Sunday, February 25, 2007

The place of offshore financial centers in an increasingly anti-tax haven world

This weekend I came across an interesting special report (“a place in the sun”) published on the Economist latest issue, which is dedicated to offshore financial centers. The report is a good reading for any international tax advisor because it provides some valuable insights into the policy and regulatory framework of offshore financial centers in an increasingly integrated global economy.

In the last decade, several important efforts were made to increase the scrutiny of offshore centers namely focusing on the necessity to counter money laundering, improve regulation on the financial services and reduce the (tax) advantage of using the so-called tax havens. For example, the OECD reports on Harmful Tax Competition, Towards Global Tax Co-operation and Improving Access to Bank Information for Tax Purposes were important tools because they laid down the principles of the reaction of onshore jurisdictions against those offshore centers. The aim of these initiatives was to counter distorting effects of harmful tax competition, by tackling certain practices with respect to mobile activities that (apparently) eroded the tax bases of other countries (i.e. country of the principal investor). The initiatives were also directed to find ways to improve international co-operation with respect to the exchange of information for tax purposes (which was sometimes in the possession of financial institutions).

According to the IMF definition, an offshore financial centers is a jurisdiction that (i) has a large number of financial institutions; (ii) where most transactions involve non-residents, (iii) where most institutions are controlled by non-residents, (iv) where the assets and liabilities are out of proportion to the domestic economy; and (v) where there is a very low or zero taxation, relaxed financial regulation and bank secrecy. There are multiple possible uses of OFC (i.e. offshore banking, captive insurance companies, establishing special purpose vehicles and asset management and protection) and some of them addressed in the report of the Economist.

It is interesting to note that, the OECD initially identified, in the framework of its project on harmful practices, 47 jurisdictions as tax havens. Nevertheless, 33 jurisdictions made in the meantime commitments to transparency and effective exchange of information and are now considered co-operative jurisdictions. There are only a few that remain unco-operative tax havens.

With the overwhelming increase of assets held by OFC in the 80’s and 90’s (according to the IMF cross-border assets held by OFC reached a level of US$4.6 trillion at end-June 1999) it was more than natural that other initiatives at the international level pursued the other (non-tax) elements of the OFC. For example, the Financial Action Task Force (FATF) was established to help protect financial systems from money-laundering and counter-terrorist financing systems. The FATF’s Non-Cooperative Countries and Territories process can be considered a success since the 23 jurisdictions that were listed as NCCTs in 2000 and 2001 are no longer on listed. Another initiative is the one headed by the Financial Stability Forum (FSF) which has been arguing for OFC to meet international financial markets standards and address problem areas, such as effective cross-border cooperation, information exchange and adequacy of supervisory resources.

Notwithstanding, it was visible throughout this process that there was a great variety in regulatory standards and infrastructure between the major international financial centers and other (less transparent) financial centers, where supervision was simply non-existent. As such, increased attention has been directed in the last years into reinforcing transparency and effective exchange of information for tax purposes. In that regard, the OECD Global Forum has just published a report, "Tax Co-operation: Towards a Level Playing Field – 2006 Assessment by the Global Forum on Taxation", which surveys 82 OECD and non-OECD countries and jurisdictions. This report undertakes a factual review on the legal and administrative frameworks in the areas of the existence of mechanisms for exchange of information, access to bank information and access and availability to ownership, identity and accounting information. This work is related to the wider initiative of developing a Model Agreement on Exchange of Information on Tax Matters, which is now being used by countries such as the United States (U.S.) as the basis for negotiating bilateral agreements.

For example, Article 5 (exchange of information upon request) of that Model provides that only in very few instances will the competent authority, receiving the information request, be able to circumvent the legal obligation of providing the tax-related information. The country receiving a must then provide the information, when it relates to a particular examination, inquiry or investigation in the other Country, even if the requested country does not need the information for its own tax purposes (i.e. because it has more lax rules). The rule (in connection with Art. 7) includes, nevertheless, certain safeguards (e.g. non-disclosure of trade or business secrets) as to when information requests may be refused. It is important to note that bank secrecy cannot be considered a part of public policy and therefore used as an excuse not to exchange information.

