Dual residence Kees Van Raad

1. According to the updated Commentary on Art. 4
of the OECD Model, a person who, under the
domestic laws of States A and B, is a resident of
both states but who, under the tax treaty
between States A and B, is a resident only of
State A cannot, as a domestic law resident of
State B, have access to a tax treaty between
State B and a third state from which he derives
income. This article examines whether the new
Commentary has the intended effect.
1. Introduction
This article deals with the (tax treaty) residence status
that dual residents have under treaties with third
(source) countries. Let us assume that person X (an
individual or company) is a resident of both States A and
B under the domestic laws of each state. It is further
assumed that there is an OECD Model-type tax treaty in
force between States A and B and that, under the tie-
breaker rules (Arts. 4(2) and (3) of the OECD Model Tax
Convention) in the State A–State B treaty, X is a treaty
resident only of State A. Therefore, for purposes of the
State A–State B treaty, State B is the “loser” state in rela-
tion to X. If X derives income from State C (a third state),
the question arises whether X could apply the State
B–State C treaty as a domestic law resident of State B.
Or does State B’s loser status in relation to X under the
State A–State B treaty affect the applicability of the State
B–State C treaty to X? Art. 4(1) of the OECD Model
reads:
For the purposes of this Convention, the term “resident of a
Contracting State”means any person who, under the laws of that
State, is liable to tax therein by reason of his domicile, residence,
place of management or any other criterion of a similar nature,
and also includes that State and any political subdivision or local
authority thereof. This term, however, does not include any per-
son who is liable to tax in that State in respect only of income
from sources in that State or capital situated therein.
It is sometimes observed that one tax treaty cannot have
an effect on the application of another tax treaty. This
observation does not seem to be generally accurate. Let
us assume that one treaty requires, for its application to
person X,that X have a particular legal characteristic,but
X no longer has that characteristic because of the restric-
tive effect that another applicable treaty has on the appli-
cation of e.g. the domestic law of X’s residence state; thus,
the latter treaty influences the outcome of the former
treaty’s application to X. Consequently, the latter treaty
does affect the application of the former treaty.
This effect should be distinguished from the cumulative
effect that two tax treaties (simultaneously) may have on
the taxation of a single person. If a resident (X) of one
state derives an item of income that two other states,
under their domestic laws, consider as being sourced in
their state and their treaties with X’s residence state leave
to each of the two states the right to tax that income
while requiring the residence state to grant double taxa-
tion relief, the relief to be granted by the residence state
under its treaty with one source state does not have an
impact on the relief it may be required to grant under its
treaty with the other source state; relief under both
treaties must be granted. Similarly, if from one source
state an item of income is derived byY, who is a domestic
law and tax treaty resident of one state and, at the same
time, is a domestic law and tax treaty resident of another
state, the restrictions that the two treaties (between each
of the residence states and the source state) may impose
on the application of the source state’s domestic law will
both apply – certainly if there is no treaty between the
two residence states.
The discussion below focuses on the question whether
the answer may be different when there is a tax treaty
between the two residence states that includes an
OECD-type dual residence tie-breaker rule.
2. Effect of Dual Residence Tie-Breaker Rule
In the first example above,X,for purposes of the StateA–
State B tax treaty, is a (treaty) resident only of State A;
State B may tax X only on the income items which,under
the distributive rules of the treaty,“may be taxed” by the
“other” state (here, State B).While under its domestic tax
law State B would tax X on X’s worldwide income, the
State A–State B treaty restricts State B to taxing X only on
a limited number of income items (i.e. those which,
under the treaty’s distributive rules, may be taxed by the
“other”state). This treaty-imposed restriction on State B’s
taxation of X does not by itself generally affect X’s status
under State B’s domestic law as a resident taxpayer,1
but
its effect is that State B may tax its resident X only on the
* © Kees van Raad, 2009. Professor of Law, Leiden University, the
Netherlands; Chairman of the International Tax Center Leiden; and Of
Counsel, Loyens & Loeff.
