Technical Explanation Convention and Protocol… US and Portugal… Taxes on Income, signed Sept 6, 1994

TREASURY DEPARTMENT TECHNICAL EXPLANATION OF THE
CONVENTION AND PROTOCOL BETWEEN THE
UNITED STATES OF AMERICA AND THE PORTUGUESE REPUBLIC
FOR THE AVOIDANCE OF DOUBLE TAXATION AND THE
PREVENTION OF FISCAL EVASION WITH RESPECT TO
TAXES ON INCOME SIGNED AT WASHINGTON
ON SEPTEMBER 6, 1994

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TREASURY DEPARTMENT TECHNICAL EXPLANATION OF THE
CONVENTION AND PROTOCOL BETWEEN THE
UNITED STATES OF AMERICA AND THE PORTUGUESE REPUBLIC
FOR THE AVOIDANCE OF DOUBLE TAXATION AND THE
PREVENTION OF FISCAL EVASION WITH RESPECT TO
TAXES ON INCOME SIGNED AT WASHINGTON
ON SEPTEMBER 6, 1994
INTRODUCTION
This is a technical explanation of the Convention between
the United states and Portugal signed on September 6, 1994 (the
"Convention"). The Convention is based on the u.s. Treasury
Department's former draft Model Income Tax Convention, published
on June 16, 1981, the Model Tax Convention on Income and Capital
published by the OECD in 1992 (the "OECD Model"), and recent U.S.
and Portuguese income tax conventions. Although the former u.s.
Model has been withdrawn pending development of a new model, it
was relevant at the time during which much of the Convention was
negotiated.
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.
The terms "he" or "his" should be read to mean also "she" or
"her."

Article 1. GENERAL SCOPE
This article provides that the Convention is applicable to
residents of the united States or Portugal except where the terms
of the Convention provide otherwise. Under Article 4 (Resident),
a person is 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 domicile or other similar criteria, subject to certaln
limitations. If a person is, under those criteria, a resident of
both Contracting states, a single state of residence (or no state
of residence) is assigned under Article 4. These rules govern
for all purposes of the Convention. certain provisions of the
Convention are also applicable, however, to persons who may not
be residents of either Contracting State. Examples include
Articles 26 (Non-Discrimination) and 28 (Exchange of
Information) .
Paragraph 1 of the Protocol contains the other provisions
normally included in the General Scope Article of U.s. income tax
treaties. Subparagraph l(a) (i) of the Protocol explains that the
Convention may not restrict any exclusion, exemption, deduction,
credit, or other benefit accorded by the tax laws of the
Contracting states. In effect, subparagraph l(a) (i) provides
that the Convention may not increase the overall tax burden on a
resident of a contracting state beyond the burden imposed under
domestic law. Thus, a right to tax granted by the Convention to
a contracting state cannot be exercised unless the domestic law
of that state also provides for such taxation.
Under the principle of subparagraph l(a) (i), a taxpayer's
U.s. tax liability need not be determined under the Convention if
the Internal Revenue Code would produce a more favorable result.
This does not mean, however, that a taxpayer may pick and choose
among Code and Convention provisions in an inconsistent manner in
order to minimize tax. For example, suppose a Portuguese
resident has three separate businesses in the United states. One
is a profitable permanent establishment and the other two are
trades or businesses that earn taxable income under the Code but
do not meet the permanent establishment threshold tests of the
Convention. One trade or business is profitable, and the other
incurs a loss. Under the Convention, the income of the permanent
establishment would be taxable, and both the profit and the loss
of the other two businesses would be ignored. Under the Code,
all three would be taxable and the loss would be offset against
the profits of the two profitable ventures. In this situation
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 loss trade or business against the profit of the
permanent establ~shment. (See Rev. Rul. 84-17, 1984-1 C.B. 308.)
If the taxpayer lnvokes the Code for the taxation of all three
venture~, ho~ever, he would not be precluded from invoking the
Conventl0n wlth respect, for example, to any dividend income he
may receive from the United States that is not effectively

-3-
connected with any of his business activities in the United
states.
Subparagraph l(a) (i) of the Protocol also provides that the
Convention does not override any benefit provided under other
bilateral agreements that were in force as of the date on which
the Convention was signed (September 6, 1994).
Subparagraph l(a) (ii) of the Protocol affects obligations
undertaken by the Contracting states under other agreements.
Subparagraph l(a) (ii) of the Protocol provides that,
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 this Convention, and the procedures under this Convention
exclusively shall apply to the dispute. Thus, dispute resolution
procedures provided for in trade, investment, or other agreements
between the Contracting states shall not apply for the purpose of
determining the scope of the Convention.
Subparagraph lea) (iii) of the Protocol provides that, unless
the competent authorities agree that a taxation measure is not
within the scope of this convention, the nondiscrimination
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, any national
treatment and MFN obligations undertaken by the Contracting
States under agreements other than the Convention, with the
exception of GATT as applicable to trade in goods, shall not
apply to a taxation measure.
Subparagraph l(a) (iv) of the Protocol defines a "measure" as
a law, regulation, rule, procedure, decision, administrative
action, or any other form of measure.
Subparagraph l(b) of the Protocol contains the traditional
U.S. treaty "saving clause." Under this paragraph, each
Contracting state may tax its residents, and the United States
may tax its citizens, in accordance with its domestic law,
notwithstanding any Convention provision to the contrary. If,
for example, a Portuguese 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 14
(Independent Personal Services) would normally prevent the United
states from taxing the income. If, however, the Portuguese
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

-4-
normal Code rules (i.e., without regard to Code section 894(a».
Special foreign tax credit rules concerning u.S. taxation of
certain income of u.S. citizens resident in Portugal are provided
in paragraph 2 of Article 25 (Relief from Double Taxation) .
For purposes of the saving clause of paragraph l(b) of the
Protocol, residence is determined under Article 4 (Resident).
Subparagraph l(b) of the Protocol states that 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 the period of 10 years following such loss.
This permits the United States to apply the rules of Code section
877. Subparagraph l(b) of the Protocol concludes by providing
that, upon request by the Portuguese competent authority, the
competent authorities will consult under Article 27 (Mutual
Agreement Procedure) on the purposes of such loss of citizenship.
Thus, if the united states taxes a former u.S. citizen who is a
resident of Portugal, the Portuguese competent authorities may
request a discussion with their u.S. counterparts of the
circumstances involved in the case.
Subparagraph l(c) of the Protocol lists several exceptions
to the saving clause, under which benefits granted by a
Contracting State under the Convention are extended to its
citizens and residents. Under subparagraph l(c) (i), u.S.
residents and citizens are entitled to the following u.S.
benefits provided under the Convention: the corresponding
adjustments authorized by paragraph 2 of Article 9 (Associated
Enterprises); the provisions of paragraph 3 of Article 14
(Capital Gains) regarding gain from the alienation of certain
property; the exemption from u.S. tax of social security benefits
paid by Portugal that is provided in subparagraph l(b) of Article
20 (pensions, Annuities, Alimony, and Child Support); the
exemption from u.S. tax of child support payments paid by a
Portuguese resident that is provided in paragraph 4 of Article 20
(Pensions, Annuities, Alimony, and Child Support); the foreign
tax credit provisions of Article 25 (Relief from Double
Taxation); the nondiscrimination protection of Article 26 (Non-
Discrimination); and the competent authority procedures of
Article 27 (Mutual Agreement Procedure).
Subparagraph l(c) (ii) of the Protocol provides additional
exceptions to the saving clause for individuals resident in a
Contracting State who are neither citizens of, nor have immigrant
status in, that state. These exceptions preserve the benefits
extended by the united States under the Convention to persons
other than u.S. citizens and "green card" holders who are:
employees of the Portuguese Government under Article 21
(Government Service); visiting teachers or researchers under
Article 22 (Teachers and Researchers); visiting students or
trainees under Article 23 (Students and Trainees); or members of

-5-
diplomatic or consular missions under Article 29 (Diplomatic
Agents and Consular Officers).
Article 2. TAXES COVERED
This Article identifies the U.S. and Portuguese taxes to
which all articles of the Convention apply. certain provisions
of the Convention and the Protocol are also applicable, however,
with respect to certain taxes in addition to those specified in
Article 2. For example, Article 26 (Non-Discrimination) applies
with respect to all taxes imposed at all levels of gqvernment,
including state and local governments. Article 28 (Exchange of
Information) applies with respect to all taxes imposed by a
Contracting State (i.e., at the national level). Paragraph 8 of
the Protocol applies with respect to the substitute gift and
inheritance tax (Imposto sobre Sucessoes e Doacoes por Avenca)
imposed by Portugal.
In the case of Portugal, the Convention generally applies to
the personal income tax (Imposto sobre 0 Rendimento das Pessoas
Singulares-IRS), the corporate income tax (Imposto sobre 0
Rendimento das Pessoas Colectivas-IRC), and the local surtax on
corporate income tax (Derrama). As noted above, other
provisions, such as Articles 26 (Non-Discrimination) and 28
(Exchange of Information) of the Convention and paragraph 8 of
the Protocol, apply to certain additional taxes.
In the case of the United states, the Convention generally
applies to the Federal income taxes imposed by the Internal
Revenue Code. The Convention applies to the excise taxes imposed
with respect to the investment income of private foundations
under Code sections 4940 et ~, but does not apply with respect
to the excise taxes imposed on insurance premiums paid on
policies issued by foreign insurers under Code section 4371. The
social security taxes provided in Code sections 1401, 3101, and
3111 are generally excluded from coverage. However, as noted
above, certain other provisions of the convention, such as
Articles 26 (Non-Discrimination) and 28 (Exchange of
Information), apply to all taxes imposed by the United states,
including the insurance premiums excise taxes and the social
security taxes. In addition, as in other U.s. treaties, Article
26 (Non-Discrimination) applies to taxes imposed by state and
local governments.
Under paragraph 2 of Article 2 (Taxes Covered), the
Convention will apply to any taxes that are identical or
substantially similar to those enumerated in paragraph 1 and that
are imposed in addition to, or in place of, the existing taxes
after September 6, 1994 (the date of signature of the
Convention). Paragraph 2 also provides that the U.s. and
Portuguese competent authorities will notify each other of
changes in their taxation laws that are of significance to the

-6-
operation of the Convention. The competent authorities will also
notify each other of official published materials concerning the
application of the Convention.
Paragraph 2 of the Protocol provides additional information
regarding taxes that are and are not covered. Paragraph 2(a) of
the Protocol clarifies that Article 2 does not apply to social
security contributions established under Portuguese law. These
amounts are not covered because, as under the U.S. system, they
are treated as contributions to Portugal's social security
system, not as taxes. As noted above, Article 2 itself makes
clear that U.S. social security contributions are not covered.
Subparagraph 2(b) of the Protocol limits the application of
the Convention with respect to the personal holding company tax
(Code section 541) and the accumulated earnings tax (Code section
531). Subparagraph 2(b) (i) exempts a Portuguese company from
liability for the personal holding company tax only for taxable
years in which all of the Portuguese company's stock is owned by
individuals who are not residents or citizens of the United
States, in their capacity as individuals. Thus, if there is any
owner that is not an individual, or any owner that is a U.S.
citizen or U.S. resident, the Portuguese company may be liable
for the personal holding company tax. Under subparagraph
2(b) (ii) of the Protocol, Portuguese companies that are described
in paragraph l(c) of Article 17 (Limitation on Benefits), which
pertains to certain publicly traded companies, are exempt from
the accumulated earnings tax. In general, this is intended to
relieve such a Portuguese company from any obligation to prove
that its earnings and profits have not accumulated beyond the
reasonable needs of the company. It is understood that such
publicly traded companies are unlikely to be mere holding or
investment companies and that the interests of the shareholders
of such companies are likely to operate so as to prevent an
unreasonable accumulation of earnings and profits.
Article 3. GENERAL DEFINITIONS
Paragraph 1 defines a number of basic terms used in the
Convention. certain other terms are defined in other articles of
the Convention. For example, the term "resident of a Contracting
State" is defined in Article 4 (Resident). The term "permanent
establishmen~".is define~ in Article 5 (Permanent Establishment).
The terms "dlvldends," "lnterest," and "royalties" are defined in
Article
7
10 (Divide~ds), 11 (Interest), and 12 (Royalties),
respectlvely. The lntroductory language makes clear that the
definitions specified in paragraph 1 apply for all purposes of
the Convention, unless the context otherwise requires. The
latter condition allows flexibility in interpretation of the
treaty in order to avoid results not intended by the treaty's
'I"IP(,H"lt-; ntors.

