Wednesday, January 17, 2007

2007 Tax Agenda: What to expect from the usual suspects?

Will a new deal for a European constitution boost the possibility for further agreement concerning other EU wide-ranging tax project such as the common consolidated corporate tax base? Will the newly elected Democrat congress stall the Bush corporate tax reform projects? Will the OECD finally conclude its PE attribution project? Will the UN “wake up” in terms of international tax issues and become a larger player in the policy discussions?

Enough of open questions and let’s make a “tour de table” of some of the issues that are in the agenda and may receive fresh inputs during 2007. Personally, I have a feeling that 2007 will probably be a transitional year in terms of international and European tax issues and that more challenging and exciting times await us in 2008. But that does not mean that the developments are not expected from the prolific “usual suspects”, namely OECD, the EU Commission and the ECJ.

The OECD tax agenda
The winds and waves are always on the side of the ablest navigators.
By Edward Gibbon, The Decline and Fall of the Roman Empire

As usual, the agenda of the OECD is impressive and several topics are expected to see the green light. In the tax treaty topics, a good news is that the ongoing project on profit attribution to permanent establishments is finally close to an end. The OECD published in December 2006 the long expected new versions of Parts I, II and III of its Report on the Attribution of Profits to Permanent Establishments, along with a cover note containing an update on the status of that project. As to the announced necessary changes to the language of OECD Model Tax Convention and Commentaries, somewhere in 2007 appears to be the target of the OECD.

But the issues under discussion go well beyond profit attribution and include, dispute resolution, taxation of services, non-discrimination, collective vehicles, employment income and last but not least the place of effective management.

Dispute resolution in the framework of tax treaties (Art. 25 of the OECD Model) is one of the hot topics at the moment. The discussion draft "Proposals for Improving the Process for the Resolution of Tax Treaty Disputes", of 1 February 2006, examines the ways of improving the effectiveness of the mutual agreement procedure under Article 25 of the OECD Model, including the consideration of other dispute resolution techniques. The 2006 draft, proposes a system for the mandatory arbitration of tax disputes (new paragraph 5) between two treaty countries when the tax authorities of those countries have been unable to resolve those disputes within a two-year period. Strangely enough the recent protocol concluded between the US and Germany adopted a different arbitration approach than the one suggested by the OECD (the so-called baseball arbitration).

The application of tax treaties to services (Art. 7 of the OECD Model) is a new topic in the agenda. The recently disclosed discussion draft entitled “The Tax Treaty Treatment of Services” includes new paragraphs 42.11 to 42.45 to the Commentary on Art. 5 of the OECD Model. The new paragraphs address the appropriateness of the current provisions of the OECD Model to deal with the tax treatment of services, views (and policy reasons) of States that do not agree with the principle of exclusive residence taxation of services and finally a alternative paragraph for Art. 5 of the OECD Model that secures additional source taxation rights, in certain circumstances, with respect to services performed within the territory of the source State.

As regards, place of effective management as a tie-breaker rule (Art. 4 of the OECD Model), the discussion draft dates back already to May 2003. The OECD Model was already updated in 2005 but nothing was said about the OECD abandoning this topic. On the contrary, recent case-law from OECD countries may trigger an interest in having a fresher look at the topic (See UK Court of Appeal decision in Wood v. Holden (2006) STC 443 on the question of corporate management and control/residence). The 2003 draft develops the two alternative proposals to improve the place of effective management concept under Article 4 paragraph 3 of the Model Tax Convention. The first proposal seeks to refine the concept of “place of effective management” by expanding the Commentary explanations as to how the concept should be interpreted. The second proposal puts forward the tie-breaker rule for persons other than individuals to modify Article 4 paragraph 3 of the Model Tax Convention together with Commentary thereon. I would expect further discussion on the topic.

Another project, where a draft is available but no recent news was received on its status, is the OECD plans to revisit the scope of paragraph 2 of Article 15. The discussion draft "Proposed Clarification of the Scope of Paragraph 2 of Article 15 of the Model Tax Convention" of 5 April 2004, clarifies its application in situations when services are provided through “offshore” intermediaries by addressing the interpretation of the word “employer”, the distinction between employment and self-employment. The issue, touching upon a wide industry practice of hiring-out of labour, may have large impact and that may well explain that no further developments are available.