1. This is different in countries, such as the United Kingdom and Canada,
whose domestic law effectively provides that a person who is not a treaty resi-
dent under any of that country’s tax treaties will not be considered to be a resi-
dent for domestic tax purposes (and therefore cannot qualify as a treaty resi-
dent of that country under any of that country’s other tax treaties).
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2008 OECD Model: Operation and Effect
of Article 4(1) in Dual Residence
Issues under the Updated Commentary
Prof. Kees van Raad*
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2. income items which the State A–State B treaty leaves to
the “other” state (i.e. the state that is not the residence
state). These income items are generally of the same
nature as the income items on which State B taxes a non-
resident under its domestic tax law. This is not surpris-
ing, of course, since most states tax non-residents on
income derived from that state, while the distributive
rules of tax treaties leave many of the items of income
derived from the“other”state to be taxed by that state.
3. Definition of Treaty Resident in the
OECD Model
In the OECD Model, the definition of resident for tax
treaty purposes is laid down in Art. 4(1). From the Com-
mentary on this provision, it is clear that the definition is
aimed at persons who, according to the taxation laws of
one state,2
are subject to worldwide tax liability3
or to the
most comprehensive form of tax liability under that
state’s domestic tax law.4
The latter part of this rule
implies that if, under a country’s domestic tax law, one
group of taxpayers is subject to worldwide taxation and
another group to more limited taxation, the latter group
cannot meet the definition of treaty resident in Art. 4(1).
The second sentence of Art. 4(1) provides an exception
to the first sentence: a person who is subject to tax by a
state only on income from sources in that state is not to
be considered a treaty resident of that state.As discussed
in 4., the Commentary indicates that this rule was
designed for diplomats.5
This exception implies that,
without the exception, such a person would be a treaty
resident of that state. Of course, if the state concerned
distinguishes between two groups of taxpayers – one
subject to worldwide taxation and one subject to more
limited taxation – as noted above, persons in the second
group would not qualify as residents under the defini-
tion in Art.4(1) to begin with; thus,the question whether
this group would come under the exception in the sec-
ond sentence does not arise.
The question therefore remains whether persons who,
under the tax laws of a country, are residents of that
country subject to worldwide taxation, but who, as a
result of a (tax or other) treaty, are not effectively subject
to such taxation, are excepted by the second sentence of
Art. 4.1 from qualifying as a treaty resident of that coun-
try.
4. Article 4(1) and Diplomats
The second sentence of Art. 4(1) was introduced in 1977
to take care of a minor issue.A diplomat of State A who is
stationed in host State B will often, because of his effec-
tively residing in State B,6
be a resident of State B. At the
same time, the diplomat will, under sending State A’s
domestic tax law, remain a deemed resident of State A. It
was apparently felt that a diplomat should not have
access to the tax treaty networks of both states and that
he therefore should not be entitled to the treaties con-
cluded by host State B. This exclusion was accomplished
by the addition of a second sentence to Art. 4(1) which
excepts from “treaty resident” as defined in the first sen-
tence “any person who is liable to tax in that State in
respect only of income from sources in that State ...”. The
use of the word “source” may not surprise the average
reader who perhaps thinks that the OECD Model, in
addition to the terms “resident” and “residence”, also fre-
quently uses the word “source”. In fact, the word “source”
is used only in Art. 4(1) and in Art. 20 (Students).7
The
question therefore arises as to the reason why this word
is used here in connection with diplomats and as to its
precise meaning.
The Commentary on Art. 4 provides an indication.
Para. 8.1, second sentence, refers to the “situation ... of
foreign diplomatic and consular staff serving in their ter-
ritory”. This “territory” is apparently the territory of the
host state in which the diplomat, etc., serves as such. In
their host state, diplomats are entitled to the benefits
granted to them by the 1961 Vienna Convention on
Diplomatic Relations (“1961 Vienna (Diplomatic) Con-
vention”).With respect to income taxation,Art.34 of this
Convention grants diplomats an exemption from all
taxes, except (as provided in Art. 34(d))“taxes on private
income having its source in the receiving State”. Diplo-
mats may be taxed by their host State on such income
only.