-7-
Subparagraph l(a) defines the term "Contracting State" to
mean the united states or Portugal, depending on the context in
which the term is used.
Subparagraph l(b) defines the term "Portugal" to mean the
Portuguese Republic. This includes the territory on the European
continent and the archipelagoes of AZores and Madeira, the
respective territorial seas and any other zone in which, in
accordance with the laws of Portugal and international law, the
Portuguese Republic has sovereign rights with respect to the
exploration and exploitation of the natural resources of the
seabed and subsoil and of the superjacent waters.
Subparagraph l(c) defines the term "united States" to mean
the united States of America. The term does not include Puerto
Rico or the Virgin Islands, Guam, or any other u.s. possession or
territory. When used in a geographical sense, the term "united
states" includes the States, the District of Columbia, the
territorial sea adjacent to those States, and any other zone
adjacent thereto over which, in accordance with the laws of the
united States and international law, the united states has
sovereign rights with respect to the exploration and exploitation
of the natural resources of the seabed and subsoil and of the
superjacent waters.
Subparagraph l(d) defines the term "person" to include an
individual, a company, and any other body of persons. This
definition is consistent which that used in the OECD Model and in
other u.s. treaties. Any person that qualifies as a "resident"
of a Contracting State under Article 4 (Resident) is entitled to
the benefits of the Convention, subject to the provisions of
Article 17 (Limitation on Benefits).
subparagraph l(e) defines the term "company" as any body
corporate or any entity treated as a body corporate for tax
purposes. In the case of the united States, the rules of Treas.
Reg. §301.770l-2 generally will apply to determine whether an
entity is an association taxable as a corporation, and thus is a
company, for purposes of the Convention. Similarly, in the case
of the united states, a publicly traded partnership that is
treated as a corporation under Code section 7704 will be treated
as a company for purposes of the Convention.
Subparagraph l(f) defines the terms "enterprise of a
Contracting state" and "enterprise of the other contracting
State" to mean an enterprise carried on by a resident of the
appropriate contracting State. Thus, an enterprise of a
Contracting state need not be carried on in that State. It may
be carried on in the other state or in a third state.
Subparagraph l(g) defines the term "national" to mean any
individual possessing the nationality of a Contracting state and

-8-
any legal person, association, or other entity deriving its
status as such from the laws in the force in a Contracting state.
This definition, which comes from the OECD Model, has been used
in other u.s. treaties. In the case of the united states, the
term "national" means a u.s. citizen when applied to an
individual.
Subparagraph l(h) defines the term "international traffic"
to mean any transport by a ship or aircraft, except when such
transport is solely between places within a Contracting state.
The exclusion from international traffic of transport solely
between places within a Contracting state means, for example,
that the transport of goods or passengers solely between New York
and Chicago by a Portuguese carrier (if permitted) would not be
treated as international traffic. If, however, goods or
passengers were carried by a Portuguese airline from Lisbon to
New York and then to Chicago, the entire trip would be considered
international traffic. This would be true even if a Portuguese
carrier transferred goods at the u.s. port of entry from a ship
or plane to a land vehicle, or if the overland portion of the
trip in the United states were handled by an independent carrier
under contract with the Portuguese carrier, so long as both parts
of the trip were reflected in the original bill of lading.
Subparagraph l(i) defines the term "competent authority."
The competent authorities of the Contracting states are charged
with administering the provisions of the Convention and with
attempting to resolve any doubts or difficulties that may arise
in interpreting its provisions. 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, delegated
the authority to the Assistant Commissioner (International).
With respect to interpretive issues, the Assistant Commissioner
acts with the concurrence of the Associate Chief Counsel
(International) of the Internal Revenue Service. In Portugal,
the competent authority is the Minister of Finance, the Director
General of Taxation (Director Geral das Contribuicoes e
Impostos), or their authorized representative.
Paragraph 2 of Article 3 provides that, in the application
of the Convention, any term used but not defined in the
Convention will have the meaning that it has under the tax law of
the cont:acting State whose tax is b
7
ing applied. If, however,
the meanlng of a term cannot be readlly determined under the law
of a Contracting state, or if there is a conflict in meaning
under the laws of the two States that creates difficulties in the
application of the convention, the competent authorities may
pursuant to paragraph 3 of Article 27 (Mutual Agreement '
Procedure), agree to a common meaning in order to prevent double
taxation or further any other purpose of the Convention.
Likewise, if the definition of a term under either paragraph 1 of

-9-
Article 3 or the tax law of a Contracting state would result in a
circumstance unintended by the treaty negotiators or by the
contracting states, the competent authorities may agree to a
common
meaning of the term. This cornman meaning need not conform
to the meaning of the term under the laws of either contracting
state.
Article 4. RESIDENT
This Article 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.
However, the fact that a person is determined to be a resident of
a contracting state under Article 4 does not necessarily entitle
that person to the benefits of the Convention. In addition to
being a resident, a person must qualify for benefits under
Article 17 (Limitation on Benefits).
Under paragraph 1, the determination of residence for
Convention purposes looks first to a person's liability to tax as
a resident under the taxation laws of the Contracting state
involved. Thus, a person that is liable to tax under the laws of
a contracting State by reason of its domicile, residence, place
of management, place of incorporation, or any other similar
criterion is treated as a resident of that State. A person that,
under those laws, is a resident of one contracting State and not
of the other generally need look no further.
Paragraph 1 concludes with an exception to the general rule
of this paragraph. A person that is liable to tax in a
contracting state Qnly in respect of income from sources within
that state will not be treated as a resident of that Contracting
State for purposes of the Convention. Thus, for example, a
Portuguese consular official who is posted in the United States,
and who is subject to u.S. tax on U.s. source investment income
but not on non-U.S. source income, would not be considered a
resident of the United states for purposes of the Convention.
(In most cases, such an individual also would not be a U.s.
resident under the Code.)
Paragraph 2 provides a series of tie-breaker rules to
determine a single State of residence for an individual who,
under the laws of each Contracting State, and thus under
paragraph 1, is deemed to be a resident of both Contracting
states. These rules, which are generally included in u.s.
treaties, come from the OECD Model. The first rule establishes
residence where the individual has a permanent home. If that
test is inconclusive because the individual has a permanent home
available to him in both States, he will be considered to be a
resident of the Contracting state with which his personal and
economic relations are closest, i.e., the location of his "center

-10-
of vital interests." If this test is also inconclusive, or if he
does not have a permanent horne available to him in either state,
he will be treated as a resident of the contracting state where
he maintains an habitual abode. If he has an habitual abode in
both states or in neither, he will be treated as a resident of
the Contracting state of which he is a citizen. If he is a
citizen of both states or of neither, the competent authorities
are instructed to determine his residence by mutual agreement.
Paragraph 3 seeks to settle dual-residence issues for
persons other than individuals. A corporation is treated as a
resident in the united states if it is created or organized under
the laws of the United states or a political subdivision thereof.
In Portugal, a corporation is treated as a resident of portugal
if it is either incorporated there or managed and controlled
there. Dual residence, therefore, can arise if a u.s.-
incorporated corporation is managed in Portugal. Since neither
party was prepared to give up its test of corporate residence
under a tie-breaker rule, the paragraph provides that if a
corporation or other person, other than an individual, is
resident in both the United states and Portugal under paragraph
1, the competent authorities shall seek to determine a single
State of residence for that person for purposes of the
Convention. If, however, they are unable to reach agreement,
that person shall not be considered to be a resident of either
the united States or Portugal for purposes of deriving any
benefits of the Convention. Since it is only for the purposes of
deriving treaty benefits that such dual residents are excluded
from the Convention, they may be treated as resident for other
purposes. For example, if a dual resident corporation pays a
dividend to a resident of Portugal, the U.s. withholding agent
would be permitted to withhold on that dividend at the
appropriate treaty rate, since reduced withholding is a benefit
enjoyed by the resident of Portugal, not by the dual resident.
The dual resident corporation that pays the dividend would, for
this purpose, be treated as a resident of the United states under
the Convention.
Paragraph 3 of the Protocol provides fUrther guidance on the
issue of residence. Under subparagraph 3(a) of the Protocol a
partnership, similar pass-through entity, estate, or trust will
be treated as a resident of a Contracting state to the extent
that the income derived by the partnership, similar pass-through
entity, estate, or trust is subject to tax in that State as the
income of a resident, whether in the hands of the entity deriving
the income or in the hands of its partners, members
beneficiaries, or grantors. This rule is applied t; determine
the extent to wh~ch inco~e.received by or through an estate,
trust, partnership, or similar pass-through entity such as a U.S.
limited liability company, from the other Contracting State is
entitled to Convention benefits.

-11-
Und
7
r,U.S. law, par~nerships (other than certain publicly
traded llmlted partnersh~ps and partnerships that are classified
as associations under Treas. Reg. § 301.7701-2) are never, and
estates and trusts often are not, taxable entities. Thus for
" ,
Conventlon purposes, ~ncome received by a U.S. partnership
generally is treated as received by a U.S. resident only to the
extent that it is included in the distributive share of partners
who are u.s. residents (looking through any partnerships that are
themselves partners). Similarly, the treatment under the
Convention of income received by a U.S. 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.
Subparagraph 3(b) (i) of the Protocol confirms that the term
"resident of a Contracting statel1 includes any not-for-profit
organization constituted and maintained in that State, provided
that the laws of such State or of a political or administrative
subdivision thereof limit the use of the organization's
resources, both currently and upon the dissolution or liquidation
of such organization, to the accomplishment of the purposes that
serve as the basis for such organization's exemption from income
tax. Subparagraph 3(b) (ii) of the Protocol similarly confirms
that a pension trust or any other organization or arrangement
that is constituted and operated exclusively to provide pension,
retirement, or employee benefits and that is established or
sponsored by a person that is otherwise a resident of a
Contracting State under Article 4 (Residence) is to be treated as
a resident of that State for purposes of the Convention. This is
the case notwithstanding the fact that all or part of the income
of the organization, trust, or other arrangement may be exempt
from income tax under the domestic laws of that State.
Under subparagraph 3(c) of the Protocol, a U.S. citizen or a
nonresident alien lawfully admitted for permanent residence (a
"green card" holder) will be treated as a U.s. resident by
Portugal for purposes of the Convention only if such individual
has a substantial presence in the united States or would be
treated as a resident of the united states and not of a third
country under the principles ~f subparagraphs (a) and (b) ~f,
paragraph 2 of Article 4 (Resldence). Therefore, a U.S. c1tlzen
or "green card" holder whose permane~t hom
7
,
center,of vital
interests and habitual abode are ne1ther 1n the Unlted States
nor in po~tugal, and who does not have a sub~tantial prese~ce in
the United states, generally will not be ent1tle~ to benef~ts
under the Convention. (However, as noted above 1n connectlon
with Article 1 (Personal Scope), limited con~ention ben
7
fits are
available to certain persons who are not resldents of elther
contracting State.)

-12-
The Article does not contain the explicit provision, found
in some u.s. treaties, that the government of a Contracting state
is a resident of that State. It was not considered necessary to
clarify this point, because it is understood by both Portugal and
the united states that the Government of each contracting state
and political or administrative subdivisions and local
authorities thereof are residents of that state for purposes of
the Convention.
Article 5. PERMANENT ESTABLISHMENT
This Article defines the term "permanent establishment,"
which is relevant to several articles of the Convention. For
example, under Article 7 (Business Profits), a Contracting state
may not tax the business profits of a resident of the other
Contracting state unless that resident has a permanent
establishment in the first Contracting state. Articles 10
(Dividends), 11 (Interest), and 12 (Royalties) 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. If the income is
attributable to a permanent establishment, Article 7 (Business
Profits) applies, and if the income is attributable to a fixed
base, Article 14 (Independent Personal Services) applies.
Paragraph 1 provides the basic definition of 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. In the case of an
individual, Article 15 (Independent Personal Services) uses the
concept of a "fixed base," rather than a "permanent
establishment," but the two concepts are considered to be
similar.
Paragraph 2 contains a list of examples of fixed places of
business that constitute a permanent establishment: a place of
management, a branch, an office, a factory, a workshop, and a
mine, oil or gas well, quarry or other place of extraction of
natural resources. The use of singular nouns in this
illustrative list is not meant to imply that each such place of
business constitutes a separate permanent establishment. In the
case of mines or wells, for example, several such places of
business could constitute a single permanent establishment if the
project forms a commercial and geographical whole.
Paragraph 3 adds that the term "permanent establishment"
also includes a building site or a construction installation or
assembly project, supervisory activities in connection with such
a site or project, or,an installation or drilling rig or ship
used for the exploratlon or development of natural resources but
only if such site, project, or activities last more than 6 '

-13-
months. This 6-month threshold applies separately to each
individual site or project. The testing period begins when work
(including preparatory work carried on by the resident)
physically begins in a Contracting state. A series of contracts
or projects that are commercially and geographically
interdependent are to be treated as a single project. For
example, the construction of a housing development would be
considered a single project even if each house were constructed
for a different purchaser. Likewise, the drilling of several
wells within the same geographic area would be considered a
single permanent establishment. If the 6-month threshold is
exceeded, the site or project constitutes a permanent
establishment from its first day. This interpretation of the
Article is based on the Commentaries to paragraph 3 of Article 5
of the OECD Model, which constitute the generally accepted
international interpretation of the language in paragraph 3 of
Article 5 of the Convention.
Paragraph 4 provides that, notwithstanding the preceding
provisions of this Article, an enterprise of a contracting state
that carries on business of a permanent nature in the other
Contracting state through its own employees or any other
personnel engaged for such purpose for a period or periods
totalling 9 months or more in any 12-month period commencing or
ending in the taxable year concerned shall be deemed to have a
permanent establishment in the other state. In this context,
"business of a permanent nature" is intended to suggest business
other than that of a preparatory or auxiliary character. The 9-
month rule of this paragraph is, however, limited by paragraph 4
of the Protocol, which states that the provisions of this
paragraph shall apply only for the first 5 years in which the
provisions of the Convention have effect. For example, if the
Convention were to enter into force on July 3, 1995, paragraph 4
of Article 5 (Permanent Establishment) would be in effect only
for taxable periods beginning on or after January 1, 1996 and
before January 1, 2001.
Paragraph 5 is drawn directly from the OECD Model and lists
a number of activities that may be carried on through a fixed
place of business but that, nevertheless, will not give rise to a
permanent establishment. Under subparagraph 5(a), the use of
facilities solely to store, display, or deliver merchandise
belonging to an enterprise will not constitute a permanent
establishment of that enterprise. Under subparagraphs 5(b) and
5(C), 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 will not give rise to a permanent establishment of the
first-mentioned enterprise. Under subparagraphs 5(d) and 5(e),
the maintenance of a fixed place of business solely for
purchasing goods or collecting information for the enterprise, or
for carrying out any other activity of a preparatory or auxiliary

-14-
character for the enterprise (~, advertising, the supply of
information, or certain research activities) will not constitute
a permanent establishment of the enterprise. Finally, under
subparagraph 5(f), a combination of the activities described in
paragraph 5 will not give rise to a permanent establishment,
provided that the overall activity of the fixed place of business
resulting from this combination is of a preparatory or auxiliary
character. This is the same as the corresponding provision in
many other u.s. income tax treaties, as well as in the DECD
Model.
Paragraphs 6 and 7 specify when the activities of an agent
will give rise to a permanent establishment. Under paragraph 6,
an enterprise will be deemed to have a permanent establishment as
a result of the activities of a dependent agent 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 5 that
would not constitute a permanent establishment if carried on by
the enterprise through a fixed place of business, the activities
of the agent will not cause the enterprise to be deemed to have a
permanent establishment.
Under paragraph 7, 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 a broker or general commission agent, if the agent is
acting in the ordinary course of his business as an independent
agent.
Paragraph 8 provides that a company that is a resident of a
Contracting State will not be 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 state or that carries on business in that other State.
The determination of whether a permanent establishment exists
will be made solely on the basis of the factors described in
paragraphs 1 through 7 of the Article and paragraph 4 of the
Protocol. Whether a company is a permanent establishment of a
related company, therefore, is based solely on those factors and
not on the ownership or control relationship between the
companies.
Article 6. INCOME FROM IMMOVABLE PROPERTY (REAL PROPERTY)
Paragraph 1 provides the general rule that income derived by
a resident of a Contracting State from immovable property (real
property) located in the other Contracting State, including
income from agriculture or forestry, may be taxed in that other
State. The income may also be taxed in the State of residence.
Thus the Article does not grant an exclusive taxing right to the
situs state, but merely grants it the primary right to tax.

