States parties to a double taxation treaty may interpret it differently. Then they attach a different importance to the rules of the double taxation agreement. In such a case, the question arises of how to resolve this conflict of interpretation.

1. Problems due to conflict of interpretation in double taxation agreements

If the States Parties interpret the double taxation agreement (DTA) concluded between them differently, this disrupts the uniformity of the regulations of the DTA. This may mean that the actual goal – the avoidance of double taxation – cannot be achieved or can only be achieved to a limited extent. For this reason, it is necessary to resolve conflicts in the interpretation and application of double taxation.

This requires special administrative procedures. These must enable the tax authorities of the individual contracting states to resolve problems in the interpretation and application of the DTA by consensus. These special administrative procedures are called communication procedures. However, there are different types of communication procedures. The Federal Ministry of Finance has published the “Framework on International Understanding and Arbitration Procedures in the Field of Income and Asset Taxes” on cross-border dispute resolution.

Methods for settling disputes of interpretation

2.1. Communication procedure in the narrow sense

On the one hand, there are communication procedures in the narrower sense. They are explicitly provided for in the DBA. The OECD Model Agreement provides for the understanding procedure set out in Article 25(1) and (2) of the OECD-MA. Understanding procedures in the narrower sense make it possible, on a case-by-case basis, to avoid or abolish taxation by one or both Contracting States which is not in accordance with the Agreement.

Understanding procedures in the narrower sense can include advance pricing agreements (APAs). Nationally, they are regulated in § 89a AO. These take place preventively before the contested transaction is concluded. For example, they play a role for cross-border companies in the context of the profit accruals to affiliated companies (transfer pricing) and the allocation of profit to permanent establishments. However, they are applicable to all cross-border situations.

2.2. Consultation procedure

Another instrument for the uniform interpretation and application of double taxation agreements in a conflict of interpretation is consultation procedures. They serve in general or in individual applications, but without reference to a specific taxpayer, to eliminate difficulties or doubts in the interpretation or application of the agreements (concrete consultation procedure) or to close gaps in the contract (abstract consultation procedure), see § 2 (2) sentence 2 AO. Thus, it is a matter of clarifying legal issues without reference to a specific individual case. For this reason, these methods can be operated alongside an understanding method in the narrower sense. Despite the lack of reference to a specific individual case, however, these proceedings are also not binding on the courts. Nor can the DTA itself be changed by such agreements. Rather, consultation procedures are only interpretative tools for DBA.

2.3 Arbitration

Increasingly, double taxation agreements allow arbitration within the meaning of Article 25(4) OECD-MA. Arbitration procedures have been developed to remedy the procedural shortcomings of the mutual understanding procedures in the narrow sense stated above. Therefore, the arbitration procedures provide, among other things, for an agreement obligation. This is why the international trend is to agree more mandatory arbitration clauses in order to improve tax protection.

Arbitration under a DTA is an independent part of the understanding procedure itself. Arbitral awards are, insofar as the applicant agrees, implemented by concluding an agreement of the same content. However, the procedural prerequisite is that the authorities were not able to reach agreement over a period of two years in the context of the actual understanding procedure. This period shall begin only from the date on which all the information necessary to resolve the case has been made available to the authority. In addition, due to the lack of agreement, it must have already come to an agreement-incompatible taxation. If a court decision on the specific facts has already been made, arbitration may not be initiated.

2.4. procedure at EU level

For disputes between EU Member States, the EU Dispute Settlement Directive provides, among other things, for dispute settlement through mutual understanding procedures. It was transformed into national law by the EU-DBA Dispute Resolution Act. The aim of this is to close regulatory gaps for intra-European double taxation conflicts. This is intended to complement the existing DBA dispute settlement mechanisms. Controversy arising from the interpretation and application of agreements and conventions which provide for the elimination of double taxation of income and, where applicable, property

In the context of transfer pricing conflicts, the EU Arbitration Convention provides for binding dispute settlement mechanisms through arbitration.

Taxpayer’s right to choose in the event of a conflict of interpretation

If the requirements of the various dispute resolution instruments are met, the taxable person may choose which of the dispute resolution procedures he/she wishes to apply for. For the choice of the most advantageous method, some factors must be considered. In addition, the taxable person should consider bringing national remedies in parallel with the intergovernmental understanding procedure.

If the taxpayer has applied for a dispute settlement complaint under the EU-DBA-SBG, earlier mutual understanding procedures are automatically terminated. Subsequently strenuous communication procedures are inadmissible.

If, on the other hand, the taxpayer strives for an agreement procedure under the DTA and subsequently requests an agreement procedure under the EU Arbitration Convention (and vice versa), the tax administration rejects the later procedure if the taxpayer has not withdrawn the application for the first requested procedure. If the taxable person has submitted the applications at the same time, the taxable person must choose one of the procedures within a time limit set by the BZSt. Otherwise, the BZSt will interpret the application for the benefit of the applicant at due discretion.

4. design of the mutual understanding procedures in the event of conflict of interpretation

4.1. Legal nature as mere administrative procedure

Consensus procedures are administrative procedures and therefore not judicial or appeal procedures. Therefore, they are subject only to equity and practicability considerations. However, the principles and guarantees of legal proceedings do not apply.

3.2. Status of taxable persons

Taxpayers are not involved in the interstate communication procedures. They therefore have no rights which only parties to the proceedings are entitled to.

3.3 Status of Financial Authorities

The financial authorities of the Contracting States are the parties to the understanding procedure. But it is not their duty to agree. This obligation is provided only by increasingly agreed arbitration procedures – for example, under Article 25(5) OECD-MA.

If the financial authorities agree, this follows from an obligation under international treaty. According to § 175a AO, this is to be implemented domestically without further ado. Thus, the agreement in Germany has the legal character of a (simple) administrative agreement. The courts are not bound by this. But the financial authorities are bound.