A release of a draft concerning the ongoing project of revising the non-discrimination article (Art. 24), may well prove to be one of the highlights of the year. Taking into account the developments in the EU and the fact that the OECD Commentaries on Art. 24 remain largely unchanged since 1977, it is expected that the project of re-examining the non-discrimination principle will probably focus on: (i) the application of Article 24 to various existing group relief concepts (e.g., consolidation, inter-corporate dividend exemptions, tax-free intra-group asset transfers); (ii) the application of Article 24 to branch level taxation; and (iii) the application of Article 24 to the thin capitalization concept, particularly its relationship to Article 9.

A far-reaching project, which recently received new impetus, is the one concerning the Taxation of Collective Investment Vehicles. After the CTPA roundtable (including tax authorities and tax specialists of the financial sector) met in Paris on 1-2 February 2006 to discuss a number of issues related to the application of tax treaties to collective investment, the OECD decided to form an informal consultative group. This group of government and private sector representatives, under the auspices of the OECD, will tackle the tax treaty issues raised by the large cross-border portfolio investments held through collective investment vehicles and global custodians. The project will examine both substantive issues and practical administrative issues related to the application of tax treaties to these investments.

But OECD is not only a synonym of work in the field of tax treaties. The OECD global tax agenda includes, amongst others, developments in the field of (i) Transfer Pricing (i.e. monitoring of the OECD Transfer Pricing Guidelines); (ii) Consumption Taxes/VAT (iii) Transparency and Information Exchange and (iv) Tax Policy. Basically it is a very wide range of issues.

The European hidden tax agenda
“Much good work is lost for the lack of a little more”
By Edward H. Harriman

The state of uncertainty in Europe is already commonplace and presidential manoeuvres in France, political changes in the UK, hard politics with Turkey and digestion problems related to the latest enlargement are probably bound to be decisive in maintaining that feeling in 2007. Europeans may expect in addition to sluggish economic growth, a new attempt to approve a new (redux) constitution, probably as an outcome of a downsizing EU summit sponsored by Germany. All this facts may have hardly any impact on the European tax agenda for 2007. Apart of the new push towards the Constitution, the development and breeding of new ideas in the tax area will continue to come from the two main players, i.e. EU Commission and from the ECJ.

As regards the first player, a special attention should be given to advances on the creation of a common consolidated corporate tax base (CCCTB) in the EU. The target is only to release a proposal is 2008, but it is expected that position making of the EU member states will become more visible during 2007. The Commission will in fact attempt to reach in 2007 a consensus agreement on a draft CCCTB project and for that will receive the additional support of the German EU presidency. The Commission will have to convince with the “carrot” some reluctant Member States (and even Commissioners such as the Irish Charlie McCreevy) that the best way forward is not to prolong tax competition amongst member states and adopt a common tax base. The “stick” to be used is the enhanced cooperation, which would allow one-third of EU Member States (9 out of 27) to adopt legislation that couldn't be passed unanimously.

However the CCCTB is hardly the remedy for the entire panacea, since there also continues to be a need for more targeted measures for short & medium term problems and for individual taxpayers. Hence, the need for better coordination of un-harmonised direct tax systems.

For this purposes, the new soft-law approach of the EU Commission is also expected to receive further developments. The end of 2006 saw the release of a set of Communications on a co-ordination of national direct tax systems, with a special emphasis on exit taxation and cross-border loss relief. The year of 2007 will probably be the year of the Commission communications ultimately directed to: (i) remove discrimination and double taxation; (ii) prevent inadvertent non-taxation and abuse; and (iii) reduce the compliance costs associated with cross-border investment.

In fact, the Commission considers a key topic that of the control of the application of specific Community tax provisions and of the Treaty freedoms. For that purposes, it plans, besides watching over the correct application of EU law by member states, to issue soft policy communications and guidelines designed to lead the member states to the desired result through coordination. This will probably be followed by benchmarks of best practices in several areas intended to pave the way for reform and alignment of domestic law with EC Tax principles. It would be no surprise if the Commission future work would focus on issues such as withholding taxes, group taxation, taxation of permanent establishments and anti-avoidance rules.

Other areas where inputs from the EU Commission are expected include, the ongoing project of the one stop shop in the area of VAT, the fight against tax fraud through the revamp of the mutual assistance directive and finally the area of environmental taxation (by means of ‘green taxes’, CO2 tax, vehicle taxes and tax incentives).

