3.3.4.2 Qualification differences resulting from differences in national law

If the two treaty countries interpret the terms in a treaty differently, there is a qualification difference.1 As a result, the state of residence and the source state can apply different treaty articles with a non-equal allocation rule to the income. What’s more, the qualification difference may result in a certain article leading to two different outcomes. The OECD Commentary pays extensive attention to qualification differences.2 The OECD starts from the basic premise that the state of residence may tax the worldwide income without limitation through the application of a tax treaty. Yet, the tax treaty is of major importance for the position of the source state: it limits the source state's taxing right. Therefore, it must be determined whether the source state taxes in accordance with the provisions of the Convention. If the item of income may be taxed in the source state in accordance with the Convention, the state of residence must provide for the elimination of double taxation.3

If the source state applies other treaty provisions to certain items of income under domestic law than the state of residence would have done under domestic law, the question is whether such taxation is in accordance with the treaty. According to the OECD, this is the case if the source state concludes and can conclude under its national law that taxation is allowed. In such a case, the state of residence must also provide for the avoidance of double taxation.4 The OECD hence takes the application of the tax treaty advocated by the source state as the starting point for this qualification difference.5 The qualification based on the national law of the state of residence plays no role in this context. Therefore, double taxation is eliminated, and a contribution is made to realizing the objectives of the OECD MTC.

The system described above also applies for preventing situations of double non-taxation. If the source state concludes that a certain asset may not be taxed based on the tax treaty provision and under national law, the state of residence may assume that the item of income may not be taxed by the source state in accordance with the treaty provisions. In this respect it is not relevant that the residence state would have applied the Convention differently had it been the source state. If the state of residence applies the exemption method, no exemption needs to be granted in such a situation.6 In this context, too, the source state's interpretation of the tax treaty is leading. This system in principle prevents double non-taxation in accordance with the objectives of the OECD MTC. However, it is strange that such double non-taxation would not have been an issue if both states would have applied the same tax treaty rule, while the residence state has no taxing rights under the treaty and the source state does not levy a tax under its domestic law.7

Various countries do not follow the approach advocated by the OECD. If a tax treaty is seen purely as a method of distributing taxing rights, it is not obvious to take the application of one of the Contracting States as the starting point. Such a starting point also does not seem to ensue from the wording of the provision, which is based on the position of the state of residence and involves determining whether the income may be taxed in the other state in accordance with the treaty provisions.8 A further examination of the national interpretation in the other state hence does not seem necessary. The OECD too states that a major advantage of the exemption method is that it is a practical method for which the actual position in the other state does not have to be taken into account.9 There is no such advantage in the approach described by the OECD.