This already indicates a significant amount of pressure that can be used against the use of OFC through the conclusion of this bilateral exchange of information agreements. For example the U.S. has concluded in recent years such type of agreements with jurisdictions such as Aruba, Jersey, Isle Of Man, Guernsey, Netherlands Antilles, British Virgin Islands, Bahamas, Antigua and Barbuda and the Cayman Islands.

The recent cooperation commitments by tax havens for effective exchange of information may thus appear to constitute a “light in the end of the tunnel” for the countries that initiated the process against harmful tax measures back in 1996. As mentioned in the Economist report, the OECD prefers now to differentiate between well and poorly regulated financial centers rather than onshore or offshore and the focus has apparently shifted from (the lack of) tax to more regulatory issues. In fact, the OECD appears now to consider that “low or no taxes on their own do not constitute a harmful tax practice”.

Perhaps it is only under this stricter OFC regulatory framework, that one may understand a title in the Economist such as “Tax havens are an unavoidable part of globalisation and, ultimately, a healthy one”. Nevertheless, the issue is far from unquestionable and some of the points raised in the report deserve further reflection.

For example, the mention that “tax competition nowadays is mostly about big countries competing with each other” is an important reference. Recent years have brought increased tax competition even between jurisdictions once tagged as “high tax jurisdictions”. The difficulty today is that some traditional European jurisdictions instead of providing low corporate taxes such as Ireland (12.5%) are introducing exemptions at the level of the tax base, such as notional interest deduction in Belgium or the patent box in the Netherlands which ultimately may also have an impact in diverting of shifting certain mobile activities such as intra-group financing or licensing activities. This is one reason why in my view it is harder to frame the tax competition, when we are dealing with the so-called “big countries”. It is therefore not a surprise that the EU Code of Conduct on business taxation, which consists of a commitment not to introduce new harmful measures (standstill mechanism) and to revise existing tax measures deemed to be harmful (rollback mechanism) has lost slightly its political momentum.

Another highlight of the report is the reference to a recent study entitled Do Tax Havens Divert Economic Activity?, where economists found that tax havens boosted economic activity in nearby non-havens rather than diverting it. These references may have the benefit of re-launching the debate as to the role and place of OFC and their possible unintended or positive consequences.

In conclusion, after reading the whole report one remains with the overall impression that under the premise that tax competition may bring benefits, the role of the well run and regulated OFCs in tax evasion is perhaps being slightly dramatized. Nevertheless, one has first to listen to the interview and read the articles before taking conclusions!

Past posts on related subjects:
Corporate Tax Avoidance: The Case of Abusive Tax Shelters
Is Switzerland under enough pressure from Europe institutions to clamp tax competition?
“Benefits or evils” of Tax Competition
“Tax harmonisation is not on the agenda, nor will it be.”
Subsidy to the Celtic tiger or just healthy tax competition?


Sunday, February 18, 2007

Pitfalls from cross-border services: where is the source of the income?

The Indian case discussed below is not a tax treaty case simply because there is (until now) no tax treaty between India and Luxembourg.

The case involves a Luxembourg company, which approached the Indian Ruling Authority on the question of certain marketing and promotion payments received from an Indian Hotel. Due to the absence of a tax treaty, the issue was simply whether the payments in question were under Indian domestic law qualified as business income, royalty or fee for technical services (so as to be taxable in India) or whether they were mere reimbursement of expenses incurred by the Luxembourg company for the benefit of the Indian hotel (so as not to be taxable in India).

Although essentially a domestic case it is still an interesting decision for several reasons. The case decided by the Authority For Advance Ruling (AAR) in 27 November 2006 is then a good exercise to analyze not only the pitfalls of international transactions when no tax treaty is in place but also the problem of some domestic wide definitions of source of income.

1. The case facts

International Hotel Licensing Company, SARL (IHLC) is a Luxembourg company, which is part of the well-known Marriott group. IHLC is engaged in the business of promoting enterprises and is conducting international advertising, marketing and sales programs for the Marriott chain of hotels in order to promote them in the foreign markets.

