only if the income is attributable to a permanent establishment or a fixed base in the source country.

Rules similar to the rules provided in Article 8 apply to the taxation of gains from the disposition of ships or aircraft operated in international traffic (Article 13(4)).

ARTICLE 9. ASSOCIATED ENTERPRISES

The proposed treaty, like most other U.S. tax treaties, contains an arm's-length pricing provision, similar to Code section 482, that recognizes the right of each country to make an allocation of income, deductions, credits, or allowances to that country in the case of transactions between related enterprises to reflect the conditions and arrangements that would have been made between independent persons.

For purposes of the proposed treaty, an enterprise is related to another enterprise if either enterprise person owns or controls directly or indirectly the other, or if any third person or persons own or control directly or indirectly both enterprises.

If, pursuant to this article, one country includes in the profits of its resident, and taxes accordingly, profits on which a resident of the other country has been subjected to tax in that other country,