D e p a r t me n t of B u s i n e s s L aw
The Use of Double Tax Treaties
and Treaty Shopping
How to Find the Borderline?
Master Thesis
15 credits (15 ECTS)
Volodymyr Vitko
Email address: vladimir.vitko@gmail.com
Telephone number: 0737396548
Master´s Programme in European and International Tax Law
HARM 53
Examiner: Cécile Brokelind
Tutor: Lars-Gunnar Svensson
Contents
ABBREVIATIONS…………………………………………………………....3
1. INTRODUCTION…………………………………………………………..4
1.1. Background………………………………………………………………..4
1.2. Purpose ……………………………………………………………….…..5
1.3. Delimitation and methodology……………………………………...…….5
1.4. Disposition…………………………………………………….…….…….6
2. THE MECHANICS OF TREATY SHOPPING……………………….….7
2.1. A Direct Conduit Strategy…………………………………………..….…..8
2.2. A Stepping-Stone Strategy ………………………………………………...9
2.3. A Bona Fide Structure……………………………………………...……..11
3. ABUSIVE ELEMENTS IN TREATY SHOPPING ………….…..……..13
3.1. Factors…………………………………………………………………......13
3.2. Doctrines ……………………………………………………………...….20
3.2.1. A Beneficial Ownership Doctrine……………………………..………...20
3.2.2. An Economic Substance Doctrine ………………………………..….…22
4. SUMMARY OF THE METHODS …………………………………..…..26
CONCLUSION………………………………………………………..……...28
BIBLIOGRAPHY………………………………………………………….…30
2
ABBREVIATIONS
Double tax treaty
1977 OECD Model
Tax Convention
1986 OECD Conduit
Companies Report
2003 OECD Model
Tax Convention
2010 OECD Model
Tax Convention
OECD
A Treaty (convention) for the avoidance of double
taxation
the 1977 Model Convention with Respect to Taxes on
Income and on Capital
The Report on Double Taxation Conventions and the
Use of Conduit Companies, the Committee on Fiscal
Affairs of the OECD, 27 November 1986
the 2003 Model Convention with Respect to Taxes on
Income and on Capital
the 2010 Model Convention with Respect to Taxes on
Income and on Capital
The Organization for Economic Cooperation and
Development
3
1. INTRODUCTION
1.1 Background
The first treaties for the avoidance of double taxation (double tax treaty) were
concluded in the middle of the 19th century primarily among the various states
of Germany and of the Austro- Hungarian Empire. However, the first “modern”
international treaty for the prevention of double taxation of income is generally
considered to be that between Austria–Hungary and Prussia, concluded on 22
June 1899.1 While the skeleton of the majority of present-day double tax
treaties, called a “model” tax treaty, was adopted in 1928 by the Group of
Experts under the aegis of the League of Nations.
The main purpose pursued by countries concluding double tax treaties was to
facilitate international trade and investment by removing obstacles for them in
the form of double, primarily judicial, taxation. However, a growing network of
bilateral double tax treaties led not only to the said consequences. Together with
the intersection of foreign and domestic tax systems, the globalization of
economics, the development of technologies, the reduction in barriers to
international trade, and the development of sophisticated financial products it
increased opportunities for international tax planning and tax avoidance with the
use of double tax treaties2.
The problem quickly awoke such a wide response, that as far back as in 1977
the Committee on Fiscal Affairs of the Organization for Economic Cooperation
and Development (hereinafter – the OECD) expressed its concern about the
improper use of tax conventions by a person (whether or not a resident of a
contracting state) acting through a legal entity created to obtain treaty benefits,
which would not be available directly to such a person.3 Nine years later, the
same committee issued a report dealing with the most important situation of this
kind, where a company situated in a treaty country is acting as a conduit for
channeling income economically accruing to a person in another State who is
thereby able to take advantage “improperly” of the benefits provided by a tax
treaty. This situation was defined as “treaty shopping”4.
For the countries suffering from treaty shopping the question on how to combat
it had arisen. Some countries started introducing general and special antiavoidance rules in their national laws, other countries chose to include specific
anti-avoidance provisions in double tax treaties limiting tax treaty benefits to
bona fide taxpayers and/or to specifically qualified persons. In addition, in 2003
the Committee on Fiscal Affairs of the OECD, actively supported countries in
their struggle with tax avoidance by incorporating into the Commentaries on
articles of the 2003 OECD Model Tax Convention some anti-avoidance
1
Do We Still Need Tax Treaties?, Alex Easson, Bulletin - Tax Treaty Monitor, December
2000, p. 619
2
Tax Treaties and Tax Avoidance: The 2003 Revisions to the Commentary to the OECD
Model, Brian J. Arnold, Bulletin - Tax Treaty Monitor, June 2004, p. 244
3
The Commentary on Article 1 of the 1977 OECD Model Convention, §9
4
Double Taxation Conventions and the Use Of Conduit Companies, the Committee on Fiscal
Affairs of the OECD, 27 November 1986, p..3, § 2
4
provisions and establishing: firstly, that one of the purposes of double tax
treaties is to prevent tax avoidance; secondly, that domestic anti-avoidance rules
do not conflict with tax treaties.
As a result, on the one hand, we currently have a well-developed network of
double tax treaties between different countries, the total number of which has
already exceeded 20005, offering great opportunities for international tax
planning. On the other hand, we have sophisticated and, sometimes, multi-tier
systems of tools adopted by many countries to combat treaty shopping (national
anti-avoidance rules, anti-avoidance provisions in double tax treaties and
provisions of international soft law), denuding a taxpayer of double tax treaties
benefits if a tax planning strategy employed by it constitutes an abuse of double
tax treaty. Accordingly, understanding how they interrelate with each other or
when a use of double tax treaties transforms into an abuse thereof or treaty
shopping is vital for a successful international tax planning.
