Supreme court decision on dynamic treaty interpretation

18/10/22

In a judgment of 14 October 2022, the Supreme Court ruled that limited meaning (‘beperkte betekenis’) should be given to the OECD model tax convention commentary of a later date, if this commentary is not merely meant as a 'specification or clarification' (‘precisering of verduidelijking’) of a previously concluded tax treaty. The case at hand concerned the interpretation of the concept of employer as part of the employment income article in the treaty for the avoidance of double taxation between the Netherlands and Germany. In the opinion of Advocate General Niessen the Netherlands should have followed the German interpretation of the concept of employer in order to avoid double taxation (please refer to our earlier article). The Supreme Court, however, did not follow this opinion stating that in this specific case there was no specification or clarification of the treaty.

Supreme Court

The question before the Supreme Court regarded whether the OECD commentary of later date could be applied when interpreting an article of an earlier tax treaty. This case concerned the interpretation of the 1959 treaty for the avoidance of double taxation between the Netherlands and Germany using the 2010 OECD commentary ('dynamic treaty interpretation'). In the ‘Notitie Fiscaal Verdragsbeleid’ (Fiscal Treaty Policy Memorandum), the Netherlands indicated that it was desirable to adhere to this international standard as much as possible.

The Supreme Court is of the opinion that the OECD commentary of a later date only has great significance if it concerns a specification or clarification of the treaty. In other words, commentary that goes beyond a specification or clarification is irrelevant when interpreting the tax treaty.

The 2010 OECD commentary stated that in the event of a difference in interpretation between the state of residence (the Netherlands) and the state of employment (Germany), the state of residence would follow the state of employment. This would mean that in this case the Netherlands would indeed have to recognise a German employer based on the 2010 OECD commentary. However, the Supreme Court ruled that the commentary has limited meaning as it went beyond a specification or clarification. The commentary also deviates significantly from the principles of the treaty. In addition, the Netherlands also made reservations to the OECD commentary.

Individualized cross-charge of salary (costs) decisive for foreign employer

Neither the treaty for the avoidance of double taxation between the Netherlands and Germany nor the Dutch national legislation contains any further definition of the concept of employer. Therefore, the Supreme Court judgments of 1 December 2006 are crucial. According to these judgments, an employer in the other country can be recognised if the salary costs for the activities performed have been individually cross-charged. There must also be an authority relationship present.

The 2010 OECD commentary states that a direct cross-charge of the salary costs is only one of the factors to be considered for the presence or absence of an employer. This commentary goes beyond specifying or clarifying the tax treaty, so it cannot be given any meaning in the opinion of the Supreme Court. As there was no individualized cross charge, a German employer cannot be assumed. Finally, the Supreme Court stated that the Higher Court was correct in establishing that there was no authority relationship with the German entity.

What does this mean for your organisation?

While a dynamic treaty interpretation is still applicable according to the Supreme Court, by which the OECD commentary of a later date may be significant for the interpretation of older treaties, its frameworks appear narrow.

Therefore, in case you carry on your business internationally, this judgment may have significant implications for you.

The Netherlands concluded its tax treaties between 1970 and 2022. The OECD commentary was substantially amended in 1977, 1992, 2010 and 2017. It is therefore likely that in your situation, a tax treaty concluded before a major amendment to the OECD commentary applies. This means that you cannot simply rely on the interpretation of the OECD commentary for a specific situation. Only in case the OECD commentary concerns a specification or clarification may you assume that it has great significance.

Background ruling 14 October 2022

In 2014, the employee involved in this case lived in the Netherlands and worked under a formal employment contract with an entity in the United Kingdom (UK). He had an international management position and performed work for the UK entity as well as a German group company. The employee was taxed in the UK and Germany respectively on income related to his days physically worked in these countries. In the Netherlands, the employee applied for a double taxation relief for its working days in the UK and Germany.

The Dutch tax authorities refused to grant double taxation relief for the income relating to German working days, because they did not consider an economic employer to be present in Germany. In their view, the existence of an economic employer required that wage costs be individually charged to the company where the employee's services were performed. This position was based on judgments of the Dutch Supreme Court from 2006.

The Zeeland-West Brabant District Court, however, followed the view of the employee and ruled that there was an economic employer in Germany. According to this Court, based on the amended OECD Commentary, it should not be examined whether the wage costs have in fact been individually charged, but whether the wage costs have been borne by the entity in the State of employment. Since the work of the employee was an integral part of the business activity of the German group company and the wages of the interested party were charged to this company on the basis of the ‘at arm's length principle', the German entity was, according to the Court, the economic employer.

The Zeeland-West Brabant District Court ruled that for the interpretation of tax treaties the dynamic method should be applied. This means that clarifying amendments to the OECD Commentary also apply to treaties concluded before the relevant amendments to the OECD Commentary took place, such as the 1959 Netherlands - Germany tax treaty, which was still applicable in 2014.

However, the Court of Appeal has stated that there is no economic employer in Germany in this case. This judgment does not solely follow from the fact that wage costs have not been individually charged, but mainly because, according to the Court of Appeal, a relationship of authority is missing between the employee and the German entity.

Advocate General Niessen concluded that the Netherlands should follow the interpretation of source country Germany in determining an economic employer. In doing so, he recommended that the appeal in cassation be upheld. The Supreme Court did not follow this conclusion as the OECD commentary of a later date did not qualify as a specification or clarification.