In connection with the plans to setting up of an Indian hotel to be constructed, furnished and equipped in Uttar Pradesh, IHLC entered into an agreement with an Indian company (Unitech) whereby Unitech (the owner of the Hotel) would participate in the marketing business promotion programs and IHLC would provide, inter alia, advertising space in magazines, newspapers and other printed media and electronic media which would be conducted by it outside India.

The agreement made it clear that the IHLC would not conduct any specific marketing activity for the Unitech. Under the agreement, the consideration that Unitech would pay to the IHLC was an annual contribution equal to 1.5% of the gross revenues of the hotel by way of reimbursement of expenses that the IHLC would incur for conducting and coordinating the international marketing activities for Marriott chain of hotels. This would be later adjusted based on the final annual figures.

Pursuant to the agreement, the IHLC had also to provide certain special programs such as the Marriott Rewards Program, (Marriott's award winning guest royalty program) for which the participants including Unitech are charged 3.4% of a Marriott Rewards Program member's room charge (including taxes) during his/her stay at the applicable hotel.

2. The Issues

The question referred to the AAR was whether the said contributions of 1.5% (marketing and advertising) and 3.4% (reward program) received by IHLC from Unitech, in connection with the marketing and business promotion activities essentially conducted outside India, would be taxable in India.

The tax authorities rejected the argument that the fees paid were simply expenditures and raised the issue of whether the payment was for technical services or for the use of the Marriott brand. The tax authorities basically submitted that under the agreement, IHLC had to provide advertising but that the expenditure for these activities are aimed not for the benefit of the Indian hotel but for the Marriott group as a whole. The tax authorities noted that the advertisements carry copyright of Marriott International Inc. and the connection between it and the IHLC is not clear. The tax authorities also argued that there was no nexus between the expenditure incurred by the IHLC in rendering the services and the consideration to be received by it. Therefore, according to the authorities the proposed payment of 1.5% of the gross revenues appears to be a payment towards royalty in a disguised form for the use of the brand "Marriott" and that the expenditure incurred by the IHLC in international advertising, is for building up of the brand. The tax authorities also considered that payments based on the gross turnover of the hotel owner have no nexus with the amount of expenditure incurred by IHLC.

In alterantive, the tax authorities considered that the proposed payment would also be consideration for rendering of any managerial, technical or consultancy service, within the meaning of "fee for technical services "(FTS), which is subject to Indian withholding tax. Finally, the tax authorities submit that the income in question would anyway be deemed to accrue or arise in India.

IHLC, on the other hand, considered that the payments being in the nature of reimbursement are not taxable in India. IHLC therefore responded by firstly refuting that it had any “business connection” (similar concept to permanent establishment) in India and that even assuming that a business connection exists, no operations are carried out by the IHLC in India. Secondly, it disputed that the payments under the agreement constitute royalty or FTS, since essentially they are not for any managerial technical or consultancy services.

3. The decision

3.1. Whether the payments were mere reimbursement of expenses incurred by the IHLC for the benefit of the Unitech

As regards the first issue, the AAR analyzed in detail the agreements. The AAR first started by asserting the meaning ascribed by dictionaries to the word “reimburse”, namely "to pay back, make restoration, to repay that expended, to indemnify or make whole". Keeping that meaning in mind and after looking at the classification of the expenses under the agreement, the AAR noted that there was no direct nexus between the owners of the hotel, and the costs and expenses of providing the said advertising, marketing promotion and sales program services. The AAR mentioned that even if after adjustment the payments in the form of contributions equal to the total costs and expenses incurred by the IHLC, it would be difficult to accept that they would amount to reimbursement of costs and expenses.

The AAR also rejected the contention of IHLC that its primary object is not to make profit but to enable the owner to attract foreign tourists from all over the world as the cost of international marketing and promotion activities would be impossible for an owner of the hotel alone to incur and that in fact the IHLC is not earning any profit.

3.2. Whether the amounts in question qualified as business income, royalty or fees for technical services

The Luxemburg entity contended that the payments could not be deemed to accrue or arise in India as it had neither any “business connection” in India nor the income had any source in India, while the tax authorities submitted that the Luxemburg entity had a “business connection” as well as the source of income was located in India.