1.2. Purpose
Therefore, this paper is aimed at determination of how the borderline between
the use of double tax treaties and treaty shopping in international tax law could
be found. For this purposes the author will examine international soft law,
relevant provisions of double tax treaties and national laws as well as judicial
doctrines developed within national legal systems.
The author hopes that this paper would be interesting to the reader with an
interest in international tax law who might gain some additional knowledge
from the study.
1.3. Delimitation and Methodology
Neither double tax treaties, nor domestic law, nor international soft law draws a
borderline between the use of double tax treaties and treaty shopping. They also
do not give any hints on how to determine it. Therefore, the author is going to
deduce the procedure for determination of the borderline between the use of
double tax treaties and treaty shopping from the definitions of treaty shopping
and anti-treaty shopping tools provided for in various sources. The author,
however, is not pursuing a purpose to analyse any particular legal system as the
present research is performed within the framework of international tax law
area. The paper also will be focused only upon treaty shopping related issues.
Hence, other forms of tax avoidance (evasion) will be left out in the cold.
For these purposes international conventions, double tax treaties and domestic
laws, acts of international soft law, existing case-law, legal databases, legal
textbooks, journal articles and literature, websites of state authorities and other
materials available on-line will be examined.
5
Supra note 1, p. 620
5
As for the methodology the author has taken a traditional legal approach along
with comparative method.
1.4. Disposition
The present thesis, as it has been already mentioned, aims to draw a procedure
of determination of the borderline between the use of double tax treaties and
treaty shopping in international tax law. For these purposes:
Firstly, the author will describe the mechanics of treaty-shopping.
Secondly, the reader will get acquainted with abusive elements of treatyshopping defined in double tax treaties and domestic laws, acts of international
soft law, existing case law.
Finally, the thesis will include an analysis of a problem and a conclusion.
6
2. THE MECHANICS OF TREATY
SHOPPING
The main purpose of double tax treaties is to prevent the risk of double taxation
by allocating taxing jurisdiction between two countries. Although they are
concluded between states, double tax treaties have a direct effect towards
taxpayers. They can invoke treaty benefits in the form of tax relief (or a reduced
tax rate) for specified types of income and therefore request the application of
treaty provisions6. The aim pursued by countries granting tax benefits in
accordance with the provisions of double tax treaties to their taxpayers is to
facilitate international trade and investment between them. These goals may be
achieved mainly if the taxpayers provide real business activity within both
states. In this case, the use of tax treaty benefits by taxpayers has legitimate
character and is, usually, supported by the contracting states.
On the other hand, double tax treaties could be used by persons in order to
derive tax advantages that the treaties were not designed to give them. Such
situations constitute an abuse or improper use of double tax treaties. There are
several forms of an abuse of double tax treaties differing from each other by
their purposes and strategies employed, e.g. using base companies, treaty
shopping, rule shopping. The author is going to concentrate upon treaty
shopping, which relates to situations, in which a person benefits from a treaty
without being a legitimate beneficiary thereof.
According to van Weeghel, the term “treaty shopping” connotes a situation in
which a person who is not entitled to the benefits of a tax treaty makes use – in
the widest meaning of the word – of an individual or legal person in order to
obtain those treaty benefits that are not available directly.7 Rohatgi defines
treaty shopping as the routing of income arising in one country to a person in
another country through an intermediary country to obtain an unintended tax
advantage of tax treaties.8 According to Becker and Wurm, treaty shopping
means that a taxpayer “shops” into the benefits of a treaty which are not
available to him [and] to this end he generally incorporates a corporation in a
country that has an advantageous tax treaty9. Vogel refers to a situation where
transactions are entered, or entities are established, in other States, solely for the
purpose of enjoying the benefit of particular treaty rules existing between the
State involved and a third State which otherwise would not be applicable, e.g.,
because the person claiming the benefit is not a resident of one of the
contracting States…10 Another interesting definition of treaty shopping was
given by the Advisory Panel on Canada’s System of International Taxation,
which defined it as : ... the situation where a person, who is resident in a given
6
Fundamentals of International Tax Planning, Raffaele Russo, IBFD, Amsterdam, 2007, p. 11
The Improper Use of Tax Treaties With Particular Reference to the Netherlands and the United
States, Stef van Weeghel, Kluwer, London 1998, p. 119
8
Basic International Taxation the 2nd edition, Roy Rohatgi, BNA International Inc., London,
2007 p. 165
9
Treaty Shopping. An Emerging Tax Issue and its Present Status in Various Countries, Helmut
Becker and Felix J. Wurm, Kluwer, London. 1988, p.1
10
On Double Tax Conventions, Vogel, Klaus., Kluwer, Deventer/Boston, 1991, p.50.
7
7
country (the home country) and who derives income or capital gains from
another country (the source country), is able to gain access to a tax treaty in
place between the source country and a third country that offers a more
generous tax treatment than the tax treatment otherwise applicable. This
situation could arise if the person is resident in a country that does not have a
tax treaty with the source country, or if the tax treaty between the source
country and the person’s home country offers less generous tax treatment than
the tax treaty between the source country and the third country.11
Nevertheless there are some small differences among the scholars in
understanding the term “treaty shopping”, they all agree that there are two
principal treaty shopping strategies – a direct conduit strategy and a steppingstone strategy.
2.1. A Direct Conduit Strategy
In accordance with the first strategy (see Scheme 1), Company C from State C,
is planning to receive income in the form of dividends (royalties or interest)
from a subsidiary Company A in State A. However, there is no a double tax
treaty between State C and State A or provisions of a double tax treaty between
them do not eliminate a withholding tax levied by State A on the above types of
income. At the same time, provisions of a double tax treaty between State A and
State B reduce the rate or eliminate in whole a withholding tax on dividends
(royalties or interest) paid to a resident of State B. State B, in its turn, does not
levy taxes on foreign sourced income and does not levy a withholding tax on
dividends (royalties or interest) paid to a State C resident in accordance with the
provisions of a double tax treaty concluded between State B and State C.
