How To Interpret a Tax Treaty – Guidance from a Canadian Tax Lawyer

What is a tax treaty

A tax treaty is a bilateral agreement made by two countries to resolve certain tax issues such as double taxation, pension treatment or residence status determination for tax purposes. It often lists special circumstances or exemptions, such as how the income arising from one country is taxed in another country. Since Canada has signed a number of tax treaties with other countries, this article will focus on the interpretive approaches to a tax treaty.

The Vienna Convention

The Vienna Convention has been signed by many countries, and it applies to all treaties, not just tax treaties. Article 31(1) of the Vienna Convention sets the basic rule for interpreting any treaty including a tax treaty:

• A treaty shall be interpreted in good faith in accordance with the ordinary meaning to be given to the terms of the treaty in their context and in the light of its object and purpose.

In addition, Article 32 of the Vienna Convention considers supplementary materials for the interpretation of a tax treaty to confirm the meaning established pursuant to Article 31. Although the approach provided by Articles 31(1) and 32 sound intuitive, they may support almost any type of interpretive approach due to the vagueness of the wording. Therefore, the Vienna Convention barely has any practical assistance in determining the appropriate meaning of certain provisions of a treaty.

UN and OECD Model

Canada has signed tax treaties with more than 60 countries, and the majority of these treaties are based on the United Nations Model Double Taxation Convention between Developed and Developing Countries (United Nations Model Convention) and the Organisation for Economic Co-operation and Development Model Tax Convention on Income and on Capital (OECD Model).

The UN and OECD Model Conventions and Commentaries offer more meaningful and practical guidance with respect to tax treaties based on the UN and OECD Models, and there is an internal rule of interpretation in Article 3(2) of the UN and OECD Model Conventions:

• As regards the application of the Convention at any time by a Contracting State, any term not defined therein shall, unless the context otherwise requires, have the meaning that it has at that time under the law of that State for the purposes of the taxes to which the Convention applies, any meaning under the applicable tax laws of that State prevailing over a meaning given to the term under other laws of that State.

This provision essentially sets out a three-stage process:

1. Does the treaty define the term?
2. If the treaty does not give a definition, what is the domestic meaning (not necessarily the definition under domestic law) of the term?
3. Does the context of the treaty require a meaning different from the domestic meaning?

The definition of a specific term in a tax treaty may be inclusive or exclusive, but it may contain terms that are not defined. In that case, Article 3(2) of the UN and OECD Conventions will apply to determine the ordinary meaning under domestic law. However, an undefined term may still not be defined under domestic law or have more than one meaning under a country’s general domestic law and tax law. Under the latter circumstance, the meaning under the domestic tax law should prevail over the meaning provided by other domestic laws. In addition, the context of the treaty must be taken into consideration to determine the meaning of an undefined term, and an alternative meaning of the term may be more appropriate. This analysis should involve the following factors:

• The ordinary meaning of the term compared with the meaning under the domestic law;
• The meaning of the term under the other country’s tax law;
• The purpose of the relevant provision of the treaty; and
• Extrinsic material such as commentaries.

Pro tax tips – consult with an experienced Canadian tax lawyer if you need help with tax treaty interpretation

So far, there hasn’t been any comprehensive assessment of national courts’ interpretive approach to tax treaties. However, the survey conducted by Klaus Vogel’s review of tax treaty cases for the period from 2000 to 2008 from a small selection of countries indicates the courts have made fundamental errors. Unfortunately, since there is no simple answer to how a tax treaty should be interpreted, a taxpayer should always seek a consultation with an experienced Canadian tax lawyer in Toronto if they need help with the interpretation of a tax treaty.

FAQ

What is a tax treaty?

A tax treaty is an agreement between two countries to settle tax issues such as double taxation and tax evasion. A tax treaty usually outlines the taxes that are to be paid and helps decide in which country a person is considered resident.

What is the OECD Model Tax Convention

The OECD Model Tax Convention, a model for countries concluding bilateral tax conventions, plays a crucial role in removing tax-related barriers to cross-border trade and investment. It is the basis for the negotiation and application of bilateral tax treaties between countries, designed to assist businesses while helping to prevent tax evasion and avoidance. The OECD Model also provides a means for settling on a uniform basis the most common problems that arise in the field of international double taxation.

About the Author

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David J. Rotfleisch

David J. Rotfleisch, a leading Canadian tax lawyer, is not only a certified specialist in taxation but also a chartered professional accountant. Most recently, David is a pioneer in Canadian crypto taxation.

As of April 2020, he was one of 12 Ontario Certified Specialists In Taxation™.

Learn more about David J. Rotfleisch