3.3.4.3 Qualification differences resulting from a different interpretation of the facts or the treaty provisions

The approach included in the OECD Commentary only addresses qualification differences resulting from differences in domestic law. The Commentary hence does not provide a solution in situations where a divergent interpretation of the facts or treaty provisions results in double taxation. In such situations, only a MAP can provide a solution for the taxpayer involved.1 The OECD MTC does not explain why a different methodology is used in this context.

The fact that double taxation provisions are not interpreted and implemented consistently may lead to conflicts about the definition of various terms used in the treaty. It can also lead to conflicts on whether or not a permanent establishment exists. These conflicts can lead to double taxation and provide tax avoidance opportunities, which is contrary to the objectives of the OECD MTC.2

If the source state considers that it should not tax based on facts or treaty provisions, while a different interpretation causes the state of residence to consider that the source state should tax, a situation of unintended double non-taxation could arise under the exemption method.3 Art. 23 A, par. 4, OECD MTC includes a specific provision to prevent this. This provision prevents application of the exemption of foreign items of income by the state of residence if the source state exempts the income or only subjects it to a limited amount of taxation under the treaty provisions.4 The aim is to avoid double non-taxation resulting from differing views on the facts of the case or the interpretation of treaty provisions between the state of residence and the source state. This contributes to realizing the objectives of the OECD MTC.

Art. 23 A, par. 4, OECD MTC does not apply if the source state may tax an asset without limitation under the treaty, but does not effectively tax that asset under national legislation.5 In other words, art. 23 A, par. 4, OECD MTC is not intended to function as a subject-to-tax requirement.

Moreover, the provision does not apply if the qualification of an item of income under the national legislation of the source state results in the inability to tax that income under the treaty. In such a case, there is no taxation by the source state in accordance with the treaty, so that art. 23 A, par. 1, OECD MTC already did not apply.6 This produces a logical outcome. After all, if the source state interprets a term in line with art. 3, par. 2, OECD MTC and concludes that a treaty provision applies which ensures that no tax may be levied in the source state, taxation is in line with the treaty provisions. It is then up to the state of residence to follow this interpretation and not to apply an exemption. This already solves any double non-taxation. Since art. 23 A, par. 4, OECD MTC is an exception to the first paragraph of that provision, the provision only applies if the state of residence would be obliged to exempt the income under the application of the first paragraph.

For the sake of completeness, a provision similar to art. 23 A, par. 4, OECD MTC is logically not part of art. 23 B OECD MTC. If the source state does not levy tax, the state of residence will tax the income without giving a credit.7