Hence, Company C establishes subsidiary Company B12 in State B, which
provides no or minimal business activity, and routes the income from Company
A through it. State A does not levy a withholding tax on the income in the form
of dividends (royalties or interest) or reduces its rate in accordance with the
provisions of a double tax treaty between State A and State B. Then State B
does not tax this income in accordance with the provisions of national law and
does not levy a withholding tax on dividends (royalties or interest) 13 paid to
Company C in concordance with the provisions of a double tax treaty between
State B and State A (or in concordance with the provisions of national law of
State B). Under such conditions Company C receives the income from
Company A with minimal tax expenditures. In contrast, if the income from
Company A is paid directly to Company C, it would be subject to State A
withholding tax with no or very restricted double tax treaty benefits;
accordingly the tax expenditures would be much more higher.
Enhancing Canada’s International Tax Advantage: A Consultation Paper Issued by the
Advisory Panel on Canada’s System of International Taxation
12
It could also be a partnership, trust or other entity having taxable status under the domestic
law of the relevant state.
13
In order to enjoy the benefits of double tax treaty between State C and State B the income
could be re-characterized (e.g. from dividends to interest or royalties and vice versa). The
scheme could also involve more conduit companies and, accordingly, more transitional states
11
8
Scheme 1
State A
Company A
No or restricted double
tax treaty benefits
100%
A double tax treaty
reduces or
eliminates
withholding taxes
State C
State B
Company C
Company B
100%
A double tax treaty
reduces or eliminates
withholding taxes
No domestic tax in
State B due to the
special tax regime
Finally, it should be noted that in a pure treaty shopping situation – companies
A, B, C in Scheme 1 are affiliated persons.
2.2. A Stepping-Stone Strategy
A stepping-stone strategy could be better explained with an example of scheme
2. Thus, similarly to the situation in Scheme 1, Company D from State D, is
planning to receive income in the form of dividends (royalties or interest) from
a subsidiary Company A in State A. However, there is no a double tax treaty
between State D and State A or provisions of a double tax treaty between them
do not eliminate withholding tax levied by State A on the above types of
income. At the same time, provisions of a double tax treaty between State A and
State B reduce the rate or eliminate in whole a withholding tax on dividends
(royalties or interest) paid to a resident of State B. State B, which is usually a
high tax country, in its turn, levies taxes on foreign sourced income and due to
the provisions of a domestic law or a double treaty between State C and State B
allows deduction of expenses occurred in State C. While State C does not levy
taxes on foreign sourced income and does not levy a withholding tax on
dividends (royalties or interest) paid to State D residents in accordance with the
provisions of a double tax treaty concluded between State D and State C.
9
Hence, Company D establishes subsidiaries Company C in State C and
Company B in State B, which provide no or minimal business activity, and
routes the income from Company A through them. State A does not levy a
withholding tax on income in the form of dividends (royalties or interest) paid
by Company A to Company B or reduces its rate in accordance with the
provisions of a double tax treaty between State A and State B. Accordingly,
Company B offsets the income received from Company A against expenditures
in the form of commission, high interest, service fees paid to Company C. This
operation effectively results in the transformation of the income. Further, in
concordance with the provisions of a double tax treaty between State D and
State C (or in concordance with the provisions of national law of State C) State
C does not withhold a tax from the income transferred by Company C14 to
Company D. Under such conditions Company D receives the income from
Company A with minimal tax expenditures. In contrast, if the income from
Company A is transferred directly to Company D, it would be subject to State A
withholding tax with no or very restricted double tax treaty benefits;
accordingly the tax expenditures would be much more higher.
Scheme 2
State A
Company A
No or restricted double
tax treaty benefits
A double tax treaty
reduces the rate of or
eliminates a
withholding tax
100%
State D
Company D
A double tax
treaty
reduces the
rate of or
eliminates a
withholding
tax
State C
100%
Company C
No domestic Tax
in State C due to
the special tax
regime
14
State B
100%
Company B
Company B’s income is
fully taxable in State B,
however, due to the
provisions of domestic
law or a double treaty
between State C and
State B expenses
occurred in State C are
fully deductible
Company C is needed only if State D provides preferential comparatively to other types of
income regime for the passive income in the form of dividends, royalties and interest
10
Finally, it should be noted that in a pure treaty shopping situation – companies
A, B, C, D in Scheme 2 are affiliated persons.
2.3. A Bona Fide Structure
In Scheme 1 and Scheme 2 the author has shown examples of clear treaty
shopping structures. The next structure, drawn on Scheme 3, is a bona fide one.
This structure was created for commercial reasons which occasionally fit into
the treaty-shopping model.
Scheme 3
State A
Company A
A double tax treaty
reduces the rate of
or eliminates a
withholding tax
No or restricted double
tax treaty benefits
100%
State C
51%
Company C
State B
Company B
A double tax treaty
reduces the rate of or
eliminates a
withholding tax
No domestic Tax in
State B due to the
special tax regime
The situation with tax regimes in State A, State B and State C and double tax
treaties between them in Scheme 3 is similar to the situation in Scheme 1.
Thus, Company B, which is a real entity, engaged in actual manufacturing
business in State B, establishes Company A for distribution its goods in State A.
Later, Company C from State C buys control of company B (purchases 51% of
its shares). Since Company A makes substantial profit, it distributes dividends
to Company B, which in its turn distributes the dividends to Company C.
State A does not levy a withholding tax on dividends or reduces its rate in
accordance with the provisions of a double tax treaty between State A and State
B. Then State B does not tax this income in accordance with the provisions of
11
national law and does not levy a withholding tax on dividends paid to Company
C in concordance with the provisions of a double tax treaty between State B and
State A (or in concordance with the provisions of national law of State B).