Under the OECD Model language, therefore, diplomats
cannot be a treaty resident of their host state. Without
the rule in Art. 4(1), second sentence, there would be no
standard answer to the question of which of the two
states (the sending state or the host state) the diplomat is
a (treaty) resident. If he stays long enough in the host
state to be considered a resident of that state under its
domestic tax law or otherwise meets that state’s defini-
tion of resident, while at the same time he, as a diplomat,
remains a deemed resident of his sending state, he would
have dual residence under the treaty residence rule in
Art. 4(1), first sentence. If the diplomat had not main-
tained a home available to him (i.e. not rented out) in the
sending state, under the tie-breaker rule in Art. 4(2) a),
he would, for purposes of the treaty between the sending
state and the host state, be a (treaty) resident only of the
host state. If he still had a residence available to him back
home, the state with which his personal and economic
relations are closer (his“centre of vital interests”) will win
the tie, and that can be either state depending on the
diplomat’s circumstances.
2. Para. 8, fifth sentence, of the Commentary on Art. 4 explains the expres-
sion “the laws of that State” in Art. 4(1) as “the taxation laws of [that] State”
(emphasis added).
3. Para. 8, fourth sentence, of the Commentary on Art. 4.
4. Para. 8.3 (end) of the Commentary on Art. 4.
5. Para. 8, fifth sentence, of the Commentary on Art. 4.
6. Para. 8.1, first sentence, of the Commentary on Art. 4 curiously notes
that the diplomat may be considered to be a resident according to the domes-
tic laws“although [he is] not domiciled in that State”. Perhaps“domicile”is used
here in the meaning it has under UK tax law.
7. The word “sources” as used at the end of the definition of immovable
property in Art.6(2) does not refer to sources in relation to income,but to nat-
ural sources (of water, etc.).
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3. The difference in effect between the tie-breaker rules in
Arts. 4(2) and 4(3), on the one hand, and the special pro-
vision for diplomats in Art. 4(1), second sentence, on the
other, is that the latter rule operates not only in the treaty
between the host state and the sending state, but in any
tax treaty of the host state. In contrast, the tie-breaker
rules in the treaty between the host state and the sending
state would not deny a diplomat’s access to other tax
treaties of his host state (unless one accepts the view-
point of the OECD mentioned below).
5. Article 4(1) and Conduit Companies
The 1992 Commentary also brought conduit companies
under the exception in Art. 4(1), second sentence.With a
minor adjustment made to its text by the 2008 Update,
Para. 8.2, first sentence, of the Commentary on Art. 4
reads: “According to its wording and spirit the second
sentence also excludes from the definition of a resident
of a Contracting State foreign held companies exempted
from tax on their foreign income by privileges tailored to
attract conduit companies.”
6. Article 4(1) and Dual Residents
The 2008 Update of the Commentary added a third cat-
egory to the reach of Art. 4(1), second sentence: “It also
excludes companies and other persons who are not sub-
ject to comprehensive liability to tax in a Contracting
State because these persons, whilst being residents of
that State under that State’s tax law, are considered to be
residents of another State pursuant to a treaty between
these two States.”8
The effect of this interpretation is that
a dual resident is denied access to the other treaties con-
cluded by his “loser” residence state in instances where
Art. 4(1) of those treaties includes the second sentence.
The OECD’s line of reasoning apparently is that a person
who is a domestic law resident of one treaty state, but for
treaty purposes a (treaty) resident of the other treaty
state, is liable to tax in the first state in respect “only of
income from sources in that State”. It is apparently
assumed that income which, under the OECD Model’s
distributive rules in such a case, may be taxed by the
“other” state can be equated with “income from sources
in that State”.
