Spanish Supreme Court: Tax treaties cannot be interpreted from later model conventions and their commentaries if there are material differences between them
Spain Tax Alert
In a recent judgment delivered on March 3, 2020 (cassation appeal 5448/2018), the Supreme Court ruled on the limits of the interpretation of tax treaties in light of later versions of model conventions (and their commentaries) published by the OECD.
In the case examined in the judgment, the National Appellate Court rejected the argument that the branch in Switzerland of a Spanish resident entity could be characterized as a permanent establishment because, in its view, the activity carried on by the branch was merely ancillary, even though the branch was being treated in Switzerland as a permanent establishment.
As a result, the National Appellate Court confirmed the tax authorities’ interpretation that the Spanish resident entity was not entitled to claim the international double taxation credit allowed in the Spain-Switzerland tax treaty.
The court based its decision on the definition of permanent establishment provided in a later model convention than the model used for the Spain-Switzerland tax treaty, and on the commentaries accompanying that model convention.
The Supreme Court, however, concluded as follows:
- The definition of permanent establishment contained in the Spain-Switzerland tax treaty is materially different from that provided in the model convention applied by the National Appellate Court.
- Besides, the commentaries on the model convention are not sources of law.
- The National Appellate Court therefore applied the definition of permanent establishment retroactively, and unilaterally rendered ineffective the definition of permanent establishment covenanted between Switzerland and Spain in the applicable tax treaty, by replacing it with another later one.
In short, in the examined case a “dynamic interpretation” in the strict sense has not taken place of the Spain-Switzerland tax treaty; what the National Appellate Court has done is pretermit the source of law system for Spanish law, by applying a definition of permanent establishment other than that covenanted by the two contracting states in the applicable tax treaty.
In relation to the issue with cassational interest that had been observed in the admission decision, relating to the limits of dynamic interpretation of tax treaties, the Supreme Court affirmed that this type of interpretation cannot be held valid retroactively, or founded exclusively on interpretation commentaries or guidelines not expressly assumed by the signing states; and, lastly, it cannot give rise to a double taxation scenario contrary to the purpose of the tax treaty itself (the tax authority must consider the effective tax substantiated in the other country signing the tax treaty).
The Supreme Court rebuked the tax authorities which, despite being aware that the Swiss authorities had treated the branch in Switzerland as a permanent establishment for the purposes of the tax treaty, had not applied the mechanisms set out in the tax treaty itself for resolution of disputes of this type, which has given rise to a double taxation scenario contrary to the spirit and purpose of the tax treaty.