In such a way the flow-through of dividends from Company A to Company C
leads to substantial tax savings. In contrast, if the income from Company A is
paid directly to Company C, it would be subject to State A withholding tax with
no or very restricted double tax treaty benefits; accordingly the tax expenditures
would be much more higher.
To sum up, the structures shown in Scheme 1 and Scheme 2 in the majority of
the states will be classified as treaty shopping and the taxpayers will not be
granted tax treaty benefits, while the structure in Scheme 3 is a clear bona fide
structure, set up for valid commercial reasons, therefore, tax treaty benefits most
probably will be granted here to a tax payer (Company B) acting in good faith.
12
3. ABUSIVE ELEMENTS IN TREATY
SHOPPING
As is evident from the foregoing, the structures exhibited in Scheme 1 and
Scheme 3 are quite similar, however,, it should be mentioned that the
consequences of their application for the taxpayers are completely different. In
order to determine why they are treated differently it is vital to define the
abusive elements in treaty shopping.
The examples of abusive elements could be found in anti-treaty shopping tools
implemented by states. These include:






specific legislative anti-abuse rules found in domestic law;
general legislative anti-abuse rules found in domestic law;
judicial doctrines that are part of domestic law;
specific anti-abuse rules found in tax treaties;
general anti-abuse rules in tax treaties;
the interpretation of tax treaty provisions15.
Despite they have different names, forms and ways of adoption these tools are
based on two main strategies separately or jointly employed by States when
combating treaty shopping. The first one is limiting possibility for using conduit
companies through exclusion from treaty benefits legal entities, which have got
or have not got some specific characteristics (factors). The second one is using
specific anti-treaty shopping doctrines.
3.1. Factors
Let us commence from the first strategy. There are several important factors,
that are usually taken by states into account for determining whether
transactions (schemes) under review are abusive (used for treaty shopping) or
not. These factors are usually included in the double tax treaties in the form of
limitation on benefits provision. The latter could be classified as follows:
1. A ‘look-through’ test is designed to establish whether the legal entity
established in a residence state receiving income and claiming an
exemption from a withholding tax (or a reduced rate) in a source state
owned directly or indirectly by persons who are not residents of one of
the contracting state.
This test was firstly proposed by the OECD in its 1987 report, called Double
Taxation Conventions and the Use of Conduit Companies (hereinafter – the
1987 OECD Conduit report). An operative example of such a test could be
15
Improper Use of Tax Treaties, the UN Committee of Experts on International Cooperation in
Tax Matters, June 2009, p.5, §10
13
found16 in §2 of the protocol to the 1995 Convention Between the Kingdom of
Spain and the Kingdom of Belgium for the Avoidance of Double Taxation and
the Prevention of Fiscal Evasion with Respect to Taxes on Income and on
Capital:
Notwithstanding the provisions of the Articles mentioned above, tax
reductions or exemptions which would otherwise apply to dividends,
interest, royalties and capital gains, shall not apply if these items of income
from a Contracting State are derived by a company which is a resident of the
other Contracting State, where persons who are not residents of that other
State hold, directly or indirectly, more than 50% of the capital of that
company.17
Accordingly, if the answer to the question is positive, the legal entity is denied
double tax treaty benefits.
2. An exclusion test is aimed at defining whether the legal entity
established in a residence state receiving income and claiming an
exemption from a withholding tax (or a reduced rate) in a source state a
tax-exempt or nearly tax-exempt company.
This test was supported by the OECD for combating treaty shopping in the 1986
OECD Conduit Companies Report; by that time it was already applied by some
States. An operative example of such test could be found in the note of the
French Government of 8 September 1970 to the 1958 Convention between
France and the Grand Duchy of Luxembourg for the Avoidance of Double
Taxation and the Establishment of Rules of Reciprocal Administrative
Assistance with Respect to Taxes on Income and Capital:
… this Convention, as from its entry into force should not apply to holding
companies within the meaning of specific Luxembourg law (i.e., presently
the Law of 31 July, 1929 and the Decree law of 27 December, 1937) nor to
the income of residents of France derived from such companies nor to their
participations in such companies.18
Much the same as in case of the first test, if the answer to the question is
positive, the legal entity is denied double tax treaty benefits.
16
Another example of such a test is also contained in §2 of art. 17 Artistes and Sportsmen of the
OECD Model Tax Convention and the UN Model Tax Convention and in the majority of
present-day double tax treaties. This paragraph sets forth that: ‘where income in respect of
personal activities exercised by an entertainer or a sportsman in his capacity as such accrues not
to the entertainer or sportsman himself but to another person, that income may, notwithstanding
the provisions of Articles 7 and 15, be taxed in the Contracting State in which the activities of
the entertainer or sportsman are exercised.’
17
The Protocol to the 1995 Convention Between the Kingdom of Spain and the Kingdom of
Belgium for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with
Respect to Taxes on Income and on Capital, §2
18
The note of the French Government of 8 September 1970 to the 1958 Convention between
France and the Grand Duchy of Luxembourg for the Avoidance of Double Taxation and the
Establishment of Rules of Reciprocal Administrative Assistance with Respect to Taxes on
Income and Capital
14
3. A subject-to-tax test is seeking whether the respective income received
from the source state (dividends, royalty, interest) subject to tax in the
state of residence.