Under Indian domestic tax law, “all income accruing or arising, whether directly or indirectly, through or from any business connection in India” is deemed to accrue or arise in India. Basically, if the nonresident has a business connection in India, the non-resident is then liable to tax in India on the income earned, which is attributable to the operations carried out in India. It should be noted that the use of a dependent agent is also considered a business connection. Though not entirely defined, the term “business connection” has a wider meaning than the well-known term “permanent establishment”. For example, in the leading Indian case of CIT v. R.D. Aggarwal and Co. (1965), the Supreme Court of India held that “business connection” means something more than business.

According to the AAR, "the essential features of the business connection concept are:
(a) a real and intimate relation must exist between the trading activities carried on outside India by a non-resident and the activities within India; (b) such relation, shall contribute, directly or indirectly, to the earning of income by the non-resident in his business; (c) a course of dealing or continuity of relationship and not a mere isolated or stray nexus between the business of the non-resident outside India and the activity in India, would furnish a strong indication of 'business connection' in India."

Taking into account the above facts, the AAR considered that the first and the second requirements of business connection were satisfied. In as much as the agreement was valid for 25 years, extendable for a further 10 years, the third requirement was also satisfied. The existence of business connection was then sufficient to attract taxation to the amounts in question, especially in the absence of a tax treaty.

The AAR further considered that the question as to whether the source of income is in India is unnecessary but since both parties referred to it, the AAR decided to further analyze the issue. The Luxemburg company contended that the “source of income” was outside India, since (i) IHLC conducts international marketing and business promotion activities outside India; (ii) it has no form of presence in India nor is the owner of the hotel an agent of the IHLC; and (iii) that no activity of the owner of the hotel result in any earning of the income of the IHLC.

The issue highlighted by the AAR was that some of those advertising activities were also are carried out in India and even when they were primarily carried out from outside India, they had an extension in India as well. For example, the advertisements were not confined to magazines with circulation outside India and even samples of advertisements in Indian magazines were put forward. Further, the AAR considered that advertising on foreign TV channels is also very much accessible in India and they have the effect of advertisement in India. Therefore the AAR concluded that the payments by the owner of the Hotel for the purpose of service of advertisement has relation to the activities of the IHLC, which generate activities of the owner of hotel business. As such, the AAR held that the source of income was located in India.

The AAR further rejected the argument of the tax authorities that what was being paid by way of contributions was nothing but "royalties”. As regards whether the payments constitute fees for technical services, the AAR discussed whether the amounts paid would in fact fall within the meaning of “consideration including any lump sum consideration for the rendering of any managerial, technical or consultancy services (including the provision of services of technical or other personnel)”. In this case, the AAR concluded that the services provided by the IHLC, both within and outside India, in the form of advertising, marketing promotion, sales program and special services, would amount to rendering managerial and consultancy services.

Accordingly, the AAR held that the amounts received by IHLC from the Indian Hotel owner in connection with the marketing and business promotion activities said to be conducted outside India would be taxable in India.

4. Source of income, the taxation of services and tax treaties

In an increasing global economy, it is simpler to carry on business activities and render services, without any physical presence. In the case above, the Luxemburg service provider claimed that the services were carried out outside India, but the AAR pointed that the facts made it clear that these service activities had extension in India and, therefore, the source of income was considered in India.

At a domestic tax level, tax liability usually arises either because of a personal or substantial economic attachment to a particular jurisdiction. Such attachment typically results on: (1) unlimited tax liability - worldwide income and assets (residence taxation); or (ii) limited tax liability (source taxation). Source taxation subjects income to tax because it is considered to arise within a certain jurisdiction. It can be for example the case of a company having a permanent establishment in a particular jurisdiction or deriving a defined category of income, such as dividends, interest or royalties, from a particular jurisdiction. Nevertheless, domestic provisions generally determine the source of an item of income in several different ways. Source may for instance refer to where the tangible or intangible property is located or used; where the services are performed or even where the payer is located.

For example, in the US income from services has generally its source where the services are rendered and is deemed effectively connected with the conduct of a US trade or business and taxed by the US on a net basis. The problem is that as technology and communications progresses it is increasingly more difficult to determine the jurisdiction where the services are actually performed. In addition, this case also demonstrates that services, even if conducted or primarily performed outside a jurisdiction, they may have an economic impact or a so-called extension in the source jurisdiction. Will this be sufficient connection to tax?

