Tuesday, January 30, 2007

Does Cross-Border Tax Arbitrage warrants an international solution?

Cross-border tax arbitrage is generally used to qualify transactions, which exploit differences in the tax systems of two (or more) countries. The subject is very current, not only due to the increasing international tax planning through complex transactions undertaken by multinational companies but also by the recent national reactions to the problem (e.g. New UK Rules on International Arbitrage).

Since the “holy grail” of international tax planners is the so-called double non-taxation, it is natural that taxpayers attempt to exploit “conflicting” tax rules in different jurisdictions so as to achieve a reduction of the total tax liability. Residence arbitrage through dual resident companies, entity characterisation through hybrid entities, hybrid financing, repos and double dip lease transactions are examples of “labelled” cross-border tax arbitrage transactions. Nevertheless, since in most cases of cross-border tax arbitrage, the taxpayer takes advantage of publicly known differences in tax regimes and technically complies with the said laws, it is difficult to say that the taxpayer is violating the law by planning in such manner. As such it is no surprise that some taxpayers maintain that the existence of cross-border tax arbitrage warrants no government action. Others consider that the problem of tax arbitrage needs an international solution.

This topic arises today because of an interesting paper entitled "Tax Competition, Tax Arbitrage, and The International Tax Regime" from the Prof. Reuven S. Avi-Yonah (University of Michigan), which brings interesting arguments to the theoretical discussion around the topic of tax arbitrage.

International tax is in fact a difficult concept to define. Traditionally, international taxation refers to treaty provisions relieving international double taxation but in broader terms, it also includes all domestic legislation with an international element (e.g. rules concerning foreign income of residents or source income of non-residents).

In "Tax Competition, Tax Arbitrage, and The International Tax Regime", Prof. Avi-Yonah argues that a "coherent international tax regime exists, embodied in both the tax treaty network and in domestic laws, forms a significant part of international law (both treaty-based and customary)". This ultimately means that countries are not free to adopt any international tax rules they please, but rather operate in the context of the so-called international tax regime.

For the purposes of defining the structure of the international tax regime, Prof. Avi-Yonah guides the reader through the content of what he calls the two basic principles that form part of such regime: (1) the single tax principle (i.e., that income should be taxed once- not more and not less) and (2) the benefits principle (i.e., that active business income should be taxed primarily at source, and passive investment income primarily at residence).

Accordingly, although the benefits principle is broadly accepted and reflected in both domestic rules and tax treaty network, there is a debate on whether (if one would assume that a international tax regime exists) the said regime incorporates the single tax principle. This is important when for example one has to address if the prevention of double non-taxation is an objective of the so-called international tax regime.

At the opening of the paper, Prof. Avi-Yonah asks if there is an International Tax Regime? In support of a positive answer, elements such as the existence of an extensive bilateral tax treaty network (similar in policy and language), the remarkable convergence of domestic tax systems in the recent year and the need of some degree of integration between tax systems are put forward. They play a role in arguing that a coherent international tax regime does exist.

The next question is whether such treaties and the domestic tax laws can be said to form an international tax regime that is part of customary international law. In dealing with this issue, Prof. Avi-Yonah refers the readers back to the argumentation set out in a previous paper, International Tax Law as International Law (published in Tax Law Rev. 57, no. 4, 2004), where he concluded that international tax law is part of international law, even if it differs in some of its details from generally applicable international law.

In fact, if one takes the example of tax treaties, one easily reaches the conclusion of the exceptional aspect of tax treaties (when compared with other treaties), mainly due to their profound interaction with domestic legislation, through the use of the same language and even by incorporating elements of domestic law of each party.

In support his view (that international tax law can be seen as customary international law and therefore as binding even in the absence of treaties), Prof. Avi-Yonah provides insightful examples where one can argue that international tax regime rises to the level of customary international law. These examples are the jurisdiction to tax, the non-discrimination, the arm's length standard, and the foreign tax credits. In his view, this is important step specially when dealing with a transversal issue such as tax arbitrage, whereby transactions are simply structured to take advantage of differences between tax systems and achieve double non-taxation.

The backbone of the paper is perhaps that since an international tax regime (part of customary international law) should be said to exist, a recent phenomena's such as cross-border tax arbitrage, which puts at risk the single tax principle (i.e. income should be taxed once), should be tackled under the framework of this same regime. Recent developments demonstrate, in his view, that there is an increasing consensus rejecting the ultimate result of tax arbitrage, i.e. double non-taxation and that still more can be done. In his conclusion, Prof. Avi-Yonah suggests that the OECD should take the single tax principle "more explicitly into consideration in revising its model treaty, and revise the model so that it functions better to prevent both double taxation and double non-taxation".

The problem of such view is that although one may see the non-taxation arising from tax arbitrage as the flip side of double taxation that does not mean that the tax treaties are the best equipped tool to deal with this issue. Domestic laws are inherently different and warranting a solution through treaties may well prove a difficult and frustrating exercise. In addition, domestic sudbstance over form tests may be useless in cross-border cases and international coordination fruitless, unless it is focused on the wider policy issue of tax competition.

Although I have my reservations as to whether cross-border tax arbitrage deserves an international solution, I will continue to follow the international debate around and wait for somebody to really convince me to abandon the“sceptics” club.

Further Listening
International Tax Arbitrage, A lecture by Prof. H. David Rosenbloom

Further Reading
Diane M. Ring, One Nation Among Many: Policy Implications of Cross-Border Tax Arbitrage,

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Blogger Eduardo said...

Excelente resumo, Tiagon!

15 February, 2007 23:10  

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