7. OECD’s Reason for Denying Benefits of a
Treaty between a (Loser) Residence State and
a Third (Source) State
Before analysing whether this line of reasoning regard-
ing the application of Art. 4(1), second sentence, to tie-
breaker losers is correct and effective, it is useful to
examine what the OECD’s reason might have been to
deny a taxpayer the benefit of a treaty between his (loser)
residence state and a third (source) state. If the taxpayer’s
residence state cannot effectively tax him on his world-
wide income because, under a treaty with another (resi-
dence) state, the first state has accepted to restrict the
scope of its taxation of the taxpayer, why should this sit-
uation result in the latter state’s treaties with third states
not being applicable? Perhaps it is the source state’s fear
that, in instances where its treaty with the loser state
restricts its (the source state’s) taxation more than the
treaty with the winner state, the taxpayer may artificially
have created dual residence in order to avail himself of a
treaty with the source state that provides for such further
restriction of the source state’s taxation than the treaty of
his“true”(winner) residence state.
If this is indeed the reason for the current attempt to ren-
der the loser state’s treaty with the source country inap-
plicable, a few observations should be made. First, the
measure appears to amount to serious overkill, as it also
denies treaty access where a company is a resident of the
loser state not because it is incorporated there, but
because of a substantive residential presence in that state.
Second, if the second residence is created in a state that
does not have a treaty with the first residence state or, if
the treaty between the two residence states does not con-
tain Art. 4(1), second sentence, the application of the
treaty between the second residence state and the source
state will not be affected. As the aim of the expanded
application of the second sentence can therefore easily
be circumvented, it leaves the effect of this application
restricted to the uninitiated and to those without room
to manoeuvre. From a more general perspective, the
question may be raised whether the measure fits in with
the emerging trend among states to be concerned more
about a reduction in a taxpayer’s global tax liability than
about shifts in the amounts of tax due by the taxpayer in
the different states where he has a tax presence.
8. Questions of Treaty Interpretation
At a technical level, the use of the second sentence to
deny a person who is a resident of a“loser”state access to
the latter state’s treaties with third states raises questions
as to the correct treaty interpretation. The suggested
interpretation of the expression“income from sources in
that State” does not seem to be based on the rules gov-
erning the interpretation of tax treaties. The term
“source” is not defined in the OECD Model. Under the
general interpretation rule in Art. 3(2), the meaning of a
term should be established under the domestic law of the
state applying the treaty (unless the treaty context other-
wise provides). In the domestic laws of many states, the
term “source” does not have a particular meaning for tax
purposes (at least not in a geographical sense). In such
cases, the term should be interpreted according to the
rule in Art. 31(1) of the 1969 Vienna Convention on the
Law of Treaties (“1969 Vienna (Treaty) Convention”): it
should be given its “ordinary meaning” taking into
account the term’s “context” and the treaty’s “object and
purpose”. The ordinary geographical meaning of “source”
is “point of origin” (see Webster’s Third New International
Dictionary) (hereafter “ordinary meaning”). In tax
treaties,the concept of source is typically viewed as refer-
ring to the distributive rules: the items of income that
8. Para. 8.2, second sentence, of the Commentary on Art. 4.
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4. may be taxed by the “other” state are considered to have
their source in that state (hereafter “treaty meaning”).
Somewhat similarly, in domestic law, the concept of
source is often understood as referring to the items of
income that a source state taxes in the hands of non-resi-
dent recipients (“domestic source”) and, conversely, the
items of income in respect of which resident taxpayers
are entitled to double taxation relief (“foreign source”)
(hereafter jointly“domestic meaning”).
Para. 8.1 of the Commentary on Art. 4 refers, after the
addition of the second sentence to Art. 4(1) in 1977, to
the situation of being subject, as a resident of a state,“to a
taxation limited to the income from sources in that State”
as existing “in some States in relation to individuals, e.g.
in the case of foreign diplomatic and consular staff in
their territory”. As mentioned above, such taxation is
based on the 1961Vienna (Diplomatic) Convention.Art.