Finally, a topic where much development is expected in the near future is the area State Aid. The past year was marked in this area by new communications on the effective use of R&D tax incentives and the State Aid decision concerning the Luxembourg 1929 Holding regime. As regards 2006, the highlights will probably be the decision on the recent Dutch tax reform and the forthcoming decision of the Court of First Instance in the Gibraltar case, where the court will have the first opportunity to test the line of defence based on regional autonomy (see Azores case).

As regards the European Court of Justice, the last year has demonstrated that European Tax Law has maintained its importance. The key cases of the last year were definitely Marks & Spencer (cross-border losses), Cadbury Schweppes (CFC), Denkavit international (Outbound Dividends), Kerkhart & Morres (Relief for juridical double taxation), N case (Exit tax) Bouniach (withholding tax), Halifax (VAT Avoidance) and Banca Popolare de Cremona (IRAP). The year of 2007 will probably be the year of consolidation of the important jurisprudence issued in 2005 and 2006. It may also well be the year where the scope of the EC freedom of capital as regards third countries will be finally clarified (the non-tax case of Fidum Finanz set the grounds on 2006).

As regards the year to come, the ECJ continues to have an agenda rich of tax cases. Amongst the currently pending cases (some of them to be decided in 2007 or 2008), one may highlight the following:

(1) Meilicke (C-292/04). This case, which deals with the German corporation tax credit for foreign dividends, will give an opportunity to the Court to further develop the theory of the temporal limitation of the effects of judgments. The Advocate General suggested that the temporal effects of the judgment in Meilicke against Germany should not be limited.
(2) Thin Cap Group Litigation (C-524/04). This case deals with the UK thin cap provisions. The Advocate General already suggested that the UK thin capitalization regime is generally compatible with freedom of establishment.
(3) Skatteverket (S) v. A (C-101/05). This case deals with the Tax-neutral spin-off and the question submitted was whether a dividend distribution from a parent company, in the form of shares in its subsidiary located in a third state (with no exchange of information provision) should be tax exempt.
(4) Skatteverket (S) v. A and B (C-102/05). This case concerns the taxation of dividends distributed by close companies located in third countries, in this case Russia.
(5) Holböck (C-157/05). This case, which deals with free movement of capital and third countries, concerns an individual shareholder resident in Austria received higher taxed dividends from a corporation resident in Switzerland on which he held two thirds of the shares.
(6) Columbus Container Services BVBA (C-298/05). This case deals with the potential compatibility of a German treaty-override provision, which provides for a switch-over from the exemption method to the credit method in respect of low-taxed passive foreign permanent establishment (PE) income, with the basic freedoms under the EC Treaty.
(7) Amurta S.G.P.S. (C-379/05). This case concerns compatibility of the dividend withholding tax exemptions for non-resident companies with the EC freedom of establishment and free movement of capital (discrimination of outbound dividends) .
(8) Orange European Smallcup Fund NV (C-194/06), this case, in which no credit was given for Portuguese and German withholding taxes, deals with the question of whether the refusal to credit this tax infringed the freedom of capital movement.
(9) Cartesio (C-210/06). This case deals with on the scope of the freedom of establishment and its effect on national company laws, in particular, on the constraints imposed by this freedom on the regulation by the home and the host EU Member State of the transfer of seat of companies established under their national laws.
(10) Deutsche Shell GmbH (C-293/06). This case deals with the treatment of currency losses from the repatriation of start-up equity of PE.
(11) Heinrich Bauer Verlag (C-360/06), this case deals with different valuation of domestic and foreign participations.
(12) M+T (C-414/06). This case is one of the two pending ECJ two cases on the deductibility of losses of a foreign permanent establishment at the level of its parent which were rejected on the basis that the exemption method in the double tax treaties applied not only to positive but also to negative income. In this case, the PE was situated in Luxembourg.
(13) SEW (C-415/06). This case is the second of the two pending ECJ two cases on the deductibility of losses of a foreign permanent establishment at the level of its parent which were rejected on the basis that the exemption method in the double tax treaties applied not only to positive but also to negative income. In this case, the PE was situated in the US.
(14) Gronfeldt (C-436/06). This case deals with different thresholds for capital gains from domestic and foreign participations.
(15) Hollmann (C-443/06). This case deals with the not application to non-residents of the reduced tax base (50%) for capital gains.

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