It should be noted that “source” and “origin” do not always mean the same thing, as Prof. Kemmeren (Tilburg University) exposed in its work called The Principle of Origin in Tax Conventions. Prof. Kemmeren believes that the essence for the allocation of tax jurisdiction does not lie in the “physical” place where income is formally generated, but rather the place of origin of income, that is, where the intellectual element is to be found or a substantial income-producing activity is carried on.

Regardless of whether there is a need for a new configuration of the source principle (especially for certain items of income such as passive income), the current framework of tax treaties only allow for residence taxation unless the profits from services (preformed in the Source State) are attributable to a permanent establishment situated in that same Source State. Therefore in this case the services would be taxable only in the Residence State.

Some States, such as India, are naturally reluctant to adopt the principle of exclusive residence taxation of services and therefore support additional source taxation rights under a treaty with respect to services performed in their territory. Such States may secure source taxation by including an extended permanent establishment provision to cover services (Service PE) or a special provision to cover the so-called technical services.

One important premise of a service PE provision is that source taxation should not extend to services performed outside the territory of the source State. Under the treaties that allow service taxation, such as the ones following the UN Model, it is therefore not only sufficient that the relevant services be furnished to a resident of the Source State, these services must also be performed in the territory of that Source State. Pay attention to the source/territory aspect found in the Model provisions:

See the UN Model Provision:
Art. 5(3) The term “permanent establishment” also encompasses: (…)
(b) The furnishing of services, including consultancy services, by an enterprise through employees or other personnel engaged by the enterprise for such purpose, but only if activities of that nature continue (for the same or a connected project) within a Contracting State for a period or periods aggregating more than six months within any twelve-month period.

Under the UN Model, even if the Luxembourg company furnishing the services would have no fixed place of business in India (under Art.5(1)), the mere fact that the service or the consultancy is supplied for a certain period of time, means it would be deemed to have a permanent establishment, and would consequently be taxed on the income by the source country. One of the conditions is that the activity of furnishing services or consultancy is performed within the source state. Services, which are performed in the residence state of the service-performer, or in any other state besides the source country, are not within the scope of this rule.

See the new OECD Model (draft) Provision
"Notwithstanding the provisions of paragraphs 1, 2 and 3, where an enterprise of a Contracting State performs services in the other Contracting State
a) through an individual who is present in that other State during a period or periods exceeding in the aggregate 183 days in any twelve month period, and more than 50 per cent of the gross revenues attributable to active business activities of the enterprise during this period or periods are derived from the services performed in that other State through that individual, or
b) during a period or periods exceeding in the aggregate 183 days in any twelve month period, and these services are performed for the same project or for connected projects through one or more individuals who are performing such services in that other State or are present in that other State for the purpose of performing such services,
the activities carried on in that other State in performing these services shall be deemed to be carried on through a permanent establishment that the enterprise has in that other State, unless these services are limited to those mentioned in paragraph 4 which, if performed through a fixed place of business, would not make this fixed place of business a permanent establishment under the provisions of that paragraph."

Under the 2006 OECD draft, the proposed alternative provision is clear by stating it only applies to services that are performed in a State by a foreign enterprise. The example used in the draft mentions an enterprise that "provides telecommunication services to customers located in a State through a satellite located outside that State, the services performed through the satellite would not be covered by the provision because they are not performed in the State."

As mentioned above, the source state may also opt, instead of a Service PE, to have a special provision (or an extended royalty provision) to tax certain type of more technical services. The major difference with taxation of technical fees as “royalties” is that only the source of the payment is basically relevant. In this case, the assignment of tax jurisdiction is simply justified because of the payer’s location and taxation is levied on a gross basis.

The fact that under the OECD Model consideration for technical services is not to be treated as a royalty, led to the reaction by certain countries, which then concluded treaties including a technical fees provision in their own tax treaties.