This test, was proposed by the OECD in the same 1986 Conduit Companies
Report. This test resembles to the previous one. A good exemplification thereof
could be found in article 20 of the 1971 Convention between the United States
of America and the Kingdom of Norway for the Avoidance of Double Taxation
and the Prevention of Fiscal Evasion with Respect to Taxes on Income and
Property:
A corporation of one of the Contracting Stated deriving dividends,
interest, royalties, or capital gains from sources within the other
Contracting State shall not be entitled to the benefits of Articles 8
(Dividends), 9 (Interest), 10 (Royalties), or 12 (Capital gains) if:
(a) by reason of special measures the tax imposed on such corporation by
the first-mentioned Contracting State with respect to such dividends,
interest, royalties, or capital gain is substantially less than the tax
generally imposed by such Contracting State on corporate profits, and
(b) 25 percent or more of the capital of such corporation is held of record
or is otherwise determined, after consultation between the competent
authorities of the Contracting States, to be owned directly or indirectly,
by one or more persons who are not individual residents of the firstmentioned Contracting State (or, in the case of a Norwegian corporation,
who are citizens of the United States).19
If the answer to the question is negative, the legal entity is denied double tax
treaty benefits.
4. The channel test establishes whether the tax base of the company in the
residence state more than on 50% eroded through payments to nonresident related entities.
This test is favoured by the OECD. It is targeting stepping-stone companies.
Such a test is contained in § 1 of article 22 of the 1978 Convention between the
Swiss Confederation and the Kingdom of Belgium for the Avoidance of Double
Taxation with Respect to Taxes on Income and Capital:
A legal entity which is a resident of a Contracting State, and in which
persons who are not residents of that State have, directly or indirectly, a
substantial interest in the form of a participation, or otherwise, may only
claim the tax reductions provided for in Articles 10, 11 and 12 with
respect to dividends, interest, and royalties, derived from sources in the
other Contracting State, where:
(a) the interest-bearing debts to persons who are not residents of the
first-mentioned State are not higher than six times the equity capital and
reserves; this condition shall not apply to banks of both Contracting
States;
19
The 1971 Convention between the United States of America and the Kingdom of Norway for
the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes
on Income and Property, art. 20
15
(b) the interest paid on loans contracted with such persons is not paid at
a higher rate than the normal interest rate; the normal interest rate
means:
(1) in Belgium: the legal rate of interest permitted as professional
charges;
(2) in Switzerland: the average interest rate on debentures issued by the
Swiss Confederation plus two percentage points;
(c) not more than 50 percent of the relevant income from sources in the
other Contracting State is used to satisfy claims (interest, royalties,
development, advertising, initial and travel expenses, depreciation on
any kind of business asset including intangible assets, processes, etc.)
by persons not resident in the first-mentioned State;
(d) expenses connected with the relevant income derived from sources
in the other Contracting State are met exclusively from such income;
and
(e) the corporation distributes at least 25 percent of the relevant income
derived from sources in the other Contracting State.20
Accordingly, if the answer to the question is positive, the legal entity is denied
double tax treaty benefits.
As all of the above tests could potentially affect innocent taxpayers not involved
in conduit operations at all, states also developed a few supplementary tests
called bona fide tests aimed on protection normal business operations. These
tests are discussed below.
5. A general bona fide test is answering a question whether the principal
purpose of the company, the conduct of its business and the acquisition
or maintenance by it of the shareholding or other property from which
the income in question is derived, motivated by sound business reasons
and thus do not have as primary purpose the obtaining of any such
benefits.
An example of such a test could be found in §19 of the commentary on art. 1 of
the 2010 OECD Model Convention with Respect to Taxes on Income and on
Capital (hereinafter – the 2010 OECD Commentaries):
The foregoing provisions shall not apply where the company establishes
that the principal purpose of the company, the conduct of its business
and the acquisition or maintenance by it of the shareholding or other
property from which the income in question is derived, are motivated by
sound business reasons and do not have as primary purpose the
obtaining of any benefits under this Convention.21
Therefore, if the answer to the mentioned question is positive, than the legal
entity should be granted tax treaty benefits nevertheless one or a few previous
tests were not satisfied.
20
The 1978 Convention Between the Swiss Confederation and the Kingdom of Belgium for the
Avoidance of Double Taxation with Respect to Taxes on Income and Capital, art. 22
21
The Commentaries on the Articles of the 2010 OECD Model Convention with Respect to
Taxes on Income and on Capital, §19
16
6. An active business test is seeking whether the company engaged in
substantive business operations in the Contracting State of which it is a
resident and is the relief from taxation claimed from the other
Contracting State with respect to income which is connected with such
operations.
This test could be found in the article 27 of the 2004 Convention between the
Government of the Republic of Poland and the Government of the Kingdom of
Sweden for the Avoidance of Double Taxation and the Prevention of Fiscal
Evasion with Respect to Taxes on Income:
Notwithstanding any other provisions of this Convention, where:
(a) a company that is a resident of a Contracting State derives its income
primarily from other States
(i) from activities such as banking, shipping, financing or insurance; or
(ii) from being the headquarters, co-ordination centre or similar entity
providing administrative services or other support to a group of
companies which carry on business primarily in other States; and’
(b) except for the application of the method of elimination of double
taxation normally applied by that State, such income would bear a
significantly lower tax under the laws of that State than income from
similar activities carried out within that State or from being the
headquarters, co-ordination centre or similar entity providing
administrative services or other support to a group of companies which
carry on business in that State, as the case may be,
any provisions of this Convention conferring an exemption or a reduction
of tax shall not apply to the income of such company and to the dividends
paid by such company.22
Accordingly, if the answer to the question is positive, than the legal entity
should be granted tax treaty benefits nevertheless one or a few of the first four
tests were not satisfied.
7. A detailed subject to tax test asks the question whether the reduction of
tax claimed greater than the tax actually imposed by the Contracting
State of which the company is a resident?