-15-
Paragraph 2 defines the term "immovable property" or "real
property" by reference to the domestic law of the situs state.
In addition, the paragraph specifies certain classes of property
that, regardless of domestic law definitions, are to be included
within the meaning of the term for purposes of the Convention.
It also specifies that the term "real property" does not include
ships or aircraft in any event.
Paragraph 3 clarifies that all forms of income from the
exploitation of real property are taxable in the situs state,
including but not limited to income from direct use of real
property by the owner and rental income from the letting of real
property. Income from the disposition of real property, however,
is not considered to be income derived from real property and is
not covered by this Article. The taxation of such amounts is
addressed in Article 14 (Capital Gains). similarly, interest
paid on a mortgage on real property and distributions by a U.s.
real estate investment trust are not considered to be income
derived from real property. The taxation of these items is
addressed in Articles 10 (Interest) and 11 (Dividends),
respectively.
Paragraph 4 clarifies that income from real property of an
enterprise is covered by this Article and not by Article 7
(Business Profits). Similarly, income from real property used
for the performance of independent personal services is covered
by this Article and not by Article 14 (Independent Personal
Services). Thus, the situs State may tax the real property
income of a resident of the other State even if such income is
not attributable to a permanent establishment or fixed base of an
enterprise of that resident in the situs State.
The provision in the former U.S. Model for a binding
election by the taxpayer to be taxed on real property income on a
net basis was not included in the Convention. Portugal permits
taxation on a net basis only if the income is attributable to a
permanent establishment. otherwise, tax is imposed on the gross
amount, subject to a withholding of 25 percent by the payer.
This is similar to the situation with Spain.
Paragraph 5 of the Protocol clarifies that the provisions of
Article 6 also apply to income from associated personal property
and from the provision of services for the maintenance or
operation of real property.
Article 7. BUSINESS PROFITS
This Article provides rules for the taxation by a
Contracting state of the business profits of an enterprise of the
other Contracting state. Paragraph 1 provides the general rule
that business profits of an enterprise of one Contracting State
may not be taxed by the other contracting state unless the

-16-
enterprise carries on or has carried 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 in which the permanent
establishment is situated may tax the business profits of the
enterprise, but only so much as is attributable to that permanent
establishment.
Paragraph 2 provides that the Contracting states will
attribute to a permanent establishment the profits that 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 and dealing wholly independently with
the enterprise of which it is a permanent establishment and with
any other associated enterprise. The computation of business
profits attributable to a permanent establishment under this
paragraph is subject to the rules of paragraph 3 for the
allowance of expenses incurred for purposes of earning the
income.
Profits attributable to a permanent establishment are
taxable in the State where the permanent establishment is
situated or was situated at the time the profits were derived.
This rule incorporates the rule of Code section 864(c) (6) with
respect to deferred payments, which is also reflected in the
provisions of Articles 11 (Interest), 13 (Royalties), 15
(Independent Personal Services), and 24 (Other Income) dealing
with amounts attributable to a permanent establishment or fixed
base. If income is attributable to a permanent establishment or
fixed base, it is taxable by the state where the permanent
establishment or fixed base was located, even if the income is
deferred (i.e., not taken into account) until the permanent
establishment or fixed base has ceased to exist.
The concept of "attributable to" in paragraph 2 is analogous
to, but somewhat narrower than, the concept of "effectively
connected" in Code section 864(c). For example, the profits
attributable to a permanent establishment may be from sources
within or without a Contracting State. Thus, Code section
864(c) (3) is consistent with paragraph 2, i.e., the items of
foreign source income described in Code section 864(c) (4) (B) may
be attributed to a u.s. permanent establishment of a Portuguese
resident and subject to tax in the United States. The limited
"force of attraction" rule in Code section 864(c) (3) is not
applicable under the Convention, however, because only those
profits attributable to a permanent establishment's assets or
activities may be taxed by the Contracting State in which the
permanent establishment is located.
Paragraph 3 provides that, in determining the business
profits of a permanent establishment, deductions shall be allowed
for expenses that are incurred for the purposes of the permanent

-17-
establishment. These include expenses directly incurred by the
permanent establishment and a reasonable allocation of expenses
incurred by the home office, or by other permanent establishments
of the home office, as long as the expenses were incurred for the
purposes of the permanent establishment. Such expenses include,
but are not limited to, research and development expenses,
interest, and executive and general administrative expenses,
wherever incurred and without regard to whether they are actually
reimbursed by the permanent establishment.
In connection with paragraph 3, paragraph 6 of the Protocol
confirms that it is understood that each Contracting state may
apply its own domestic law, whether based on tracing or
allocation, for attributing research and development expenses,
interest, and other similar expenses to a permanent establishment
situated in its territory, provided that such rules are
consistent with the provisions of Article 7. This language
confirms that the united States may apply its expense allocation
rules under Treas. Reg. §§ 1.861-8 and 1.882-5.
Paragraph 4 provides that no business profits will be
attributed to a permanent establishment merely because it
purchases goods or merchandise for the enterprise of which it is
a permanent establishment. This rule refers to a permanent
establishment that performs more than one function for the
enterprise, including purchasing. For example, the 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 establish-
ment with respect to its sales activities, no profits are
attributable to it with respect to its purchasing activities. If
the sole activity of the office were the purchasing of goods or
merchandise for the enterprise, however, the issue of the
attribution of income would not arise. Under subparagraph 5(d)
of Article 5 (Permanent Establishment), the office would not be a
permanent establishment to which profits could be attributed.
Paragraph 5 is intended to assure consistent tax treatment
over time for permanent establishments by providing that profits
shall be determined by the same method of accounting each year,
unless there is good reason to change the method used. This
provision, however, does not restrict a Contracting State from
imposing additional requirements on a permanent establishment, as
provided in its law, in the event of a change in accounting
method, to prevent amounts from being duplicated or omitted (see,
~, code section 481).
Paragraph 6 coordinates the provisions of this Article and
other provisions of the Convention. Under paragraph 6, where
business profits include items of income that are dealt with
separately under other articles of the Convention, the provisions
Df those other articles will take precedence over the provisions

-18-
of Article 7, except where they specifically provide to the
contrary. Thus, for example, the taxation of interest will be
determined by the rules of Article 11 (Interest), and not by
Article 7, except where (as provided in paragraph 6 of Article
11) the interest is attributable to a permanent establishment.
This Article is subject to the "saving clause" of
subparagraph l(b) of the Protocol. Thus, if a citizen of the
United states who is a resident of Portugal 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 24 (Relief from Double Taxation),
tax those profits, notwithstanding the provisions of this
Article.
Article 8. SHIPPING AND AIR TRANSPORT
This Article governs the taxation of profits from the
operation of ships and aircraft in international traffic. Under
paragraph 1, profits derived by an enterprise of a Contracting
state from the operation of ships or aircraft in international
traffic are taxable only in that state. By virtue of paragraph 6
of Article 7 (Business Profits), profits of an enterprise of a
contracting state that are exempt in the other Contracting state
under this paragraph are exempt in that other State even if the
enterprise has a permanent establishment there.
Paragraph 2 clarifies that the provisions of paragraph 1
apply to income from participation in a pool, joint business, or
international operating agency. This refers to various
arrangements for international cooperation by carriers in
shipping and air transport. For example, if the Portuguese
airline, TAP, were to form a consortium with airlines of other
countries, the Portuguese participant's share of the total income
derived by the consortium from u.s. sources would be covered by
this Article.
Paragraph 7 of the Protocol clarifies what income is to be
considered profits from the operation of ships or aircraft. It
specifies that the term "income from the operation of ships or
aircraft in international traffic" is to be interpreted in
accordance with paragraphs 5 to 12 of the Commentary to Article 8
of the 1992 OECD Model. As such, it is understood that full
charters of ships and aircraft used in international traffic are
covered by paragraph 1. International Shipping profits include
rents from bareboat charters made by shipping and aircraft
companies only when such charters are occasional and incidental
to the international traffic operations of those companies.
Rental income from bareboat charters that are not occasional and
incidental to the lessor's international traffic operations are
not covered by this Article, but may be covered by other articles

-19-
of the Convention, such as Article 13 (Royalties) or Article 7
(Business Profits). Thus, if an oil company that owns a deep-
water tug (used in its offshore oil explorations) were to make a
bareboat rental of that tug during periods of idle use, the
income from such rental would not be covered by Article 8 because
such company is not normally engaged in international traffic.
It is also understood that the occasional and incidental leasing
of terminal facilities for the loading and unloading of cargo or
passengers would be auxiliary activity covered by the definition
of international shipping profits if carried on by an operating
company.
The "profits of an enterprise of a Contracting state from
the operation of ships or aircraft in international traffic"
include those profits accruing to the enterprise that are
attributable to transport between places in the other Contracting
state when such transport is in connection with or incidental to
transport outside of the other Contracting state, regardless of
whether such transport is actually conducted by the enterprise.
That is, because such transport is not solely between places
within the other contracting state but, rather, is in connection
with or incidental to transport outside of the other Contracting
state, such transport is covered by the definition of
international traffic. For example, when a shipping enterprise
of a Contracting state undertakes to provide, in connection with
such transport, for the transshipment and delivery by rail of the
transported goods to a consignee within the other contracting
state and derives profits from either direct payments by the
consignee or commissions from the transshipment agent, such
profits are part of the shipping enterprise's profits from the
international traffic and, as such, are not taxable in the other
Contracting state.
Profits of an enterprise of a Contracting state from the
use, maintenance, or rental of containers, and related equipment
for the transport of containers, used for the transport of goods
or merchandise in international traffic are treated as royalties,
unless attributable to a permanent establishment. However,
paragraph 11 of the Protocol provides that such royalties are
taxable only by the Contracting State of which the recipient is a
resident. It is understood that in the context of paragraph 11
of the Protocol, the term "containers" includes related equipment
incidental to the transport of containers, such as cranes and
trailers.
Article 9. ASSOCIATED ENTERPRISES
This Article incorporates into the Convention the general
principles of Code section 482. It provides generally that when
a resident of one Contracting state engages in transactions with
a related person resident in the other contracting state, and
such transactions are not conducted on an arm's length basis, the

-20-
Contracting States may make appropriate adjustments to the
taxable income and tax liability of such persons to reflect the
income or tax liability with respect to such transactions that
each person would have had if the relationship between them had
been at arm's length.
Paragraph 1 deals with the circumstances where 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 when the same persons participate directly
or indirectly in the management, control, or capital of an
enterprise of one Contracting state and of an enterprise of the
other Contracting state. The term "control" includes any kind of
control, whether or not legally enforceable and however exercised
or exercisable. If, in either circumstance, the two enterprises
make or impose conditions in their commercial or financial
relations that differ from the conditions that would exist in
relations between independent enterprises, the competent
authorities may adjust the income of the related enterprises to
reflect the profits that would have accrued to either enterprise
if the two enterprises had been independent of each other.
Paragraph 2 provides that, where a Contracting State has
made an adjustment that is consistent with the provisions of
paragraph 1, the other Contracting state will make an appropriate
corresponding adjustment to the tax liability of the related
enterprise in that other state. It is understood that the other
Contracting State need adjust its tax only if it agrees that the
initial adjustment under paragraph 1 is appropriate. The
Contracting state making a corresponding adjustment under this
paragraph will take the other provisions of the Convention into
account. For example, if the effect of a corresponding
adjustment is to treat a Portuguese corporation as having made a
distribution of profits to its u.s. parent corporation, the
provisions of Article 10 (Dividends) will apply to that
distribution. The competent authorities are authorized to
consult, if necessary, to resolve any differences in the
application of this paragraph.
paragraph 2 of Article 27 (Mutual Agreement Procedure)
requires that any corresponding adjustment made under paragraph 2
of this Article be implemented notwithstanding any time limits or
procedural limitations in the law of the Contracting state making
the adjustment.
The "saving clause" of subparagraph l(b) of the Protocol
does not apply to paragraph 2 of this Article. Thus, U.S.
benefits are also available to U.s. citizens and residents.
Therefore, even if the statute of limitations has run, or there
is a closing agreement between the Internal Revenue Service and
the taxpayer, a refund of tax may be made in order to implement a
corresponding adjustment. Statutory or procedural limitations,

-21-
however, cannot be overridden to impose additional tax, because,
under subparagraph l(a) of the Protocol, the Convention cannot
restrict any statutory benefit.
Paragraph 3 simply confirms that this Article does not
restrict the provisions of either Contracting state's domestic
law relating to the determination of the tax liability of a
person, provided that the determination is consistent with the
principles stated in this Article, i.e., that the adjustment
reflects what would have transpired had the related parties been
acting at arm's length. Thus, a Contracting State is free to
make adjustments to losses or credits, for example, to the extent
permitted under its domestic law and the arm's-length principles
of this Article, although such adjustments are not specified in
paragraph 1.
Article 10. DIVIDENDS
This Article provides rules for the taxation of dividends
paid by a company resident in one Contracting State to a resident
of the other contracting state. The article permits full
residence state taxation and limited source state taxation of
such dividends.
Paragraph 1 preserves the residence State's general right to
tax its residents on dividends paid by a company that is a
resident of the other Contracting state.
Paragraph 2 grants the source State the right to tax
dividends paid by a company that is a resident of that state to a
beneficial owner that is a resident of the other Contracting
state. The source State tax is limited to 15 percent of the
gross amount of the dividend. Use of the term "beneficial owner"
emphasizes that sUbstance will prevail over form in determining
the appropriate tax treatment, so that treaty benefits may be
denied to a nominal recipient not entitled to the beneficial
enjoyment of the dividend income.
In the absence of such a provision, the united States would
apply its statutory withholding rate of 30 percent to dividends
paid to a Portuguese resident, and Portugal would apply its
statutory withholding rate of 25 or 15 percent to dividends paid
to a U.s. resident.
paragraph 2 also provides that the competent authorities of
the Contracting states shall by mutual agreement settle the mode
of application of this rate limitation. For example, they may
agree on procedures whereby determinations are made as to who is
entitled to the reduced withholding rate under this provision.
Paragraph 2 does not affect the taxation of the company in
respect of the profits out of which the dividends are paid.

