THE LISBON INTERNATIONAL & EUROPEAN TAX LAW SEMINARS

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A GENERAL ANTI-ABUSE PRINCIPLE UNDERLYING TAX

TREATIES

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Prof. Dr. LUC DE BROE (Uni. Leuven)

March 16, 2012 >> Lisbon Law School

Sponsors: SECIL || IBFD

Org. >> IDEFF/ Prof. Dr. Ana Paula Dourado/ Adv LLM José Almeida Fernandes/ Mestre Gustavo Courinha

Anti-abuse Principles in Tax Treaties

Prof. Luc De Broe, KU Leuven

Lisboa, 16 March 2012

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Improper Use of Tax Treaties

• Treaties are not identical and may serve different interests– Different WHT rates, different rules on PE etc.

• Treaty shopping : a premeditated effort to take advantage of the international treaty network and careful selection of the most favorable treaty for specific purpose (e.g. relief WHT in source State, avoidance of PE)

– Rosenbloom: “the practice of some investors of ‘borrowing’ a tax treaty by forming an entity (usually a corporation) in a country having a favourable tax treaty network with the country of source, that is the country where the investment is to be made and the income in question is to be earned”

• Rule shopping : taxpayer is entitled to benefits of a given treaty and employstreaty so that one distributive rule applies rather than another

– Conversion of income schemes: taxable dividends converted in (tax free ) capital gains

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Improper Use of Tax Treaty - Case 1 - Treaty Shopping (Relief of WHT in Source State)

X LtdState A

State B Y Ltd

•Resident of State A interposes company

resident of State B to receive intra-group loan

that is to be onlent to resident of State C

(back-to-back intra-group loans)

•Nominal spread taxable in State B

•No tax treaty between State A and State C

•Tax treaty between State B and State C

reduces interest withholding tax of State C to

5 percent

• No interest WHT in State B on payment to

non-resident

1111State C Z Ltd

Interest payment

(subject to reduced 5%

IWT rate under B-C tax

treaty)

Intra-group loan

Intra-group loan

• Relevance of contractual obligation?

• Analysis different if dividends?

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Improper Use of Tax Treaty – Case 2 - Treaty Shopping (Capital Gains)

X LtdState A

State B Y Ltd

1111State C Z Ltd

•Under State C domestic law non-resident is

taxed on capital gains on shares in State C

company

•There is no tax treaty between State A and

State C

•State A company incorporates and funds a

company (Y Ltd) in State B that acquires the

State C shareholding.

•Tax treaty between between B and C follows

OECD MC: capital gains taxable only in the

State of residence of the shareholder (State B)

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Improper Use of Tax Treaty - Case 2 - Treaty Shopping (Capital Gains)

X LtdState A

State B Y Ltd

1111State C Z Ltd

•State B company (Y Ltd) sells and transfers Z

Ltd shares to third party purchaser (B Ltd) and

realizes a capital gain

•No capital gains tax levied in State B

$$$

1111Z Ltd

1111B LtdShares Z Ltd

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Improper Use of Tax Treaty - Case 3 - Transfer of Effective Management

X LtdState A

Y Ltd

•Company resident of State A (X

Ltd) owns all shares of subsidiary

also resident of State A (Y Ltd)

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Improper Use of Tax Treaty - Case 3 - Transfer of Effective Management

X Ltd

State A

Y Ltd

•Parent company X Ltd becomes resident of

State B under (domestic) effective management

test of State B

•State B exempts dividend income under

participation exemption

State B

X Ltd

Dividends

Effective

management

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Improper Use of Tax Treaty - Case 3 - Transfer of Effective Management

X Ltd

State A

Y Ltd

•Parent company X Ltd becomes resident of

State B under (domestic) effective management

test of State B

•State B exempts dividend income under

participation exemption

•Tax authorities of State A: the transfer of

effective management / tax residence had as its

sole purpose to avoid State A income tax at

parent level on dividends to be received from

the subsidiary

•Israel Court: transfer of residence (based on

OECD MC tie breaker) and treaty benefits can be

denied

State B

X Ltd

Dividends

Effective

management

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Improper Use of Tax Treaty – Today’s Discussion

– Legitimacy of treaty shopping

– Application of domestic rules

– Treaty interpretation

– Inherent anti-abuse rule in tax treaties?

– Specific anti-avoidance rules in treaty (Beneficial ownership, LOB, treaty GAAR etc.) (Not discussed today)

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Improper Use of Tax Treaties

• Treaty shopping/ Rule shopping: permissible tax plan ning or improper use of tax treaty?

• What is improper use?