Just a simple search in the IBFD database found 122 treaties, which include a fees for technical services provision. For example, in 1959 treaty (already not in place), Germany and India agreed to define "fees for technical services" as payments of any kind in consideration for services of a managerial, technical or consultancy nature, including the provision of services of technical or other personnel. Throughout the years, the definition found in treaties did not change significantly. For example, in the recently conclude treaty between Austria and Pakistan, "fees for technical services" means any services of a managerial, technical or consultancy nature. The problem lies sometimes in the fact that due to lack of further treaty definitions, it will be up to the local court to define what is a managerial, technical or consultancy service.

The final solution for this case, if there would be a treaty between India and Luxembourg that followed the OECD Model, would be that the marketing and business promotion activities would be only taxable in Luxembourg since there would be no arguments to conclude that a permanent establishment existed in India.

An additional issue is that in practice Indian treaties further deviate from the OECD model by including a provision covering “fees for technical services”. For the taxability of fees for technical services what is relevant is the place where services are utilized and not the place from where the services are rendered. Accordingly, the service income would be liable to tax (generally at rates from 10% to 15%) in India if the services would qualify as “fees for technical services”.

5. Conclusion

It is interesting to note that if we were faced with a tax treaty case, India would probably be prevented to tax (or would tax at reduced rates) the services performed outside the Indian territory. This case firstly demonstrates then the pitfalls of not having a treaty in place.

In a moment when the OECD is studying the possibility of clarifying the tax treaty treatment of services, this case also exemplifies how domestic (or treaty interpretations) may create further pressure on determining where the source of the income arises or the ill-effects of gross service taxation.

The OECD is now prepared to include in its Commentary on Art. 5 an alternative provision for States that whish to preserve source taxation rights on profits from certain services. This new draft includes a principle that taxation of services should not extend to services performed outside the territory of the source State. Nevertheless, the place were the services are performed and executed may perhaps deserve further consideration, especially for cases where services may have an “indirect” extension in the Source State.


Wednesday, February 14, 2007

Switzerland: the EU pressure is mounting

Just a small note following my previous post on the Switzerland-EU relations, to mention that the European Commission has finally decided to go ahead with the case against certain favorable company tax regimes in Swiss Cantons, which are considered by the EU as a form of State aid incompatible with the 1972 Agreement between the EU and Switzerland.

Now it is a question of time to see if all EU member states agree on the "tactic" to apply in negotiations with Switzerland to put an end on tax measures, which the EU consider are resulting in a distortion of competition.

Although the 1972 agreement apparently allows the EU to take retaliatory measures, the press release indicates in its final paragraph a willingness to find a negotiated settlement with the Swiss authorities. Eventhough, note that to substantiate the decision taken against Switzerland the press release even evokes past actions against State aid taken for example against Austria in 1993 (back then EFTA country) on the basis of a corresponding provision. These cases basically involved the withdrawal of tariff concessions (retaliatory measure) but ended up being litigated in the ECJ. Let’s see the next chapters of this cat and mouse soap opera

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Sunday, February 11, 2007

Corporate Tax Avoidance: The Case of Abusive Tax Shelters

‘if we could measure it, we could tax it.’
Comment of a tax official on measuring tax avoidance

In my continuous search to find interesting links and discussions to TALK TAX readers, I refer today to the discussion surrounding tax shelters. In the last few months, I have dedicated some of my available time to study issues surrounding some recent developments on corporate tax avoidance, such as the discussion on relationship between domestic anti-abuse rules and tax treaties (see for example the post on a recent Canadian Court decision), the discussion surrounding international tax arbitrage (see recent post) and the particular issue of abusive tax shelters. This short note is ultimately designed to address that the so-called tax shelters, which although predominantly a US issue are a growing concern also in other tax systems and internationally.

There is a perplexing number of tax planning techniques that even to a well-trained tax specialist are difficult to grasp. Some of them may in fact rise to the level of being qualified as tax shelters, but others are simply part of acceptable tax planning techniques, which have become a commonplace in a global economy. So the first question is what are tax shelters? and the second is were to draw the line?