-22-
Paragraph 3 provides for a lower rate of taxation at source
if the beneficial owner is a company that is a resident of the
other Contracting state and that, for an uninterrupted period of
2 years prior to the payment of the dividend, owned directly at
least 25 percent of the capital of the company paying the
dividends. (The 25-percent ownership requirement and the 2-year
holding period correspond to Portugal's threshold for entitlement
to receive a 95-percent dividends received deduction.) It is
understood that in the case of the united states "capital" refers
to voting power. In the case of Portugal, "capital" refers to
"social capital," the nominal paid-in value of the company's
shares. The lower rate applicable to these dividends is 10
percent of the gross amount with respect to dividends paid after
December 31, 1996 and before January 1, 2000. with respect to
dividends paid after December 31, 1999, the rate for each of the
Contracting states will be the rate Portugal may apply to such
dividends paid to residents of European Union member states
provided, however, that the applicable rate shall not be less
than 5 percent. It is understood by both the United states and
Portugal that the term "paid" means paid or credited.
Under its domestic law, Portugal also imposes a 5 percent
substitute gift and inheritance tax (Imposto sobre Sucessoes e
Doacoes por Avenca) on dividends paid by certain types of
companies. (Portuguese legislation currently extends the 5
percent substitute gift and inheritance tax to certain types of
interest, but the tax has not yet been imposed on interest
payments and was recently deferred again.) That tax is not
covered in this or any other Portuguese income tax treaty.
However, paragraph 8 of the Protocol provides that if in the
future the rate of tax is increased above 5 percent,that
increase will not apply to dividends owned by residents of the
United states. Portugal has never before agreed to lower this
tax by treaty or to exempt a treaty partner from future rate
increases. The fact that Portugal regards this substitute tax as
a gift or inheritance tax, as indicated by the Protocol, does not
affect the determination as to whether the tax is creditable for
U.s. income tax purposes.
Paragraph 4 provides an exception to paragraph 3 for
dividends paid by a U.s. regulated investment company (RIC) or
real estate investment trust (REIT). A dividend paid by a RIC is
subject to the 15 percent portfolio dividend rate, regardless of
the percentage of voting shares of the RIC held directly by the
recipient of the dividend. The purpose of the reduction of the
direct investment dividend rate is to relieve multiple levels of
corporate taxation in cases where the recipient of the dividend
holds a substantial interest in the payer. This rationale does
not justify a reduction of the rate in the case of dividends paid
by RICs, because RICs do not pay corporate tax with respect to
amounts distributed ~o their shareholders. Further, although
certain amounts recelved by a RIC may have been subject to U.S.

-23-
corporate tax (~, dividends paid by a publicly traded U.S.
company to a RIC), it is unlikely that a 25 percent shareholding
in a RIC by a Portuguese resident will correspond to a 25 percent
shareholding in the entity (here, the publicly traded U.S.
company) that has paid U.S. corporate tax. Thus, in the case of
dividends received by a RIC and paid out to its shareholders, the
requirement of a substantial shareholding in the entity paying
the corporate tax is presumed not to be satisfied.
In the case of a dividend paid by a U.S. REIT to a
Portuguese resident, the U.S. statutory rate of 30 percent
generally applies (except in the case of amounts subject to tax
as effectively connected income under Code section 897(h».
Dividends beneficially owned by an individual holding a less than
25 percent interest in the REIT are eligible, however, for the 15
percent portfolio dividend rate provided in paragraph 2. The
denial of the 15 percent portfolio rate to corporate shareholders
and 25 percent or greater individual shareholders is intended to
prevent indirect investment in U.s. real property through a REIT
from receiving more favorable treatment than direct investment in
such real property.
Paragraph 5 defines the term "dividends," as used in this
Article, to include income from any shares, "jouissance
ll
rights,
mining shares, founders' shares, or other rights that are not
debt claims and that participate in profits, and income from
other corporate rights that is subjected to the same taxation
treatment as income from shares by the domestic laws of the
contracting state of which the company making a distribution is a
resident. This is consistent with the definition used in many
u.S. treaties and in the OECD Model. Paragraph 5 adds that
income from arrangements, including debt obligations, will also
be a dividend, if such arrangements carry the right to
participate in profits and the income is characterized as a
dividend under the domestic law of the Contracting State in which
the income arises. In the case of Portugal, the term also
includes profits attributed under an arrangement for
participation in profits (associacao en participacao) .
Paragraph 6 provides that, where dividends are attributable
to a permanent establishment or fixed base that the beneficial
owner maintains in the source state, they are not subject to the
provisions of paragraph 1, 2, and 3 of this Article, but instead
are taxable under Article 7 (Business Profits) or Article 15
(Independent Personal Services), as appropriate. Such dividends
will be taxed on a net basis using the rates and rules of
taxation generally applicable to residents of the Contracting
state in which the permanent establishment or fixed base is
located, as modified by the Convention.
Under paragraph 7, where a company that is a resident of a
Contracting state derives profits or income from the other

-24-
Contracting state, that other State may not impose 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 is effectively
connected with a permanent establishment or a fixed base situated
in that other State.
Article 11. INTEREST
Paragraph 1 confirms that interest may be taxed by the State
in which the recipient is resident. Paragraph 2 provides that
interest arising in a Contracting state may also be taxed by that
State in accordance with its laws. However, if the beneficial
owner of such interest is a resident of the other Contracting
State, then any tax so charged may not exceed 10 percent of the
gross amount of the interest. Use of the term "beneficial owner"
emphasizes that sUbstance will prevail over form in determining
the appropriate tax treatment, to deny treaty benefits to a
nominal recipient not entitled to the beneficial enjoyment of the
interest.
In the absence of paragraph 2, Portugal generally would tax
interest at 20 percent, and the United states would impose its 30
percent statutory withholding rate on interest other than
portfolio interest.
Paragraph 2 also provides that the competent authorities
shall agree on how to implement this Article, for example on
procedures whereby determinations are made as to who is entitled
to the reduced withholding rate provided by this Article
(Interest) .
Paragraph 3 provides three cases where source-based taxation
of interest is eliminated: (1) when the debtor is the government
of the contracting state, a political or administrative
subdivision thereof, or any of its local authorities; (2) when
the recipient of the interest arising in a Contracting state is
the government of the other Contracting State, its political
subdivisions, or local authorities, or an institution or
organization wholly owned by them; and (3) when the interest is
on a loan with a term of 5 years or more granted by a bank or
other financial institution that is a resident of the other
contracting state. The second exemption, where the creditor is
the other government, a subdivision or local authority thereof,
or a wholly government-owned institution is broader than the
exemption provided under Code section 892, but is similar to the
rule in several other U.s. income tax treaties. It is
principally intended to benefit Eximbank and OPIC. Under its
domestic law, Portugal would tax interest paid to those U.s.
Government lending institutions.

-25-
Paragraph 9 of the Protocol reserves the right of the United
states to tax an excess inclusion with respect to a residual
interest in a real estate mortgage investment conduit (REMIC) in
accordance with its law. Thus, Portuguese residents will be
taxed on such excess inclusions at the U.s. statutory rate of
withholding tax (i.e., 30 percent).
Paragraph 4 provides an exception to paragraphs 2 and 3
whereby interest arising in one of the Contracting states that is
determined by reference to the profits of the issuer or of one of
its associated enterprises and that is beneficially owned by a
resident of the other Contracting state may be taxed in the state
in which it arises, and according to the laws of that state, but
the tax so charged shall not exceed the 15-percent rate
prescribed in paragraph 2 of Article 10 (Dividends).
Paragraph 5 defines the term "interest," as used in the
Convention, to include income from debt claims of every kind,
whether or not secured by a mortgage, and, subject to paragraph 5
of Article 10 (Dividends), whether or not carrying a right to
participate in profits. The term "interest" includes, in
particular, income from government securities, income from bonds
or debentures, any premiums or prizes attaching to such
securities, bonds or debentures, and all other income treated as
interest by the taxation law of the source State. The definition
does not refer to penalties and fines for late payment, which are
frequently excluded from the treaty definition of interest.
Paragraph 6 provides an exception from the general rule of
paragraph 1 in cases where the beneficial owner of the interest,
who is a resident of one contracting State, carries on business
through a permanent establishment in the other Contracting state
or performs independent personal services through a fixed base
situated in that other state and the interest is attributable to
that permanent establishment or fixed base. In such a case, the
income is taxable to the permanent establishment or fixed base in
accordance with the provisions of Article 7 (Business Profits) or
Article 15 (Independent Personal Services), respectively. This
rule applies even if the permanent establishment or fixed base no
longer exists when the interest is taken into account, as long as
the interest would have been attributable to the permanent
establishment or fixed base if it had been taken into account in
the earlier year (i.e., where the debt claim on which the
interest is paid was attributable to the permanent establishment
in such earlier year) .
Paragraph 7 provides a source rule for interest for purposes
of this Article. Under this paragraph, interest is deemed to
arise in a Contracting state when the payer is a resident of that
state or the state itself, or a political or administrative
sUbdivision or local authority thereof. Where, however, the
payer (whether or not a resident of a Contracting state) has in a

-26-
contracting State a permanent establishment or fixed base, and
the interest is borne by such permanent establishment or fixed
base, then the interest shall be deemed to arise in the state in
which the permanent establishment or fixed base is situated.
Paragraph 8 provides that if, as a result of a special
relationship between the payer and the beneficial owner of the
interest, or between both of them and some other person, the
interest paid is excessive, Article 11 applies only to the amount
of interest payments that would have been made absent such
special relationship (i.e., an arm's length interest payment).
Any excess amount of interest paid remains taxable according to
the laws of the united States and Portugal, respectively, 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, subject to the provisions of Article 10 (Dividends).
Article 12. BRANCH TAX
Article 12 and paragraph 10 of the Protocol explicitly
confirm the right of each Contracting state to impose a branch
tax, that is, a tax imposed by a Contracting state on the
earnings of an enterprise of the other Contracting state through
a permanent establishment in the first Contracting state. Such a
branch tax imposed on payments or deemed payments from branch to
home office is analogous to the withholding taxes that would be
imposed on the dividends and interest payments made by a
subsidiary to a parent corporation.
In the case of the United States, paragraph l(a) defines the
amount of branch profits subject to the tax as the portion of the
business profits of the corporation attributable to a permanent
establishment in the united states--or subject to tax in the
united states on a net basis under Article 6 (Income from
Immovable Property (Real Property» or paragraph 1 of Article 14
(Capital Gains)--that represents the "dividend equivalent amount"
(see Code section 884(b».
Paragraph l(b) also covers both interest paid and excess
interest payments, as defined by Code section 884(f), deemed to
be received by a Portuguese corporation for which deductions are
allowable for purposes of determining income attributable to its
u.S. permanent establishment (or taxable on a net basis in the
united States as income from real property or gain on real
property), to the extent such deductible amounts exceed the
interest paid by the permanent establishment or trade or
business.
Paragraph 2 provides the rate at which tax may be imposed on
the "dividend equivalent amount" and the interest amounts
described in paragraph 1. For the "dividend equivalent amount,"

-27-
the rate shall not exceed 15 percent (or, after 1997, the lower
rate applicable under paragraph 3 of Article 10 (Dividends)). In
general, branch interest may be taxed at not more than 10
percent. However, in recognition of the withholding tax
exemption for long-term bank loans under Article 11 (Interest),
the rate with respect to excess interest amounts of the U.S.
permanent establishment of a Portuguese bank is limited to 5
percent, an average of the general 10 percent rate and the
exemption applicable to interest on long-term bank loans. A
similar average rate has been used for this purpose in other U.S.
treaties, including the recent treaty with Spain.
Portugal does not presently impose a branch tax. However,
paragraph 10 of the Protocol provides complementary treatment for
Portugal with respect to the branch profits taxes described in
paragraphs 1 and 2 in the event that Portugal enacts a branch
profits tax in the future.
Article 13. ROYALTIES
Article 13 confirms that royalties may be taxed by the
Contracting State in which the recipient is resident. Royalties
arising in a contracting State may also be taxed by that State in
accordance with its laws. However, if the beneficial owner of
such royalties is a resident of the other Contracting State, then
any tax so charged may not exceed 10 percent. Use of the term
"beneficial owner" emphasizes that substance will prevail over
form in determining the appropriate tax treatment, so that treaty
benefits may be denied to a nominal recipient not entitled to the
beneficial enjoyment of the royalty income.
In the absence of paragraph 2, Portugal would apply its
statutory withholding rate of 25 or 15 percent on royalties and
the United States would impose its statutory rate of 30 percent.
Paragraph 2 provides that the competent authorities may
agree on procedures whereby determinations are made as to who is
entitled to the reduced withholding rate provided in this
Article.
Paragraph 3 defines the term "royalties" as used in the
Convention. The term "royalties" includes payments of any kind
received as a consideration for the use of, or the right to use,
any copyright of a literary, artistic, or scientific work,
including cinematographic films or films or tapes and other means
of image or sound reproduction, any patent, trademark, design or
model, plan, secret formula or process, or other like right or
property; for the use or the right to use industrial, commercial,
or scientific equipment; or for information concerning
industrial, commercial, or scientific experience. The reference
to "other means" of reproduction makes clear that subsequent
technological advances will not affect the treatment of payments