– Nothing in OECD Model

– OECD Conduit Report 1987 addresses the problem of treaty shopping (§7: “use is improper where a person acts through a legal entity

created in a State primarily to obtain treaty benefits otherwise not available”)

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Improper Use of Tax Treaties

• What is improper use? (cont’d)- OECD Commentary Art. 1 recognizes concept of improper use (§7-12) and of treaty shopping (§ 11 and 13-20)

• Refers to purpose of tax treaties: “It is also a purpose of tax conventions to prevent tax avoidance and evasion” (§7)

• No benefits for abusive arrangements (§ 9.4)• A guiding principle: “(…) benefits of a double tax convention should not be

available where a main purpose for entering into certain transactions or arrangements was to secure a more favourable tax position and obtaining that more favourable treatment in these circumstances would be contrary to the object and purpose of the relevant provisions”

– 2006 US Model Technical Explanation• Unlike prior version no definition of treaty shopping. §304 on LOB-provision: “Art. 22

contains anti-treaty shopping provisions that are intended to prevent residents of third countries from benefiting of what is intented to be a recipricol arrangement between two countries”

– 2009 UN Model Commentary on Art. 1 (modelled after OECD Commentary)

• Easier to follow than OECD Commentary• Recognizes legal ceratinty and taxpayer’s right• Detailed examples of improper use (§42-103)

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Legitimacy of Treaty Shopping – Cons and Pros

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Legitimacy of Treaty Shopping – Indian perspective

• Azadi Bachao Andolan vs Union of India (SC - 2003) – Tax planning is legitimate within legal framework– Duke-of-Westminster-doctrine (UK, 1936) still prevails– Treaty shopping is not per se illegal or unethical– Treaty allocates taxing rights and not taxes– Treaty may be entered for non-fiscal reasons

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Legitimacy of Treaty Shopping – Indian perspective

Azadi Bachao Andolan vs Union of India

– Developing countries may allow it as tax incentive – Developed countries encourage for financial gain– Double non-taxation is permitted under tax treaties

• "Liable to tax" is not the same as "subject to tax", in applying treaty it is not necessary for tax to be paid

• UAE: Tax treaties with country with no taxes!

– If deemed improper need provision in tax treaty• Recent treaties with partial or full LOB

– Cases: Azadi Bachao (2003, 6 ITLR 233); KSPG (2010, see case 2 with dividends and case 3 capital gains); E*Trade (2010, see case 2, 12 ITLR 701), Vodafone (2012, not a tax treaty case)

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Legitimacy of Treaty Shopping – US perspective

• U.S. view is that benefits of treaties it negotiate s are for theresidents of the countries with which it is negotia ting

– Substantive reasons

– Procedural reasons (bringing other countries to the table to negotiate points important to the U.S.)

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Improper Use of Tax Treaty (OECD Commentary)

• Striking down treaty abuse through application of dom estic rules

- "These States take account of the fact that taxes are ultimately imposed through the provisions of domestic law as restricted (…) by the provisions of tax conventions. Thus, any abuse of the provisions of a tax convention could also be characterized as an abuse of the provisions of domestic law under which tax will be levied. For these States the issue then becomes whether the provision of tax conventions may prevent the application of the anti-abuse provisions of domestic law (…)“OECD MC Commentary Article 1, §9.2

– General Report Ifa Congress 2010, page 35: “A significant numlber of reports indicate that abuse of tax treaties is dealt with by applying domestic anti-abuse principles “ (I.e. national GAARs)

•

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Improper Use of Tax Treaty (OECD Commentary)

• Striking down abuse through treaty interpretation

- "Other states prefer to view some abuse as being abuses of the convention itself, as opposed to abuses of domestic law. These states then consider that a proper construction of tax conventions allows them to disregard abusive transactions, such as those entered into with the view to obtaining unintended benefits under the provisions of these conventions. This interpretation results from the object and purpose of tax conventions as well as the obligation to interpret them in good faith (see Article 31 VCLT).“ OECD MC Commentary Article 1, §9.3

- Art. 31 VCLT: “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 light of its object and purpose”

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Striking down improper use of treaty through domestic law rule

• French judicial view on treaty shopping

– Treaty shopping as a form of tax planning – not illegal per se– Treaty shopping can be illegal:

• Violation of treaty provision• Abusive act by taxpayer, according to the relevant definition of abuse

– France: abuse of law (fictitious acts, including simulations + acts made for the sole motive of reducing the normal tax burden by applying the letter of the law against its purpose)

– See Bank of Scotland (court made abuse of law doctrine)

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Striking down abuse of treaty through domestic law rule

• Bank of Scotland Case - France

USUK

bank

Coupon

Price

FranceDividend

Treaty benefits?