This test is present in the 2002 Convention between the Government of Canada
and the Government of the Kingdom of Belgium for the Avoidance of Double
Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income
and on Capital. Thus, §5 of article 27 of the above double tax treaty sets forth:
The exemption provided under subparagraph (b) of paragraph 3 of Article
12 shall not apply where the enterprise benefiting from the royalties has,
in a State which is not a Contracting State, a permanent establishment to
which the royalties are attributable and where the royalties are subject, in
the State of residence of the enterprise and in the State where the
permanent establishment is situated, to a tax the total of which is less than
60 per cent of the tax that would be imposed in the State of residence of
the enterprise if the royalties were attributable to the enterprise and not to
22
The 2004 Convention between the Government of the Republic of Poland and the
Government of the Kingdom of Sweden for the Avoidance of Double Taxation and the
Prevention of Fiscal Evasion with Respect to Taxes on Income, art. 27
17
the permanent establishment. The provisions of this paragraph shall not
apply:
(a) if the royalties are derived in connection with or incidental to the
active conduct of a trade or business carried on in the state which is not a
Contracting State; or
(b) when Belgium is the State of residence of the enterprise, to royalties
taxed by Canada according to section 91 of the Income Tax Act, as it may
be amended without changing the general principle hereof.23
Accordingly, if the answer to the question is positive, than the legal entity
should be granted tax treaty benefits nevertheless one or a few of the first four
tests were not satisfied.
8. So-called stock exchange test seeks whether the principal class of a
company’s, resident of a Contracting State, shares registered on an
approved stock exchange in a Contracting State.
A good example of this test is provided by the OECD in the 2010
Commentaries:
The foregoing provisions shall not apply to a company that is a resident
of a Contracting State if the principal class of its shares is registered on
an approved stock exchange in a Contracting State or if such company is
wholly owned — directly or through one or more companies each of
which is a resident of the first-mentioned State — by a company which is
a resident of the first-mentioned State and the principal class of whose
shares is so registered.24
Again, if the answer to the question is positive, than the legal entity should be
granted tax treaty benefits nevertheless one or a few of the first four tests were
not satisfied.
9. An equivalent benefits test or an alternative relief test designed to
find out whether the person, a resident of the third State under the
provisions, can ultimately benefiting from payments from the suspected
conduit, claim benefits at least equivalent to those granted by the
convention to resident of the ‘conduit’ State?
This test is present in the 1995 Convention between the Government of Japan
and the Government of the French Republic for the Avoidance of Double
Taxation and the Prevention of Tax Evasion and Fraud with Regard to Taxes on
Income as amended by the 2007. Thus, §5 of article 12 of the above double tax
treaty sets forth:
A resident of a Contracting State shall not be considered as the actual
beneficial owner of royalties collected for the use of intangible assets,
23
The 2002 Convention between the Government of Canada and the Government of the
Kingdom of Belgium for the Avoidance of Double Taxation and the Prevention of Fiscal
Evasion with Respect to Taxes on Income and on Capital, art. 27
24
The Commentaries on the Articles of the 2010 OECD Model Convention with Respect to
Taxes on Income and on Capital, §19
18
when payment of such royalties to the resident was subject to the payment
of royalties by the latter, for the same intangible assets, to a person:
a)
not entitled, in connection with the royalties originating from the
other Contracting State, to benefits at least equivalent to those granted by
this Convention to a resident of the first Contracting State; and
b)
that is not a resident of either Contracting State.25
Similarly, to the previous tests, if the answer to the question is positive, than the
legal entity should be granted tax treaty benefits nevertheless one or a few of the
first four tests were not satisfied.
10. A multinational enterprises test seeks whether the legal entity
established in a residence state receiving income and claiming an
exemption from a withholding tax (or a reduced rate) a multinational
corporate group headquarter which satisfies some specific requirements.
This test is not a real bona fide test. It appeared because a lot of States have
been interested in attraction of big multinational enterprises. Therefore they,
sometimes, ‘turn a blind eye’ to some forms of tax avoidance with the
participation of multinational enterprises. The example of such a test could be
found in the majority of the modern US and Japanese double tax treaties. E.g.,
in article 21 of the 2010 Convention between the Kingdom of the Netherlands
and Japan for the Avoidance of Double Taxation and the Prevention of Fiscal
Evasion with Respect to Taxes on Income one can read:
(a) Notwithstanding that a resident of a Contracting State may not be
a qualified person, that resident shall be entitled to the benefits
granted by the provisions of paragraph 3 of Article 10, paragraph 3
of Article 11 or Article 12, 13 or 20 with respect to an item of
income described in those paragraphs or Articles derived from the
other Contracting State if:
(i) that resident functions as a headquarters company for a
multinational corporate group;
(ii) the item of income derived from that other Contracting State
either is derived in connection with, or is incidental to, the business
referred to in clause (ii) of subparagraph b); and
(iii) that resident satisfies any other specified conditions in those
paragraphs or Articles for the obtaining of such benefits.
(b) A resident of a Contracting State shall be considered a
headquarters company for a multinational corporate group for the
purpose of subparagraph a) only if:
(i) that resident provides a substantial portion of the overall
supervision and administration of the group or provides financing for
the group;
(ii) the group consists of companies which are resident in, and are
carrying on business in, at least five countries, and the business
carried on in each of the five countries generates at least 5 per cent
of the gross income of the group;
(iii) the business carried on in any one country other than that
Contracting State generate less than 50 per cent of the gross income
of the group;
25
The 1995 Convention between the Government of Japan and the Government of the French
Republic for the Avoidance of Double Taxation and the Prevention of Tax Evasion and Fraud
with Regard to Taxes on Income as amended by the 2007 protocol, art.12
19
(iv) no more than 50 per cent of its gross income is derived from the
other Contracting State;
(v) that resident has, and exercises, independent discretionary
authority to carry out the functions referred to in clause (i); and
(vi) that resident is subject to the same income taxation rules in that
Contracting State as persons described in paragraph 5.