-28-
relating to the use of such means of image or sound reproduction
from the definition of royalties. The definition of royalties
also includes payments for technical assistance performed in a
Contracting state by a resident of the other state where such
assistance is related to the application of any such right or
property. In addition, the term "royalties" includes gains
derived from the use of such right or property to the extent that
such gains are contingent on the productivity, use, or further
disposition of the property.
The united States prefers to provide a treaty exemption at
source for royalties arising in one contracting state and derived
and beneficially owned by a resident of the other Contracting
state and to exclude equipment rental income from the definition
of royalties. However, like a number of countries, Portugal
objects strongly to these positions. The maximum treaty rate of
10 percent represents a significant reduction of the Portuguese
domestic law rate. The united states has accepted this rate and
equipment rental rule in other recent treaties (see, ~,
Mexico, Spain).
As noted earlier in the discussion of Article 8, paragraph
11 of the Protocol provides that royalties received in
consideration for the use of, or the right to use containers in
international traffic shall be taxable only in the Contracting
State of which the recipient is a resident, unless attributable
to a permanent establishment in the other Contracting state.
(See below.)
Paragraph 4 provides an exception to the rules of paragraphs
1 and 2 in cases where a beneficial owner of royalties who is a
resident of one Contracting state carries on or has carried on
business through a permanent establishment in the other
Contracting state or performs or has performed independent
personal services through a fixed base in that other state and
the royalties are attributable to that permanent establishment or
fixed base, i.e., the right or property in respect of which the
royalties are paid forms part of the business property of such
permanent establishment or fixed base. In such a case, the
royalties are taxable in accordance with the provisions of
Article 7 (Business Profits) or Article 15 (Independent Personal
Services), respectively, and the source State will generally
retain the right of taxation. This rule applies even if the
permanent establishment or fixed base no longer exists when the
royalties are taken into account, as long as the royalties would
have been attributable to the permanent establishment or fixed
base if they had been taken into account in the earlier year
(i.e., where the license in respect of which the royalties are
paid was attributable to the permanent establishment in such
earlier year) .

-29-
Paragraph 5 provides rules for determining the source of
royalty payments. Royalties paid by a resident of a Contracting
state or by the government of a Contracting state, or a political
or administrative subdivision or local authority thereof,
generally are considered to have their source in that state. If
the royalties are attributable to a permanent establishment or
fixed base located in a Contracting state, they are sourced in
that Contracting state provided that they are borne by such
permanent establishment or fixed base. The term "borne by" is
understood to mean allowable as a deduction in computing taxable
income. However, when the royalties are not borne by a permanent
establishment or fixed base located in a contracting state and
the payer is not a resident of either Contracting state, then the
source of the royalties is the state in which the property or
rights are used. These rules are a compromise between the U.s.
statutory rule, which sources royalties in the state in which the
property or rights are used, and the Portuguese rule, which
sources royalties according to the residence of the payer. They
permit the United States to tax a royalty paid by a third country
resident to a resident of Portugal for the use of property in the
United states. A taxpayer who prefers the source rule of the
Code may choose to be taxed under the Code, as provided in
paragraph l(a) (i) of the Protocol. However, in that case the
taxpayer may not claim the rate reduction under the treaty; the
taxpayer must choose between either the treaty source and rate
rules or the Code source and rate rules.
Paragraph 6 provides that if, as a result of a special
relationship between the payer and the beneficial owner of a
royalty, or between both of them and some other person, the
royalty paid is excessive, Article 13 applies only to the amount
of the royalty payment that would have been made absent such
special relationship (i.e., an arm's length royalty payment).
Any excess amount of royalty paid remains taxable according to
the laws of the united states and Portugal, respectively, with
due regard to the other provisions of the Convention. If, for
example, the excess amount is treated as a distribution of
profits by a company under the domestic law of the source state,
such excess amount will be taxed as a dividend, rather than as a
royalty payment, subject to the provisions of Article 10
(Dividends) .
Article 14. CAPITAL GAINS
This Article provides rules for source and residence state
taxation of gains from the alienation of property.
paragraph 1 provides that 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 the other (situs)
state.

-30-
Paragraph 2 clarifies that the term "real property situated
in the other Contracting state" is understood to include a united
States real property interest when the united states is the
"other Contracting State." Thus, the united states preserves its
right to collect the tax imposed by Code section 897 on gains
derived by foreign persons from the disposition of united states
real property interests. For this purpose, the source rules of
Code section 861(a) (5) shall determine whether a united states
real property interest is situated in the united states. In
addition, the paragraph clarifies that real property situated in
Portugal includes stock, participations, or other rights in a
company or other legal person the property of which consists,
directly or indirectly, principally of immovable property
situated in Portugal.
The provisions of paragraph 2 apply "for the purposes of
paragraph 1" of this Article 14 (Capital Gains) and have no
effect on the right of a Contracting state 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 Article 14 does not affect the treatment of
dividends paid by such corporations. Such dividends remain
subject to the limitations on source state taxation contained in
Article 10 (Dividends) and are not governed by the unlimited
source state taxation right provided in Article 6 (Income from
Immovable Property (Real Property)) with respect to real
property.
paragraph 3 preserves the right of the source State to tax
gains from the alienation of movable (personal) property in
certain circumstances. Under paragraph 3, gains from the
alienation of movable property forming part of the business
property of a permanent establishment that an enterprise of a
Contracting state has or had in the other Contracting State, or
of movable property pertaining to a fixed base that is or was
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. In the case of the United States, this preserves the
taxing right of Code section 864(c) (7). In the case of Portugal,
it preserves Portugal's statutory taxation of gain on property
removed from a permanent establishment.
Subparagraph 12(a) of the Protocol acknowledges that the
meaning of the term "business property," as used in this
paragraph 3 of this Article, is narrower in some cases than that
of the term "assets," used in paragraph 2 of this Article
. ,
despite the use In Portuguese of the same term in both places.

-31-
However, subparagraph 12(b) of the Protocol modifies
paragraph 3 of the Convention by providing that removal of
personal property from a Contracting State by an enterprise of
the other Contracting state may be treated as an alienation of
that property and taxed by the first-mentioned State only to the
extent of the gains accrued on the property as of the date of
removal. In this case, subsequent taxation by the State of
residence of the enterprise is limited to the gains accruing
after the time of removal from the first-mentioned contracting
state. For U.S. tax purposes, the taxpayer will carryover the
basis of the property and will be required to sUbstantiate its
fair market value on the date of removal from Portugal in
computing any subsequent gain that becomes taxable in the united
states. This provision does not affect the operation of Code
section 987 with respect to foreign currency gain or loss on
remittances by a qualified business unit of property or currency.
Under this provision, each Contracting state will limit its tax
on the resident of the other Contracting state to the gain
accrued on the property while in its territory. In the absence
of this provision, there could be double taxation. Portugal
would tax the gain accrued on the property as of the date on
which property was removed from Portugal by an enterprise of the
United States, and the United states would tax the full gain at
the time the property was disposed of by the U.s. enterprise.
Subparagraph 12(c) of the Protocol ensures that a U.S.
company that incorporates a branch in Portugal will receive the
same beneficial treatment that Portugal is required to provide to
a company resident in a member state of the European Union, i.e.,
deferral of the gain by carrying over to the subsidiary the basis
of the assets of the branch. In the absence of such protection,
Portugal would treat the reorganization in such a case as a
taxable event and tax the gain on the assets of the branch at
that time.
Paragraph 4 provides that gains derived by an enterprise of
a Contracting state from the alienation of ships or aircraft
operated in international traffic are taxable only in that state.
Paragraph 5 clarifies that gains from the alienation of any
right or property described in Article 13 that are contingent on
the productivity, use, or further disposition of the property,
are taxable only in accordance with the provisions of Article 13,
as provided in paragraph 3 of that Article.
Paragraph 6 grants to the residence State the exclusive
right to tax gains from the alienation of property other than
property referred to in paragraphs 1 through 5. Therefore, for
example, gains from the sale of corporate shares that are not
attributable to a permanent establishment of the seller in the
other State will be taxable only in the state of residence of the
seller.

-32-
Article 15.
INDEPENDENT PERSONAL SERVICES
The Convention deals in separate articles with different
classes of income from personal services. Article 15 generally
deals with income from independent personal services, while
Article 16 (Dependent Personal services) generally deals with
income from employment. Exceptions and additions to these
general rules are provided for directors' fees in Article 18; for
performance income of artistes and sportsmen in Article 19; for
pensions in respect of personal service income and social
security benefits in Article 20; for government service salaries
and pensions in Article 21; for certain income of teachers and
researchers in Article 22; and for certain income of students and
trainees in Article 23.
Under paragraph 1, income derived by an individual who is a
resident of one Contracting state from the performance of
professional services in an independent capacity, or other
independent activities, in the other Contracting State is exempt
from tax in that other state unless either (a) the income is
attributable to a fixed base regularly available to the
individual in that other state for the purpose of performing his
services, in which case the income attributable to that fixed
base may be taxed in that other State, or (b) the individual
remained in that other State for more than an aggregate of 183
days in any twelve-month period, in which case the income derived
from the individual's activities performed in that other State
may be taxed in that other state. The State of residence may tax
in either case under subparagraph l(b) of the Protocol. In
addition, under that subparagraph of the Protocol, if the
individual is a Portuguese resident who performs independent
personal services in the united States, and the individual is
also a u.s. citizen, the united States may tax his income without
regard to the restrictions of this Article, subject to the
special foreign tax credit rules of paragraph 2 of Article 25
(Relief from Double Taxation) .
Paragraph 13 of the Protocol provides that the term "fixed
base" used in paragraph 1 of Article 15 (Independent Personal
Services) shall be interpreted according to paragraphs 3 and 4
of the Commentary on Article 14 (Independent Personal Services)
of the 1992 OECD Model and of any guidelines that, for the
application of such term, may be developed by the OECD in the
future. These paragraphs explain that the meaning of "fixed
base" is analogous to that of the term "permanent establishment."
Therefore, the income attributed to a fixed base will be taxed in
accordance with principles similar to those provided in Article 7
(Business Profits) for the taxation of business enterprises.
paragraph 2 of Article 15 notes that the term "professional
services" includes independent scientific, literary, artistic
. . . . ,
educational, or teachlng actlvltles, as well as the independent

-33-
acti~ities of physicians, lawyers, engineers, architects,
dentlsts, and accountants. This list, which is derived from the
OECD Model and routinely included in u.s. treaties is not
" '
exhaustlve. The term lncludes all personal services performed by
an individual for his own account, where he receives the income
and bears,the risk of loss arising from the services. However,
the taxatlon of income from the types of independent services
that are covered by Articles 18 through 23 is governed by the
provisions of those articles.
Article 16. DEPENDENT PERSONAL SERVICES
This Article deals with the taxation of remuneration derived
by a resident of a Contracting state from the performance of
personal services in the other Contracting State as an employee.
However, the more specific rules of Articles 18 (Directors'
Fees), 19 (Artistes and Sportsmen), 20 (Pensions, Annuities,
Alimony, and Child Support), 21 (Government Service), 22
(Teachers and Researchers) and 23 (Students and Trainees) apply
in the case of employment income described in one of these
articles. Thus, even though the contracting State in which
employment income has its source generally has the right to tax
such income under Article 16, it may not have the right to tax a
particular type of income under the Convention if that right is
limited by one of the aforementioned articles. Similarly, though
a source State may have no general right of taxation under
Article 16 with respect to a particular item of income, the State
may have the right to tax that income under one of the
aforementioned Articles.
Under paragraph 1, remuneration derived by an employee who
is a resident of a Contracting state may be taxed by his State of
residence. However, to the extent that the remuneration is
derived from an employment exercised (i.e., the performance of
services) in the other contracting State, the remuneration also
may be taxed by that other State unless the conditions specified
in paragraph 2 are satisfied.
Under paragraph 2, remuneration of an individual resident of
a Contracting State that is derived from the performance of
services as an employee within the other Contracting State may
not be taxed by that other State if three conditions are
satisfied: (a) the individual is present in that State for a
period or periods not exceeding in the aggregate 183 days in any
twelve-month period that begins or ends in the taxable year
concerned; (b) the remuneration is paid by, or on behalf of, an
employer who is not a resident of that State; and (c) the
remuneration is not borne by a permanent establishment or fixed
base that the employer has in that State. If a foreign employer
pays the salary of an employee, but a host country corporation or
permanent establishment reimburses the foreign employer in a
deductible payment, neither condition (b) nor condition (c) will

-34-
be considered to have been fulfilled. Conditions (b) and (c) are
intended to ensure that a Contracting state will not be required
both to allow a deduction to the payor for the amount paid and to
exempt the employee on the amount received. In order for the
remuneration to be exempt from tax in the source state, all three
conditions must be satisfied.
Paragraph 3 contains a special rule applicable to
remuneration for services performed by an individual who is a
resident of a Contracting state as an employee aboard a ship or
aircraft operated in international traffic. Such remuneration
may be taxed only in the Contracting State of residence of the
employee if the services are performed as a member of the regular
complement of the ship or aircraft. The "regular complement" of
a ship or aircraft includes the crew. In the case of a cruise
ship , it may also include others" such as entertainers or
lecturers, employed by the shipping company to serve on the ship.
The use of the term "regular complement" is intended to clarify
that a person who exercises his employment as, for example, an
insurance salesman, while aboard a ship or aircraft or a person,
such as an entertainer who visits the ship only temporarily
during stopovers, is not covered by this paragraph.
If a u.s. citizen who is resident in Portugal performs
dependent services in the united states and meets the conditions
of paragraph 2, or is a crew member on a Portuguese ship or
airline, and would therefore be exempt from u.s. tax if he were
not a u.s. citizen, he is nevertheless taxable in the united
states on his remuneration by virtue of the "saving clause" of
subparagraph l(b) of the Protocol, subject to the special foreign
tax credit rules of paragraph 2 of Article 25 (Relief from Double
Taxation) .
Article 17. LIMITATION ON BENEFITS
Article 17 addresses the problem of "treaty shopping" by
limiting the source basis tax benefits of the Convention to those
residents of the other Contracting state that are either
individuals or governmental entities or have a substantial
business nexus with or a significant business purpose for
residing in the other Contracting State. In a typical case of
treaty shopping, a resident of a third State might establish an
entity resident in a Contracting state for the purpose of
deriving income from the other Contracting State and claiming
treaty benefits with respect to that income. Article 17 limits
the abuse of the Convention by limiting the benefits of the
Convention to those persons whose residence in a Contracting
state is not considered to have been motivated by the existence
of the ,convention. ~bsent Article 17, the entity generally would
be entltled to beneflts under the treaty as a resident of a
contracting state, although the entity might be denied those
benefits as a result of limitations (~, business purpose,