Professor Michael Graetz (Yale) once amusingly defined a tax shelter as "a deal done by very smart people that, absent tax considerations, would be very stupid." This entertaining definition already provides some ideas of what is a tax shelter. Basically, one may attempt to further define a tax shelter as a transaction undertaken to secure a tax benefit that may seem, at first sight, acceptable under a literal interpretation of the law, but which the legislator did not envisages and also there is little or no business substance supporting the said transaction.

Although this definition is still far from perfect, there is in it more that meets the eye. For example, the fact that most existing tax shelters are usually “marketed” complex transactions with almost no substance, which involve an indifferent third party, already provides some additional criteria into the discussion. In fact, according to the US Internal Revenue Service, corporate tax shelters have the following characteristics: (i) lack of meaningful economic risk of loss or potential for gain; (ii) inconsistent financial and accounting treatment; (iii) presence of tax-indifferent parties; (iv) complexity; (v) unnecessary steps or novel investments; (vi) promotion or marketing; (vii) confidentiality; (viii) high transaction costs; (ix) risk reduction arrangements.

There is a lot of material available in the IRS website to understand through concrete cases what are tax shelters. For example, the listed abusive tax shelters page provides a possible start for the non-US tax lawyers attempting to enter these dangerous waters. I personally suggest another route and that is to take an example of a very complex tax shelter called Bond Linked Issue Premium Structure (BLIPS), which involves investors taking out bank loans and then shifting them to partnerships to claim tax losses. These transactions (and others) were widely discussed and even subject to an investigation by the US Senate Permanent Subcommittee on 2003, which you may recall focused on the involvement of one of the big four. Instead of reading those endless pages, I would suggest reading an interesting (and shorter) court decision on the BLIPS. In Klamath Streategic investment Fund, LLC v. United States, several interesting issues are discussed, namely: (i) the goal of the transactions; (ii) the involvement of tax advisors; (iii) the (lack of) substance issues; and (iv) the justification of the application of further penalties apart from disregarding the tax implications of the transactions. Another suggestion is listening and reading a brief description of US tax shelters.

As European, my interest is more on how fast some of these “fashions” cross the Atlantic. For example, following the US Regulations on Abusive Tax Shelters and Transactions, the UK introduced in 2004 its own disclosure rules covering tax arrangements concerning employment or certain financial products. These rules were recently (2006) widened to the whole corporate tax. Other countries are probably following with great interest the UK attempt of establishing an efficient reporting regime for tax planning arrangements. I am aware at least of (unsuccessful) attempts to introduce in France a similar regime and an ongoing discussion in Portugal. Apart from the complex regulatory and professional privilege issues that these type of rules involve, there is, I would say, a clear temptation to simply follow the American/UK model (disclose and then we see) without stopping to think what are type of transactions we want to tackle and more importantly whether there are other means more adequate to tackle them (e.g. special anti-abuse rules).

It is interesting to note that the discussion around tax shelters is also turning rather quickly into an international topic of itself. For example, the OECD Seoul Declaration of September 2006 where high ranked tax officials confronted the issue of non-compliance with the tax laws in an international context. Amongst the four areas in which the OECD Countries will intensify work we find: (i) Further developing the directory of aggressive tax planning schemes so as to identify trends and measures to counter such schemes. (ii) Examining the role of tax intermediaries (e.g. law and accounting firms, other tax advisors and financial institutions) in relation to non-compliance and the promotion of unacceptable tax minimization arrangements with a view to completing a study by the end of 2007.

This efforts already lead to the development of a Joint International Tax Shelter Information Centre (JITSIC). The JITSIC was established in 2004 by the tax administrations of four countries, Australia, Canada, the United Kingdom and the United States, to supplement the ongoing work of each of the countries in identifying and curbing abusive tax schemes.

In another front, States are also exploring additional ideas and forms to tackle the issue of tax avoidance, such as through bilateral information exchange agreements based on the OECD Model. It is important to recall that in 2002, the OECD released a model agreement for effective exchange of information in tax matters. The model agreement itself grew out of the work on curbing harmful tax practices, which identified “the lack of effective exchange of information” as one of the key criteria in determining harmful tax practices (see the OECD progress reports issued in 2000, 2001, 2004 and 2006). According to the OECD, a total of, 33 jurisdictions are committed to improve transparency and to establish effective information exchange for tax purposes. As such, it is no surprise to see the OECD congratulating Antigua and Barbuda and Australia for having signed a Tax Information and Exchange Agreement.