(c) For the purpose of subparagraph b), a resident of a Contracting
State shall be deemed to satisfy the gross income requirements
described in clause (ii), (iii) or (iv) of that subparagraph for the
taxable year in which the item of income is derived if the resident
satisfies each of those gross income requirements when averaging
the gross income of the three taxable years preceding that taxable
year.26
Similarly, to the five previous tests, if the answer to the question is positive,
than the legal entity should be granted tax treaty benefits nevertheless one or a
few of the first four tests were not satisfied.
Summing up, only a few of the double tax treaties in force contain none of the
above discussed anti-treaty shopping tests (especially earlier double tax
treaties), while the majority contain only one or a few of them. Some countries,
for instance, the US and Japan prefer including into their latest double tax
treaties27 all above mentioned tests. Whether it is reasonable the author will
discuss in the following chapters.
3.2. Doctrines
Doctrines are the most popular way of combating treaty shopping. They could
simply be divided into two main subcategories. The first one is a beneficial
ownership doctrine (concept) and the second one is an economic substance
doctrine.
3.2.1. A Beneficial Ownership Doctrine (Concept)
The doctrine of beneficial ownership is the most widespread anti-treaty
shopping tool. It has been developing and existing for many years in the
domestic (non-tax) law of the common law states. It was incorporated for the
first time in a tax treaty in relation to income into the 1966 protocol to the 1945
United Kingdom–United States double tax treaty. The doctrine was introduced
into the OECD Model Tax Convention in 1977.28 The term ‘beneficial
ownership’ is also used in later versions of both the OECD Model Tax
Convention and the UN Model Tax Convention, and has similarly been
26
The 2010 Convention between the Kingdom of the Netherlands and Japan for the Avoidance
of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income,
art.21
27
See e.g. US – Belgium, Japan – US, Japan – France, Japan – Australia, Japan – Switzerland
double tax treaties
28
The Evolution of the Term “Beneficial Ownership” in Relation to International Taxation over
the Past 45 Years, Charl du Toit, Bulletin for International Taxation, 2010 (Volume 64), No.
10/IBFD database, §1
20
incorporated into many double tax treaties between different states. The doctrine
is decisive for determination whether a person qualifies for treaty benefits and
for the allocation of the taxing right between two contracting states in respect of
dividends, interest and royalties. In this respect, tax treaties typically use a
wording to the effect that the person claiming the treaty benefits (normally a
reduced withholding tax) must be the beneficial owner of the dividends, interest
or royalties.29 It is pretty clear that the beneficial ownership limitation was
introduced to counter treaty shopping by the channeling of the relevant income
through a resident of a state with a suitably attractive treaty provision.30
Nevertheless the doctrine is so widely applied; the term “beneficial owner” is
neither defined in the OECD Model Tax Convention31, nor in the UN Model
Tax Convention, nor in the majority of existing double tax treaties. The problem
is hidden in differences in legal systems and traditions of civil and common law
countries, including different understandings and meanings of ownership. E.g.,
in Italy, the position that was traditionally taken was that the real rights (which
included ownership and usufruct) of enjoyment of an asset were expressly
defined and limited by the Italian Civil Code. These were the sole rights of
enjoyment, which could be enforced against anyone, as opposed to contractual
arrangements such as lease agreements, which could be enforced only between
the contracting parties. Any right of enjoyment other than those defined and
governed by the Italian Civil Code could not exist and, consequently, could be
deemed to be contrary to public policy.32
Due to the fact that the beneficial ownership is not explicitly defined neither in
the OECD Model Tax Convention, nor the UN Model Tax Convention and their
commentaries, countries usually follow the negative definition provided for in
the respective OECD Commentaries or their own definitions of beneficial
ownership elaborated in their domestic legislation or case-law.
The following conclusions on beneficial ownership may be derived from
various case law decisions33:
A mere legal title without any rights (e.g. copyright, patent,
trademark) does not constitute beneficial ownership.
The right of beneficial ownership must be recognized by law,
and must be enforceable by the Courts.
29
Ibid,, §2
Beneficial Ownership: After Indofood, Philip Baker, Grays Inn Tax Chamber Review, Vol.
VI, No. 1 (February 2007), p. 15
31
The commentaries on articles 10 and 11 of the OECD Model Tax Convention contain only
negative definition of the term “beneficial owner”. Thus, they state: the term “beneficial owner”
is not used in a narrow technical sense, rather, it should be understood in its context and in
light of the object and purposes of the Convention, including avoiding double taxation and the
prevention of fiscal evasion and avoidance.
Where an item of income is received by a resident of a Contracting State acting in the capacity
of agent or nominee it would be inconsistent with the object and purpose of the Convention for
the State of source to grant relief or exemption merely on account of the status of the immediate
recipient of the income as a resident of the other Contracting State.
32
The Taxation Of Trusts In Civil Law Countries – Italy: Aspects of Trust Taxation, G. Maisto,
European Taxation 8 (1998), p. 242
33
Probably the most important of them are the Royal Dutch Petroleum case, the Indofood case
and the Prévost case
30
21
Beneficial ownership does not include ownership with the
obligation to transfer it to others.
There can only be one beneficial owner in respect of a thing at a
specific point of time.34
Except for existing case law, some countries defined the term beneficial
ownership in their domestic laws. E.g. article 4(4) of the Dutch Dividend Tax
Act (1965) sets forth that a shareholder who is the recipient of dividends will
not be considered the beneficial owner of the dividends if, as a consequence of a
combination of transactions, a person other than the recipient wholly or partly
benefits from the dividends, whereby such person retains, whether directly or
indirectly, an interest in the shares on which the dividends were paid and such
person is entitled to a credit, reduction or refund of the dividend withholding tax
that is less than that to which the recipient is entitled35.