-35-
substance-over-form, step transaction, or conduit principles)
applicable to the transaction or arrangement under the domestic
law of the source state. Article 17 and the anti-abuse
provisions of domestic law complement each other, as Article 17
generally determines whether a person has a sufficient nexus to
the Contracting State to be entitled to benefits for treaty
purposes, while domestic anti-abuse provisions determine whether
a particular transaction should be recast in accordance with the
substance of the transaction.
Article 17 follows the basic structure of the limitation on
benefits articles in other recent treaties, such as the one with
Germany. The structure of the Article is as follows: Paragraph
1 lists a series of attributes of a resident of a Contracting
state, anyone of which will entitle that person to benefits of
the Convention. Paragraph 2 provides a test whereby other
residents may be granted benefits with respect to certain items
of income. Paragraph 3 provides that benefits also may be
granted to a person not entitled to benefits under the tests of
paragraph 1 or 2, if the competent authority of the source state
determines that it is appropriate to provide benefits in that
case. Paragraph 4 defines the term "recognized securities
exchange" as used in subparagraph l(c). Paragraph 5 defines the
term "gross income" as used in subparagraph l(e) (ii). Paragraph
6 provides a special rule with respect to tax-free zones.
The first two categories of persons eligible for benefits
from the other Contracting State under the Convention are
individual residents of a Contracting state (subparagraph l(a»
and the two Contracting states and their political subdivisions,
local authorities, or wholly-owned institutions or organizations
(subparagraph l(b». It is considered unlikely that persons
falling into these two categories can be used improperly to
derive treaty benefits on behalf of a third-country resident. If
an individual is receiving 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 of the requirements in those articles
that the beneficial owner of the income be a resident of a
Contracting state.
The third category, described in subparagraph l(C), consists
of companies in whose principal class of shares there is
sUbstantial and regular trading on a recognized securities
exchange (as defined in paragraph 4) and companies more than 50
percent of each class of whose shares are owned either by
companies that are residents of either Contracting State, whose
principal class of shares are so traded, or by persons referred
to in subparagraph l(b).
The fourth category, described in subparagraph l(d),
includes tax-exempt organizations, including not-for-profit

-36-
organizations, private foundations, pension trusts, and other
organizations and arrangements, described in subparagraph 3(b) of
the Protocol, provided that more than half of the beneficiaries,
members, or participants, if any, in such organization, trust, or
arrangement are residents of that Contracting state who are
entitled under this Article to benefits of the Convention.
The fifth category, described in subparagraph l(e) of
paragraph 1, includes persons who satisfy two tests: the so-
called "ownership" and "base erosion" tests. The "ownership"
test requires that more than 50 percent of the beneficial
interest in the person (or, in the case of a company, more than
50 percent of the vote and value of each class of its shares) be
ultimately beneficially owned by persons who are themselves
entitled to benefits under the other tests of paragraph 1 or who
are U.s. citizens. The "base erosion" test requires that less
than 50 percent of the person's gross income (as defined in
paragraph 5) be used, directly or indirectly, to meet liabilities
(including liabilities for interest or royalties) to persons who
are not entitled to benefits under the other tests of paragraph 1
or are not U.S. citizens.
The rationale for the two-part test of subparagraph l(e)
derives from the fact that 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. In order
to prevent such benefits from inuring substantially to third-
country residents, it is not sufficient merely to require
sUbstantial ownership of the entity by treaty country residents
or other qualified persons. It is also necessary to require that
the entity's deductible payments be made in substantial part to
such treaty country residents or other qualified persons. For
example, a third-country resident could lend funds to a
Portuguese-owned Portuguese corporation to be reloaned to the
united states. The U.s. source interest income of the Portuguese
corporation would be subject to a reduced U.s. withholding tax
under Article 11 (Interest) of the Convention. While the
Portuguese corporation would be subject to Portuguese income tax,
its taxable income could be reduced to near zero by the
deductible interest paid to the third-country resident. If,
under a Convention between Portugal and the third country, that
interest were exempt from Portuguese tax, the U.s. treaty benefit
with respect to the U.s. source interest income would have flowed
to the third-country resident.
Paragraph 2 provides that a person resident in one of the
Contracting states may be entitled to benefits with respect to
certain items of income derived from the other State if it is
engaged in the active conduct of a trade or business in its State
of residence and satisfies certain conditions. Such a person
will be entitled to the benefits of the Convention with respect

-37-
to an item of income derived from the other State if the income
is derived in connection with, or is incidental to the trade or
. ,
bus1ness conducted in the State of residence and the trade or
business is sUbstantial in relation to the income-producing
activity. This determination is made separately for each item of
income derived from the other State.
The Convention does not define the term "substantial." As
in the case of other recent Conventions, it is understood that it
is not necessary that the activity in the State of residence be
as large as the activity in the other State in order to be
considered sUbstantial. It must, however, represent more than a
de minimis percentage of the activity in the other State, whether
measured in terms of income, assets, or other similar measures.
This requirement is intended to prevent the following type of
abuse. If, for example, a third-country resident wants to
acquire a u.S. company that manufactures televisions sets for
worldwide markets, but the country of residence of the investor
has no tax treaty with the United States, any dividends generated
by the investment would be subject to a U.S. withholding tax of
30 percent. Absent a substantiality requirement, the investor
could set up a Portuguese corporation that would operate a small
outlet in Portugal to sell television sets manufactured by the
company, and, in fact, sell a few sets per year and earn a very
small amount of income. That Portuguese corporation could then
acquire the u.s. manufacturer with capital prov~ded by the third-
country resident and produce a very large number of sets for sale
in several countries, generating a much larger amount of income.
It might attempt to argue that the U.s. source income is
generated from business activities in the United States that are
related to the television sales activity of the Portuguese
parent, and that, therefore, the dividend income should be
subject to a U.S. tax of 10 percent. In this example, however,
the substantiality requirement would not be met, and the
dividends would remain subject to withholding in the United
States at a rate of 30 percent.
It is intended that the provisions of paragraphs 1 and 2
will be self-executing. Unlike the provisions of paragraph 3,
discussed below, a claim of benefits under paragraph 1 or 2 does
not require advance competent authority ruling or approval. The
tax authorities may, of course, determine on review that the
taxpayer has improperly interpreted these paragraphs and is not
entitled to the benefits claimed.
Paragraph 3 of Article 17 permits the competent authority of
the State in which income arises to grant Convention benefits in
additional cases, even if they do not meet the standards of
paragraphs 1 or 2 (or sufficient information is not available to
make such a determination). This discretionary provision is
included in recognition that, with the increasing scope and
diversity of international economic relations, there may be cases

-38-
where significant participation by third-country residents in an
enterprise of a Contracting state is warranted by sound business
practice and does not indicate a motive of attempting to derive
unintended Convention benefits.
Paragraph 4 defines the term "recognized securities
exchange" as used in subparagraph l(C). In the case of the
United States, this term means the NASDAQ System owned by the
National Association of Securities Dealers, Inc. and any stock
exchange registered with the Securities and Exchange Commission
as a national securities exchange for purposes of the Securities
Exchange Act of 1934. In the case of Portugal, the term means
the Lisbon and Oporto Stock Exchanges. The term "recognized
securities exchange" also includes any other stock exchanges that
may be agreed upon by the competent authorities.
Paragraph 5 defines the term "gross income," as used in
subparagraph l(e) (ii), generally to mean gross receipts. In the
case of an enterprise engaged in a manufacturing or production
business, the term "gross income" is defined to mean gross
receipts reduced by the direct costs of labor and materials
attributable to such manufacture or production and paid or
payable out of such receipts.
Paragraph 6 provides that, notwithstanding the provisions of
paragraphs 1 through 5, the benefits of this Convention shall not
be allowed to any person that is entitled to income tax benefits
under the provisions of the legislation and other measures
relating to the tax-free zones (zonas francas) of Madeira and
Santa Maria Island, or to benefits similar to those provided with
respect to such tax-free zones that are made available under any
legislation or other measure adopted by either Contracting State
after the date of signature of this Convention. For example,
suppose a Portuguese bank located in Lisbon, whose shares are
publicly traded on the Lisbon Stock Exchange, establishes a
wholly owned subsidiary in Madeira's International Business
Centre. In this case, the bank in Lisbon is entitled to treaty
benefits under subparagraph l(C) (i) of Article 17 (Limitation of
Benefits) because there is substantial and regular trading of its
shares on a recognized securities exchange. Although its wholly-
owned Madeira subsidiary passes the requirements for benefits
laid out in subparagraph l(c) (ii) of Article 17, the Madeira
subsidiary is not entitled to benefits under the Convention
because it is entitled to the benefits available to financial
institutions located in Madeira's International Business Center
and paragraph 6 of Article 17 applies "notwithstanding the '
provisions of paragraphs 1 through 5."
Paragraph 6 further provides that the competent authorities
shall notify each other of any future legislation or measure
providing benefits similar to those of the tax-free zones of

-39-
Madeira and Santa Maria Island and shall consult as to whether
such benefits are similar.
In order to implement paragraph 6 appropriately, it is
essential that both countries be able to exchange relevant
information to distinguish operations in these tax-free zones
from other operations in Portugal or the United States that are
entitled to the benefits of this Convention. In this connection,
see the discussion of Article 28 (Exchange of Information),
below.
Article 18. DIRECTORS' FEES
This Article provides that a Contracting State may tax the
fees paid by a company that is a resident of that State for
services performed by a resident of the other Contracting state
in his capacity as a director of the company, provided that the
services are performed outside of that other Contracting State.
This rule is an exception to the more general rules of Article 15
(Independent Personal Services) and Article 16 (Dependent
Personal Services). Thus, for example, in determining whether an
outside (non-employee) director's fee is subject to tax in the
State of residence of the company, whether the company
constitutes a fixed base of the director in that State is not
relevant.
The rule provided in this Article represents a departure
from the former U.S. Model, which treated 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 (Independent Personal Services) and inside directors
would be subject to the provisions of Article 16 (Dependent
Personal Services). The preferred Portuguese position is
reflected in the OECD Model, in which a resident of one
Contracting state who is a director of a company 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 provision in Article 18 of the Convention
represents a compromise between these two positions. The State
of residence of the company may tax nonresident directors with no
threshold, but only with respect to remuneration for services
performed outside the other contracting state.
This Article is subject to the "saving clause" of
subparagraph l(b) of the Protocol. Thus, if a U.S. citizen who
is a Portuguese resident is a director of a u.s. corporation, the
United states may tax his full remuneration regardless of the
place of performance of his services.

-40-
Article 19. ARTISTES AND SPORTSMEN
Article 19 addresses the taxation in a contracting state of
artistes (i.e., performing artists and entertainers) and
sportsmen 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 to that of one who performs his
services on behalf of another person, either as an employee of
that person or pursuant to any other arrangement. This Article
applies, however, only with respect to the income of performing
artists and sportsmen. Others involved in a performance or
athletic event, such as producers, technicians, managers, and
coaches, remain subject to the provisions of Article 15 or 16, as
the case may be.
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. Income derived by a resident of a contracting
State from his personal activities as an entertainer or sportsman
exercised in the other Contracting state may be taxed in that
other state if the amount of the compensation derived by the
individual exceeds $10,000 (or its equivalent in Portuguese
escudos) for the taxable year concerned. The $10,000 includes
expenses reimbursed to the individual or borne on his behalf. If
the compensation exceeds $10,000, the full amount, not just the
excess, may be taxed in the state of performance.
The OECD Model provides for taxation by the country of
performance of the remuneration of entertainers with no dollar or
time threshold. The United States introduces the dollar
threshold test to distinguish between two groups of entertainers
and sportsmen--those who are paid large sums of money for 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 modest amounts (and are, therefore, not
clearly distinguishable from those who earn other types of
personal service income).
Paragraph 1 applies notwithstanding the provisions of
Articles 15 (Independent Personal Services) and 16 (Dependent
Personal Services). Thus, if an individual would otherwise be
exempt from tax under those Articles, but is subject to tax under
this Article, he may be taxed. An entertainer or sportsman who
receives less than the $10,000 threshold amount, and who is
therefore, not affected by this Article, may nevertheless b~
subject to tax in the host country under Article 15 or 16 if the
tests for tax~bility u~der t~ose Articles are met. For example,
if an enterta1ner who 1S an 1ndependent contractor earns only
$9,000 of income for the calendar year, but the income is
attributable to a fixed base regularly available to him in the

-41-
state of performance, that state may tax his income under Article
15.
Paragraph 2 is intended to deal with the potential for abuse
when income from a performance by an entertainer or sportsman
does not accrue to the performer himself, but to another person.
When the income accrues to a person other than the performer, and
the performer (or persons related to him) 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 country, its
income may be subject to tax there under the provisions of
paragraph 2. Taxation under paragraph 2 is on the person
providing the services of the entertainer or sportsman. This
paragraph does not affect the rules of paragraph I, which apply
to the entertainer or sportsman himself. The income taxable by
virtue of paragraph 2 to the person providing the performer's
services is reduced to the extent of salary payments to the
performer, which are treated under paragraph 1.
For purposes of paragraph 2, income is deemed to accrue to
another person (i.e., the person providing the services of the
entertainer or sportsman) 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 entertainer or
sportsman, nor any persons related to him, participate directly
or indirectly in the profits of the person providing his
services. This exception for non-abusive cases to the paragraph
2 override of the Articles 7 and 15 protection of persons
providing the services of entertainers and sportsman is not found
in the OECD Model.
Paragraph 3 provides an exception to the rules in paragraphs
1 and 2 in the case of a visit to a Contracting state by an
entertainer or sportsman who is a resident of the other
contracting state, if the visit is substantially supported,
directly or indirectly, by the public funds of his State of
residence or of a political sUbdivision or local authority of
that state. In the circumstances described, only the Contracting
state of residence of the entertainer or sportsman may tax his