CE 29 December 2006, No. 283314, 9 ITLR, 68320

Striking down abuse of treaty through domestic law rule

• U.S. judicial view

– NIPSCO: facts see slide 3 (conduit in Netherlands Antilles for US source interest): domestic business purpose test. Held for taxpayer (115 F.3d 506 (7th Cic. 1997) affirming 105 TC 341 (1995)

– Del (facts: a complex variation of slide 3: US source via NL, N Ant, Cayman to Canada): domestic step transaction-doctrine, substance over form, conduit rules. Held against taxapyer. Bad facts? Bad law? (US Court of Appeals, 3 ITLR, 2001, 860; US Tax Court, 2 ITLR 2000, 606)

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Striking down improper use of treaty through domestic law rule

• Netherlands – common interpretation

– Dutch Supreme Court searches for shared expectations of the Contracting States:

• “Neither from the text of the treaty, nor from the explanations by the treaty partner it appears that they had the common intentionto include, for the application of said article (…), under dividends income which is treated as a dividend with the application of the doctrine of fraus legis under the national law of the state in which (the distributing company) has its residence” (Dutch HR, BNB 1994/249 and 259, similar decisions: BNB 2003/285c, BNB 1995/150; HR 2006 case 39223 and others).

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Striking down improper use of treaty through interpretation of the treaty

• U.S. judicial view

– Aiken Industries, seminal treaty shopping case (facts as in slide 3) that interprets treaty language (“received by”) to deny benefits (US Tax Court, 56 TC 925 (1971).

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Striking down improper use of treaty through interpretation of the treaty

• Canada – common interpretation

– Search for common/reciprocal interpretation undertaken by Canadian courts unless the other State’s interpretation is manifestly erroneous

• Contrast MIL with Crown Forest: intervention by other State

• In MIL reservation by Luxembourg on OECD MC Commentary Art. 1: absent provision in treaty, a State can only apply domestic anti-abuse rules after recourse to mutual agreement procedure should have been considered in determining abuse

• Prévost and MIL: use of opinion of expert from other State to determine common interpretation

* Prévost (2008, 2009) 10 ITLR 736 and 11 ITLR 757; MIL (2006, 2007) 9 ITLR 1111

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Striking down improper use of treaty through interpretation of the treaty

• France - judicial view– Identification of anti-avoidance purpose in tax treaty

• Specific provision / title / preamble• Reluctance of French courts

– Conseil d’Etat Schneider Electric (2002, on compatibility of CFC rule with F/CH treaty, 4 ITLR 1077): alleged anti-avoidance purpose, but no specific provision contradicting Art. 7

– Relationship between treaty anti-avoidance purpose and clear treaty attribution provision

• Art. 31 VCLT (although France not a party): literal meaning first• Main object and purpose remains allocation of taxing rights

– Does §7 on Art. 1 OECD MC justify wide notion of anti-avoidance beyond abuse?

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Inherent anti-abuse principle in tax treaties?

• Art. 26 and 31 VCLT: Can treaty benefits be denied b ased on good-faith-application/ interpretation?

– ICJ dissenting opinion Judge Alvarez • But no actual application by ICJ and agreement as to whether it is a general

principle of international of law

– Abuse of law is a general principle of EU law also in tax matters (Kofoed, C-321/05; Foggia, C-126/10)

– Vogel & Ward – Art. 26 obligation governing interstate relations, applicable on the

forum where taxpayer and tax authorities operate?– Case law

• Not present: MIL (facts, see slide 6-7) and Dutch Supreme Court (various cases)• Present: A Holdings (facts see slide 3, 8 ITLR 537) and Yanko Weiss (facts see

slide 6-8, 10 ITLR 524)– Art. 31 VCLT good faith interpretation of international treaties by Courts

• A better argeument than the one based on Art. 26 VCLT?

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Summary and Conclusions

• On very similar fact patterns courts in different j urisdictions (and even in the same jurisdiction) come to diametricall y opposite results

• Not satisfactory

• Reasons?• Appreciation of facts• Judicial methodology• Different approaches to fundamental questions (e.g. inherent anti-abuse

rule, interpretation of BO)• Different policies of States towards tax avoidance and treaty shopping• Willingness of courts to rely on Commentary and to apply posterior

Commentary to earlier treaties

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THE LISBON INTERNATIONAL & EUROPEAN TAX LAW SEMINARS

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UPCOMING SEMINAR – 19.04.2012

IMPACT OF MULTILATERAL TAX CONVENTIONS ON BILATERAL TAX TREATIES

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Prof. Dr. PASQUALE PISTONE (WU Vienna/Uni. Salerno)

Sponsors: SECIL || IBFD

Org. >> IDEFF/ Prof. Dr. Ana Paula Dourado/ Adv LLM José Almeida Fernandes/ Mestre Gustavo Courinha