All these interesting developments make a life of an international tax lawyer interesting…

Don’t you agree?


Wednesday, February 07, 2007

Time has come for Tax Treaty Arbitration

Following up on a previous post from April 2006, the OECD released a final report entitled “Improving the Resolution of Tax Treaty Disputes”.

The report includes in the first place a proposal to add to Art. 25 of the OECD Model Tax Convention an arbitration process to deal with unresolved issues that prevent competent authorities from reaching a mutual agreement. In addition, the report includes a revised version to the Commentary on Art. 25, ultimately designed to enhance the effectiveness of the mutual agreement procedure.

According to the report, the changes to the OECD Model were approved on 30 January 2007 by the OECD Committee on Fiscal Affairs (CFA) and will be included in the forthcoming 2008 update to the Model. The OECD countries have then finally agreed to modify the OECD Model by including the possibility of arbitration in cross-border disputes unresolved for more than two years. In that regard, the OECD will add the following new paragraph 5 to Art. 25:

“5. Where,

a) under paragraph 1, a person has presented a case to the competent authority of a Contracting State on the basis that the actions of one or both of the Contracting States have resulted for that person in taxation not in accordance with the provisions of this Convention, and

b) the competent authorities are unable to reach an agreement to resolve that case pursuant to paragraph 2 within two years from the presentation of the case to the competent authority of the other Contracting State,

any unresolved issues arising from the case shall be submitted to arbitration if the person so requests. These unresolved issues shall not, however, be submitted to arbitration if a decision on these issues has already been rendered by a court or administrative tribunal of either State. Unless a person directly affected by the case does not accept the mutual agreement that implements the arbitration decision, that decision shall be binding on both Contracting States and shall be implemented notwithstanding any time limits in the domestic laws of these States. The competent authorities of the Contracting States shall by mutual agreement settle the mode of application of this paragraph."

Although OECD also includes a detailed sample form of agreement to be used as a basis for the binding arbitration process, the OECD apparently leaves to the contracting parties the possibility to specify themselves the general approach and mechanics of the arbitration process.

For example, the OECD apparently suggests the use of the “independent opinion” approach, whereby arbitrators would be presented with the facts and arguments by the parties based on the applicable law, and would then reach their own independent decision, which would be based on a written, reasoned analysis of the facts involved and applicable legal sources. Nevertheless, the OECD also recognizes other approaches such as the "last best offer” or “final offer” approach, whereby each competent authority is required to give to the arbitral panel a proposed resolution of the issue involved and the arbitral panel would choose between the two proposals which were presented to it. This latter approach was recently included in the arbitration provision of the US-Germany protocol. Find below an extract from such provision:

“g) Each of the Contracting States will be permitted to submit, within 90 days of the appointment of the Chair of the arbitration board, a Proposed Resolution describing the proposed disposition of the specific monetary amounts of income, expense or taxation at issue in the case, and a supporting Position Paper, for consideration by the arbitration board.
h) The arbitration board will deliver a determination in writing to the Contracting States within nine months of the appointment of its Chair. The board will adopt as its determination one of the Proposed Resolutions submitted by the Contracting

Last but not least, allow me to add to the previous list of 10 must read BOOKS AND ARTICLES on the subject, the winner of the 2006 Mitchell B Carroll Prize, Dr Zvi D. Altman. His thesis entitled “Dispute Resolution under Tax Treaties” is a fascinating trip into the limits of the available mechanisms for the resolution of tax treaty-related disputes and the challenges of establishing a new international organization with links to domestic judicial networks. Definitely a must read or have to any international tax library.


Tuesday, February 06, 2007

Tulips, Tax Planning and Rock Stars

For any international tax lawyer it is uncommon to see some tax strategies discussed openly in a generalist newspaper. Nevertheless, we have to surrender ourselves to the transparency effect of globalization, where business and sometimes tax driven decisions are openly discussed and evaluated by the general public.
This introduction to suggest you a nice and entertaining article from the well-known New York Times suggestively entitled The Netherlands, the New Tax Shelter Hot Spot.