-42-
income from the performances. A similar exception is provided in
some other recent u.s. treaties.
This Article is subject to the provisions of the "saving
clause" of subparagraph l(b) of the Protocol. Thus, if an
entertainer or sportsman who is a resident of Portugal is a
citizen of the United States, the united states may tax all of
his income from performances in the united states without regard
to the provisions of this Article, subject, however, to the
special foreign tax credit provisions of paragraph 2 of Article
25 (Relief from Double Taxation).
Article 20. PENSIONS, ANNUITIES, ALIMONY, AND CHILD SUPPORT
Article 20 provides rules concerning the taxation of
pensions, social security payments, annuities, alimony, and child
support. However, the taxation of pensions in respect of
governmental services rendered to a Contracting state is covered
by the provisions of Article 21 (Governmental Service).
Paragraph l(a) grants each Contracting state an exclusive
taxing right with respect to pensions and other similar
remuneration paid to its residents in consideration of past
employment, regardless of where the past employment occurred.
Paragraph l(b) provides that social security payments and other
public pensions paid to a resident of a Contracting State or a
citizen of the United States by the other Contracting state may
be taxed in that other state. This rule includes railroad
retirement benefits provided for in the Railroad Retirement Act
of 1974. Social security payments may be taxable in both
Contracting States, with the State of the recipient's residence
allowing relief from double taxation under the provisions of
Article 25 (Relief from Double Taxation) for any taxes imposed by
the contracting state in which such payments arise.
Paragraph 2 grants an exclusive taxing right with respect to
annuities beneficially derived by a resident of a Contracting
state. The term "annuities" is defined to mean a stated sum paid
periodically at stated times during a specified time period,
under an obligation to make the payments in return for adequate
and full consideration (other than for services rendered).
Payments for services rendered are either employment income or
income from the performance of independent personal services.
Paragraph 3 provides that alimony paid to a resident of a
Contracting state is taxable only in that State and only to the
extent that it is taxable under the domestic law of that State.
The term "alimony" is broadly defined and intended to include all
periodic payments legally required to be paid as a result of a
divorce or separation (other than child support payments). Thus,
if a divorced united states resident receives alimony payments
from a former spouse resident in Portugal, Portugal may not

-43-
impose tax on those payments. However, such payments are taxable
to the recipient under u.s. domestic law.
Paragraph 4 provides that child support payments made by a
resident of one Contracting state to a resident of the other
Contracting state may not be taxed by the other Contracting
state. As with alimony, child support payments are broadly
defined and are intended to include all periodic payments legally
required to be paid for the support of minor children as a result
of divorce or separation. By prohibiting the state of residence
of the recipient from taxing such payments, the Convention
ensures that the full amount received is available for the
support of the minor children.
with the exception of paragraph 4, Article 20 is subject to
the provisions of the "saving clause" of subparagraph l(b) of the
Protocol, so that, in general, the United States may tax its
citizens and residents on pensions, annuities, and alimony
without regard to any restriction in Article 20. However, by
virtue of paragraph l(c) of the Protocol, paragraph 4 of Article
20 is not subject to the saving clause. Thus, domestic law
cannot overrule the exemption provided for in paragraph 4 from
tax for child support payments.
Article 21. GOVERNMENT SERVICE
Article 21 applies to remuneration paid by a Contracting
state (or political subdivision or local authority thereof) in
respect of services rendered to that State (or political
subdivision or local authority). Paragraph 1 applies to
remuneration, other than pensions, for governmental service, and
paragraph 2 applies to pensions arising from such governmental
service.
Paragraph l(a) grants an exclusive taxing right for
remuneration in respect of governmental service to the
Contracting state (or political subdivision or local authority
thereof) to which such services are rendered, regardless of who
renders such services or where such services are rendered.
Paragraph l(b) provides an exception to paragraph l(a). It
grants an exclusive taxing right for remuneration for
governmental services to the State in which such services are
rendered, provided that the recipient is a :esident of that state
and is either a national of that State or dld not become a
resident solely for the purpose of rendering the services. Thus,
if a Portuguese resident renders services to the u.s. Government
in Portugal, Portugal is granted the exclusive right to tax such
services if the recipient is either a Portuguese national or did
not become a Portuguese resident solely for the purpose of
providing such services.

-44-
Paragraph 2(a) grants an exclusive taxing right for any
pension paid in consideration for past governmental services to
the Contracting state (or political subdivision or local
authority thereof) to which such services were rendered.
Paragraph 2(b) provides an exception to paragraph 2(a) and grants
an exclusive taxing right for such pensions to the other
Contracting State if the recipient is both a resident and a
national thereof. Thus, the united states is granted the
exclusive right to tax a u.s. national who retires to Portugal
and receives a pension resulting from services rendered to the
U.S. Government.
Under paragraph 3, payments for (and subsequent pensions
arising from) services that are rendered in connection with a
business carried on by a Contracting state or a political
subdivision or local authority thereof are, as appropriate, dealt
with under Article 15 (Independent Personal Services), 16
(Dependent Personal Services), 18 (Directors' Fees), 19 (Artistes
and Sportsmen), or 20 (Pensions, Annuities, Alimony, and Child
Support). It is understood that determinations of whether
remuneration is for services (1) rendered to a Contracting State
(or political subdivision or local authority thereof) or (2)
rendered in connection with a business carried on by a
governmental agency or authority is to be made by reference to
the laws of the state in which the income arises.
Article 21 is subject to the provisions of the "saving
clause" of subparagraph l(b) of the Protocol, as modified by
subparagraph l(c) of the Protocol. With respect to the united
States, the modified saving clause applies to u.S. citizens and
persons having immigrant status in the United States ("green
card" holders). Thus, the provisions of the Article that would
grant exclusive taxing rights to Portugal are overridden by the
saving clause if the individuals are u.S. citizens or green card
holders.
Article 22. TEACHERS AND RESEARCHERS
Paragraph 1 of the Article deals with visiting professors,
teachers, and researchers. Paragraph 1 provides that if a
professor, teacher, or researcher who is a resident of one
Contracting State visits the other Contracting State for the
purpose of teaching or conducting research at an accredited
educational or research institution, he will be exempt from tax
in both Contracting States on his compensation for such teaching
or research for a period not exceeding two years. An individual
may claim the benefits of paragraph 1 only once.
For the exemption of paragraph 1 to apply to income from
research, the research must be undertaken in the public interest,
and not primarily for the private benefit of a specific person or
persons. For example, the exemption would not apply to a grant

-45-
from a tax-exempt research organization to search for the cure to
a disease if the results of the research become the property of a
for-profit company. The exemption would not be denied, however,
if the tax-exempt organization licensed the results of the
research to a for-profit enterprise in consideration of an arm's
length royalty consistent with its tax-exempt status.
This Article is an exception to the "saving clause" of
subparagraph l(b) of the Protocol. Thus, a Portuguese student,
teacher, or researcher is entitled to the benefits of this
Article even if such individual becomes a resident of the united
states under the "substantial presence" test of Code section
7701(b). The benefits of this Article are not available to a
u.s. citizen or "green card" holder for u.s. tax purposes.
However; Code section 911 generally exempts the first $70,000 of
foreign earned income of a U.s. citizen or resident who spends a
specified period of time in one or more foreign countries.
ARTICLE 23. STUDENTS AND TRAINEES
Paragraph 1 of Article 23 provides that a resident of a
Contracting state who visits the other Contracting state for the
primary purpose of studying at an accredited educational
institution, securing training in a professional specialty, or
studying or doing research as a recipient of a grant from a tax-
exempt organization shall be exempt from taxation in that
Contracting state with respect to certain items of income during
such per~od of study, research, or training. Paragraph l(b)
defines those exempt items of income as: (1) payments from
abroad for maintenance, education, study, research, or training;
(2) grants, allowances, or awards from a governmental, religious,
charitable, scientific, literary, or educational institution
funding the research or studies; and (3) income from personal
services performed in that other contracting state to the extent
of $5,000 (or the equivalent in Portuguese escudos) per taxable
year. The exemptions provided in paragraph 1 are available to
the visiting student or trainee for a period not exceeding five
years from the beginning of the visit.
The second paragraph of the Article provides an exemption
for residents of a Contracting state who are employed by, or
under contract with, a resident of the same Contracting state and
who temporarily visit the other contracting state for the purpose
of studying at an accredited educational institution or acquiring
technical, professional, or business training or experience in
that other contracting state, provided such training is from a
person other than the employer or contractor. Such student or
trainee is exempt from taxation in the other Contracting state
for a period of twelve consecutive months on personal
services income to the extent of $8,000 (or the equivalent in
Portuguese escudos) during that period.

-46-
The Article denies its exemptions, as does paragraph 2 of
Article 22 (Teachers and Researchers), to income from research if
such research is undertaken primarily for the private benefit of
a specific person or persons. For example, personal service
income arising from research at a corporate research facility
would, in general, not qualify as exempt income.
The benefits conferred by the other Contracting State under
Article 23 are subject to the provisions of the "saving clause"
in subparagraph l(b) of the Protocol, as modified by subparagraph
l(c) of the Protocol. With respect to the United States, the
modified saving clause applies to u.s. citizens and persons
having immigrant status in the United States ("green card"
holders). Thus, the provisions of paragraph 1 that would exempt
a Portuguese resident from taxation as a student in the United
states are overridden by the saving clause if that student is a
U.s. citizen or green card holder. On the other hand, if a
student who is not a citizen or a green card holder acquires
residence in the United states for tax purposes during that
period of study or training, he will be exempt from tax in the
United states on those items of income.
ARTICLE 24. OTHER INCOME
Paragraph 1 of Article 24 provides for exclusive residence
state taxation of items of income that are not dealt with in the
foregoing Articles of the Convention, unless the income arises in
the other contracting State. If the income arises in the other
State, that other state may also tax it. This rule applies, for
example, to prizes, awards, or gifts, and to income from third
states.
Paragraph 2 provides that, if the beneficial owner of such
other income carries on business in the other Contracting state
through a permanent establishment or fixed base situated therein
and the income is attributable to such permanent establishment or
fixed base, that other income is taxable in that other State in
accordance with the provisions of Article 7 (Business Profits) or
15 (Independent Personal Services), rather than under the
provisions of paragraph 1. Thus, for example, income of a U.S.
resident that arises in a third country but is attributable to a
permanent establishment of such person in Portugal may be taxed
by Portugal under the provisions of Article 7.
However, paragraph 2 does not provide an exception to the
exclusive taxing right granted in paragraph 1 to the state of
residence with respect to income from real property. Thus, for
example, income derived from real property located in a third
country is ~axable und~r.this conve~t~on only in the Contracting
state of whlch the reclplent (beneflclal owner) is a resident,
even if the recipient has a permanent establishment (or fixed
base) in the other Contracting state and that real property forms

-47-
part of the business property of that permanent establishment or
fixed base.
Article 24 is subject to the provisions of the "saving
clause" of subparagraph l(b) of the Protocol so that, in general,
the United States may tax "other income" of u.s. residents and
citizens without regard to the Convention. Specifically, this
means that, irrespective of the exclusive right to tax third
country income granted to the state of residence in paragraph 1,
the United States also may tax such income received by a resident
of Portugal if that resident is a u.S. citizen, subject, however,
to the special foreign tax credit provisions of paragraph 2 of
Article 25 (Relief from Double Taxation).
Article 25. RELIEF FROM DOUBLE TAXATION
In this Article, each Contracting State undertakes to
relieve double taxation by granting a foreign tax credit against
its income tax for the income tax paid to the other country.
Under paragraph 1, the credit granted by the United states 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 (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 of the u.S. domestic law in effect for the taxable
year concerned.
The U.S. foreign tax credit is generally limited under the
Code 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)). However, nothing in the
Convention would prevent the limitation of the u.S. credit from
being applied on a per-country or overall basis or some variation
thereof, if U.s. domestic law so provided. In general, where
source rules are provided in the Convention for purposes of
determining the taxing rights of the Contracting States, these
are consistent with the Code source rules for foreign tax credit
and other purposes. Where, however, there is an inconsistency
between Convention and Code source rules, the Code source rules
(~, Code section 904(g») will be used to determine the limits
for the allowance of a credit under the Convention.
Paragraph 2 provides an exception to the general rule of
paragraph 1 for the tax treatment of u.S. citizens resident in
Portugal. Under this paragraph, income that may be taxed by the
united states solely by reason of citizenship in accordance with
the "saving clause" of subparagraph l(b) of the Protocol shall be
treated as having its source in Portugal to the extent necessary
to avoid double taxation. This provision overrides u.s. law
source rules only in those cases where u.S. law would operate to
deny a foreign tax credit for taxes imposed by Portugal under the

-48-
provisions of the Convention on u.s. citizens resident in
Portugal. In no case, however, will this provision apply to
reduce the taxes paid to the United states below the amount that
would be paid if the individual were not a citizen of the united
states, i.e., the u.s. tax that would be imposed if the
individual were not a resident or citizen of the United states.
As an example of the application of paragraph 2, consider a
U.s. citizen resident in Portugal who receives $200 of portfolio
dividend income from United states sources and is subject to U.s.
tax at 28 percent ($56) on that income. Under the provisions of
Article 10 (Dividends), the U.s. tax on portfolio dividends paid
to residents of Portugal who are not U.s. citizens is limited to
15 percent ($30 in this case). Suppose Portugal taxes that
income of its resident at 40 percent ($80) and grants, in
accordance with the provisions of its domestic law and paragraph
2 of this Article, a credit for the $30 of U.s. tax imposed on
the basis of source only. The net Portuguese tax would be $50
and the combined U.s. and Portuguese tax $106. Thus, the total
tax would be higher than the total tax in either of the two
countries, indicating some double taxation. Under paragraph 2,
the United states agrees to resource enough of that dividend
income to avoid double taxation, but not to reduce the U.s. tax
paid below the $30 it is entitled to tax at source. In this
example, the U.s. will resource enough of the dividend to permit
a credit of $26, thus reducing its net tax from $56 to $30. The
total tax becomes $80 ($50 + 30), the higher of the two taxes,
and double taxation is eliminated.
By reason of subparagraph l(c) (i) of the Protocol, Article
25 is not subject to the provisions of the "saving clause" of
subparagraph l(b) of the Protocol. Thus, the saving clause
cannot be used to deny a Portuguese resident the benefit of the
credits provided for in paragraph 1 or to deny a U.s. citizen or
resident the benefit of the credits provided for in paragraphs 2
and 3.
Subparagraph 2(a) provides that Portugal shall provide a
"deduction from tax," i.e., a credit, for taxes paid to the
united states by a Portuguese resident. The credit is limited,
however, to the amount of income tax that would otherwise be owed
to Portugal on the income that may be taxed in the United states.
Portuguese domestic law does not give a credit similar to
the U.s. credit for taxes deemed paid under Code section 902.
However, subparagraph 3(b) provides the same 95-percent dividends
received deduction for dividends received by a Portuguese company
from a U.s. company that Portugal provides domestically for
dividends received by a Portuguese company from another
Portuguese company. As a practical matter, this eliminates
double taxation of such profits.