34 of this Convention provides that“[a] diplomatic agent
shall be exempt from all dues and taxes, personal or real,
national, regional or municipal, except ... (d) Dues and
taxes on private income having its source in the receiving
State ...” (emphasis added). There is a strong implication
that the term“source” is taken from this provision. Many
states have implemented this provision in their domestic
law by restricting the income taxation of diplomats who
serve in their territory to income in respect of which
they subject non-residents to tax.In doing so,these states
apply what is above called the “domestic meaning” of
source.
Both the “treaty meaning” and “domestic meaning” of
source go beyond the “ordinary meaning” of source that
refers to income originating in the given country. The
profits of a permanent establishment which, under Art. 7
of the OECD Model, may be taxed by the “other” state
(and usually will be taxed under the domestic concept of
source) are not restricted to the profits arising within
that state’s territory and may include income derived
from a third state (not only dividends, interest and royal-
ties but also active business income). Even more evi-
dently, the profits from international air and water trans-
portation which, under Art. 8 of the OECD Model, may
be taxed by the“other” state if the place of effective man-
agement of the transportation enterprise is situated in
that state (same under the domestic law of some states)
clearly cannot be said to comprise only profits geograph-
ically originating in that state.
To complicate matters, treaty practice under the 1961
Vienna (Diplomatic) Convention has been to interpret
the term “source” as used in Art. 34 as referring to the
“domestic meaning”of source. Under the 2008 extension
of the second sentence of Art. 4(1) of the OECD Model
to residents of the loser state, however, it is clear that the
“treaty meaning” of source is meant. The question arises
what the legal status is of these two meanings for pur-
poses of the interpretation rule in the 1969 Vienna
(Treaty) Convention which refers to the object and pur-
pose of the treaty concerned in the light of which the
“ordinary meaning” of the term in its context should be
established.
9. Use of Later Changes to the Commentary
The OECD seeks to apply Art. 4(1), second sentence, to
residents of a “loser” state through a change to the Com-
mentary on Art. 4.According to Para. 35 of the Introduc-
tion to the OECD Model and Commentaries, changes to
the Commentaries on existing provisions of the OECD
Model“are normally applicable to the interpretation and
application of conventions concluded before their adop-
tion, because they reflect the consensus of the OECD
Member countries as to the proper interpretation of
existing provisions and their application to specific situ-
ations”. Courts in many countries and commentators
generally do not accept, for the interpretation of existing
treaties, the parts of the Commentaries which were
added after the treaty was concluded if the addition goes
beyond an amplification of what was already in the
Commentaries at the time the treaty was concluded.9
The expansion of the meaning given in the 2008 Update
of the Commentary on Art. 4(1), second sentence,
appears to be a clear instance where the Commentary
goes beyond the interpretation given so far to this provi-
sion. Consequently, the updated Commentary will often
not be applied in the interpretation of existing treaties.
From this perspective, the effect of the updated Com-
mentary does not go much beyond amending the OECD
Model itself and incorporating the amended text in
future treaties – which should have been the preferred
method.
The current instance of a novel update of the Commen-
tary on Art. 4 raises the interesting issue whether addi-
tions to the Commentaries that are not supported by the
text of the OECD Model have any interpretational value
at all, i.e. even with respect to treaties concluded after
publication of the new Commentaries. If the new Com-
mentaries are in blatant contradiction of the text of the
OECD Model, do they nevertheless represent a “supple-
mentary means of interpretation”as referred to in Art.32
of the 1969 Vienna (Treaty) Convention or do they lack
all interpretational value?
9. Ward, David A. et al., The Interpretation of Income Tax Treaties with Par-
ticular Reference to the Commentaries on the OECD Model (IFA Canada/IBFD,
2005), Chap. 6 (Use of Later Commentaries), at 78-110.
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