-49-
Subparagraph 3(c) provides that where, in accordance with
any provision of the convention, income derived by a resident of
Portugal is exempt from tax in Portugal, Portugal may,
nevertheless, in calculating the amount of tax on the remaining
income of such resident, take into account the exempted income.
The portion of tax forgiven is thus calculated at the average tax
rate, not at either the top or bot~om bracket rate.
Article 26. NON-DISCRIMINATION
This Article prohibits the discriminatory taxation by one
Contracting state of nationals, enterprises, and residents of the
other Contracting state.
Paragraph 1 provides that a national of one Contracting
state may not be subject to taxation or any connected requirement
in the other Contracting state that is different from or more
burdensome than the taxation 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 Portugal as a Portuguese national who is in similar
circumstances. It is understood, however, that for u.s. tax
purposes, a U.S. citizen who is resident outside the United
States, whether in Portugal or a third country, is not in the
same circumstances as a national of Portugal who is a resident
outside the United States, because the U.s. citizen is subject to
U.S. tax on his worldwide income while the Portuguese national is
subject to U.s. tax only on U.S. source income and limited types
of foreign source income.
Paragraph 2 of the Article provides that a permanent
establishment in a Contracting state of a resident of the other
Contracting State may not be less favorably taxed in the first
state than an enterprise of that first state that is carrying on
the same activities. This provision, however, does not oblige a
Contracting state to grant to a resident of the other Contracting
state any tax allowances, reliefs, or deductions that it grants
to its own residents on account of their civil status or family
responsibilities. Thus, in assessing income tax on the profits
attributable to a U.s. permanent establishment of a Portuguese
enterprise owned by an individual resident in Portugal, the
United states is not obligated to allow to the Portuguese
resident the personal allowances for himself and his family that
would be allowed 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

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partner. In the context of the Convention, this obligation
applies with respect to a Portuguese 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. However, it
is understood that this distinction is not a form of
discrimination within the meaning of paragraph 2 of the Article,
but like other withholding on nonresident aliens, is 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. If tax is over-withheld, the partner can, as in
other cases of over-withholding, file for a refund.
Paragraph 3 of the Article specifies that no provision of
the Article will prevent either Contracting state from imposing
the branch tax described in paragraph 1 of Article 12 (Branch
Tax) .
Paragraph 4 prohibits discrimination in the allowance of
deductions. When a resident of a Contracting state pays interest
or royalties or makes other disbursements to a resident of the
other contracting state, the first Contracting state must allow a
deduction for those payments in computing the taxable profits of
the enterprise under the same conditions as if the payment had
been made to a resident of the first state. An exception to this
rule is provided for cases where the provisions of paragraph 1 of
Article 9 (Associated Enterprises), paragraph 8 of Article 11
(Interest), or paragraph 6 of Article 13 (Royalties) apply,
because all of these provisions permit the denial of deductions
in certain circumstances in respect to excessive (non-arm's
length) payments between related persons. 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 that includes the person incurring
the expense.
Paragraph 5 requires that a Contracting State not impose
other or more burdensome taxation or connected requirements on a
company that is a resident of that State and that is wholly or
partly owned or controlled, directly or indirectly, by one or
more residents of the other Contracting state, than the
requirements that it imposes on similar resident companies owned
by residents of the first State. The rules of Code section
367(e) (2) regarding liquidating distributions of appreciated
property by a U.S. subsidiary to a foreign parent corporation,
the provision in Code section 1446 for withholding of tax on
distributions to non-U.S. partners (discussed above), and the
rule of Code section 1361 under which nonresident alien
individuals are ineligible to become shareholders of subchapter S
corporations, do not violate the provisions of this Article.

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Paragraph 6 provides that, notwithstanding the list of taxes
covered by the Convention in Article 2 (Taxes Covered), the
nondiscrimination provisions of this Article apply 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 subparagraph 1(b) of the Protocol
does not apply to this Article, by virtue of the exceptions in
subparagraph l(c) of the Protocol. Thus, for example, a u.s.
citizen who is resident in Portugal may claim u.s. benefits under
this Article.
Article 27. MUTUAL AGREEMENT PROCEDURE
This Article provides for cooperation between the competent
authorities of the Contracting states to resolve disputes that
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 identified in
subparagraph l(i) of Article 3 (General Definitions).
Paragraph 1 provides that, where a person considers that the
actions of one or both Contracting states result or will result
for him in taxation that is not in accordance with the
Convention, he may present his case to the competent authority of
his State of residence or citizenship. The case must be
presented within three years from the first notification of the
action resulting in taxation not in accordance with the
Convention. It is not necessary for a person first to have fully
exhausted the remedies provided under the national laws of the
Contracting States before presenting a case to the competent
authorities.
Paragraph 2 provides that, if the competent authority of the
Contracting State to which the case is presented considers the
case to have merit, and if it cannot reach a satisfactory
solution unilaterally, it will seek agreement with the competent
authority of the other Contracting State to avoid taxation not in
accordance with the Convention. Any agreement reached under this
provision is to be implemented even if implementation would be
otherwise barred by the statute of limitations or by some other
procedural limitation, such as a closing agreement. Because, as
specified in subparagraph l(a) (i) of the Protocol, 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 seek to
resolve difficulties or doubts that may arise as to the
application or interpretation of the Convention. It is intended
that the competent authorities may agree, for example, to the

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same attribution of income, deductions, credits, or allowances
between a resident of one Contracting state and its permanent
establishment in the other; to the allocation of income,
deductions, credits, or allowances between persons; or to settle
a variety of interpretive issues under the Convention, including
those regarding the characterization of items of income or of
persons, the application of source rules to particular items of
income, the meaning of a term, and the application of penalties,
fines and interest. Agreements reached by the competent
authorities under this paragraph need not conform to the domestic
law provisions of either Contracting state.
Paragraph 3 also authorizes the competent authorities to
address double taxation in cases not provided for in the
Convention, with respect to types of taxes covered by the
Convention. An example 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 the
other in Portugal. Since no resident of a Contracting state is
involved in the case, the Convention does not, by its terms,
apply. The competent authorities may, nevertheless, use the
authority of the Convention to seek to prevent double taxation.
Paragraph 4 authorizes the competent authorities to
communicate with each other directly, rather than through
diplomatic channels, for these purposes.
The benefits of this Article are also available to residents
or citizens of either Contracting state under subparagraph
l(c) (i) of the Protocol. Thus, rules, definitions, procedures,
and other matters 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 those
agreements differ from the comparable Code provisions.
Similarly, U.s. law may be overridden to provide refunds of tax
to a u.s. citizen or resident under this Article.
Article 28. EXCHANGE OF INFORMATION
This Article provides for the exchange of information
between the competent authorities of the Contracting States. 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 Portugal concerning the taxes covered by the
Convention. For purposes of this Article, the taxes covered by
the Convention include all taxes imposed at the national level.
Exchange of information with respect to domestic law is
authorized insofar as the taxation under those domestic laws is
not contrary to th~ Convention. Thus, for example, information
may be exchanged wlth respect to a national-level tax, even if
the transaction to which the information relates is a purely
domestic transaction in the requesting State.

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Paragraph 1 states that information exchange is not
restricted by Article 1 (Personal 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 Portugal that engages in transactions with a
u.S. resident, the united States could request information with
respect to that permanent establishment, even though it is not a
resident of either Contracting state. such information would not
be routinely exchanged, but may be requested in specific cases.
Paragraph 1 also provides assurances that any information
received in accordance with this Article will be treated as
secret, subject to the same disclosure constraints that apply to
information obtained under the laws of the requesting State.
Information received may be disclosed only to persons, including
courts and administrative bodies, concerned with the assessment,
collection, enforcement, or prosecution in respect of the taxes
to which the information relates, or to persons concerned with
the administration of these taxes. The information must be used
by such persons in connection with these designated functions.
Persons concerned with the administration of taxes, in the United
States, include the tax-writing committees of Congress and the
General Accounting Office. Information received by these bodies
is for use in the performance of their role in overseeing the
administration of u.S. tax laws. Information received under this
Article may be disclosed in public court proceedings or in
judicial decisions.
Paragraph 2 explains that the obligations undertaken in
paragraph 1 to exchange information do not require a Contracting
State to carry out administrative measures that are at variance
with the laws or administrative practice of either Contracting
state. Nor is a State obligated to supply information not
obtainable under the laws or administrative practice of either
State. Thus, there is no obligation to furnish information if
either the requested state or the requesting State could not
obtain such information for itself in a domestic case. There is
also no obligation to disclose trade secrets or other
information, the disclosure of which would be contrary to public
policy. However, it is understood that bank records will be made
available to the same extent obtainable for enforcing domestic
tax laws, including requests for court orders where the taxpayer
does not voluntarily comply. Paragraph 14 of the Protocol
confirms that records of financial institutions, including
records relating to third parties, are among the types of records
that may be exchanged.
A contracting State may, at its discretion, subject to the
limitations of paragraph 2 and its domestic law, provide
information that it is not obligated to provide under the
provisions of this paragraph.

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Paragraph 3 provides that, when information is requested by
a Contracting state in accordance with this Article, the other
Contracting state is obligated to obtain the requested
information as if the tax in question were the tax of the
requested state, even if that State has no tax interest in the
case to which the request relates. The paragraph further
provides that the requesting state may specify the form in which
information is to be provided (~, depositions of witnesses and
authenticated copies of unedited original documents), so that the
information can be used in the judicial proceedings of the
requesting State. The requested State must provide the
information in the form requested to the same extent that it can
obtain information in that form under its own laws and
administrative practices with respect to its own taxes.
This Article is particularly important for implementing
paragraph 6 of Article 17 (Limitation of Benefits), the provision
that denies benefits under the Convention to persons entitled to
the benefits of tax-free zones. Since the tax-free zones of
Madeira and Santa Maria Island are within the Portuguese
Republic, it is essential that the united states be able to
obtain the information necessary to distinguish between income
associated with entities that are entitled to treaty benefits and
income associated with entities that are not entitled to treaty
benefits. In this regard, it is often particularly difficult to
make such distinctions for financial institutions. Portugal has
assured the united states that it will use the same measures in
responding to u.s. requests that it is able to use for its own
internal purposes. This commitment extends to requests to
Portuguese courts, if necessary, that a bank be compelled to
provide requested information. Information supplied by Portugal
suggests that when the Portuguese authorities ask their courts to
obtain necessary information from Portuguese taxpayers, the
courts provide timely, positive responses.
Article 29. DIPLOMATIC AGENTS AND CONSULAR OFFICERS
This Article confirms that any fiscal privileges to which
members of diplomatic or consular missions are entitled under the
general provisions of international law or under special
agreements will apply, notwithstanding any provisions of this
Convention to the contrary. This provision also applies to
residents of either Contracting state, provided that they are not
citizens of that State and, in the case of the United States, are
not "green card" holders. (See subparagraph 1(c) (ii) of the
Protocol. )
Article 30. ENTRY INTO FORCE
This Article provides the rules for bringing the Convention
into force and giving effect to its provisions. Paragraph 1
provides that the Convention is sUbject to ratification by each

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Contracting state, and that the instruments of ratification shall
be exchanged as soon as possible.
Paragraph 2 provides that the Convention will enter into
force on the date on which instruments of ratification are
exchanged. Subparagraph 2(a) provides that 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 following
the date of entry into force. For example, if the Convention
were to enter into force on July 1, 1995, the withholding rates
on dividends, interest and royalties would be reduced (or
eliminated) for amounts paid on or after January 1, 1996. For
all other taxes, the Convention will have effect for any taxable
year beginning on or after January 1 of the year following the
year in which the Convention enters into force, (in this example,
January 1, 1996).
Article 31. TERMINATION
The Convention is to remain in effect indefinitely, unless
terminated by one of the Contracting States in accordance with
the provisions of this Article. The Convention may be terminated
at any time after five years from the date of its entry into
force, provided that written notice has been given through
diplomatic channels at least six months in advance. If such
notice is given, the Convention will cease to apply in respect of
taxes withheld on dividends, interest, and royalties paid or
credited on or after the first day of the January following the
expiration of the six-month period. The Convention will cease to
apply with respect to other taxes for taxable periods beginning
on or after the first day of January following expiration of the
six-month period. Thus, for example, if notice of termination is
given in July or later of a calendar year, the termination will
not be effective as of the following January 1 but as of the
second January 1 thereafter, since the notice period must last at
least six months.