While under article 103 of the Ukrainian Tax Code (2011) the beneficial
(actual) recipient (owner) of income who under an international treaty shall be
entitled to a lower tax rate on dividends, interest, royalties, remuneration, etc.
received by a nonresident in Ukraine shall be an entity entitled to receive such
income. The beneficiary (actual) recipient (owner) shall not refer to a legal
entity or an individual, even if such an entity/individual is entitled to receive
income but is an agent or a nominee holder (nominee), or is only as an
intermediary with regard to this income.
The Indonesian tax authorities in its ruling letter S-95/PJ.342/2006 set forth that,
the foreign company, to qualify as a beneficial owner, must either (a) have
income subject to tax or an active business in its country of residence; or (b)
have a full power or control over the income to use in its operations; or (c) its
shares must be traded on a recognized stock exchange.36
The Technical explanation to the 2006 US Model Income Tax Convention
defines the beneficial owner as a person to which the income is attributable
under the laws of the source State. Thus, if a dividend paid by a corporation,
that is a resident of one of the States (as determined under Article 4
(Residence)), is received by a nominee or agent that is a resident of the other
State on behalf of a person that is not a resident of that other State, the dividend
is not entitled to the benefits of this Article.
As we can see there are no significant differences in understanding of the
concept of beneficial ownership between different states. Generally speaking,
under beneficial owner they understand a legal entity or an individual that has a
full power or control over the income to use in its operations not burdened by
any additional obligations. However, there is still no international definition of
the term, which means that local judges and tax authorities may apply and
interpret it differently.
34
Supra note 8, p.173
Anti-Abuse Measures and the Application of Tax Treaties in the Netherlands, Stef van
Weeghel and Reinout de Boer, IBFD Bulletin, August/September 2006, p. 363
36
Supra note 8, p. 178
35
22
3.2.2. An Economic Substance Doctrine (Concept)
As it was already mentioned a lot of states have been considering treaty
shopping as a serious problem for quite a long time and for combating this
problem a beneficial ownership doctrine has been employed. Other states
instead of or together with the beneficial owner doctrine have developed in their
domestic laws or case law anti-treaty shopping doctrines, such as substanceover-form and/or economic substance doctrines. Even though they have
different names they have very close essence. An example of the economic
substance doctrine incorporated into the law could be found in Germany. Thus,
under section 50d paragraph 3 of the German Income Tax Act (1994, revised in
2007) a foreign entity is not entitled to treaty or directive benefits if its
shareholders would not be entitled to these benefits had they received the
payments directly, and

there are no commercial or other relevant non-tax reasons for the
interposition of the foreign entity; or

the foreign company earns no more than 10 per cent of its gross
earnings from a business activity of its own; or

the foreign company is not adequately equipped to take part in
the business community given its purpose.
From 2007 onwards, these three criteria must be positively and cumulatively
met in order to be granted treaty or directive benefits if the shareholders of the
foreign entity would not be entitled to these benefits themselves.37
Another interesting example of a substance-over-form doctrine is the US
regulations dealing with financing arrangements38. For the purposes of these
regulations, a financing arrangement is a series of transactions by which the
financing entity advances money or other property to the financed entity,
provided that the money or other property flows through one or more
intermediary entities. An intermediary entity will be considered a “conduit”, and
its participation in the financing arrangements will be disregarded by the tax
authorities if (i) tax is reduced due to the existence of an intermediary, (ii) there
is a tax avoidance plan, and (iii) it is established that the intermediary would not
have participated in the transaction but for the fact that the intermediary is a
related party of the financing entity. In such cases, the related income shall be
re-characterized according to its substance39.
Other countries have dealt with the issue of treaty shopping through judicial
doctrines established by their domestic courts. For example, according to a bona
fide taxpayer doctrine established by the Russian courts in the Yukos case40 on
the basis of the Ruling the Constitutional Court of the Russian Federation of 25
July 2001, mala fide taxpayers are deprived their rights and privileges granted
37
IFA Cahiers 2010 - Volume 95A. Tax Treaties and Tax Avoidance: Application of AntiAvoidance Provisions, Germany, Alexander Linn, pp. 336 - 337
38
See the U.S. Department of Treasury conduit regulations under section 7701(l) of the Internal
Revenue Code from August 11, 1995
39
Improper Use of Tax Treaties, the UN Committee of Experts on International Cooperation in
Tax Matters, June 2009, pp.15 – 16 , §52
40
The decision of the Arbitral court of Moscow city of 26 May 2004 in case №А40-17669/04109-241
23
by Russian law, an integral part of which is double tax treaties concluded by
Russia, only to bona fide taxpayers. The taxpayer is considered as a mala fide,
if
(1) it is acting with the sole intention to deprive the state treasury of tax receipts;
and
(2) the objective result being the non-payment of taxes.41
With regard to the abovementioned substance-over-form and/or economic
substance doctrines the logical question arises whether they can override double
tax treaties. Prior to 2003 the position of the OECD was that domestic antitreaty shopping provisions should not override double tax treaty provisions,
hence, double tax treaty benefits have to be granted under the principle of
“pacta sunt servanda” even if considered to be improper under domestic law.
Accordingly, if states wanted to apply any anti-treaty shopping doctrine – they
were supposed to include the relevant provision in a double tax treaty between
them. An example of such a provision could be found in §2 of Article 25 of the
2002 Convention between the Government of the Federative Republic of Brazil
and the Government of the State of Israel for the Avoidance of Double Taxation
and the Prevention of Fiscal Evasion with Respect to Taxes on Income:
‘A competent authority of a Contracting State may deny the benefits of
this Convention to any person, or with respect to any transaction, if in
its opinion the granting of those benefits would constitute an abuse of
the Convention according to its purpose. Notice of the application of
this provision will be given by the competent authority of the
Contracting State concerned to the competent authority of the other
Contracting State.’
However, in 2003 the OECD changed its position at the issue and stated that
such rules are part of the basic domestic rules set by domestic tax laws for
determination which facts give rise to a tax liability; these rules are not
addressed in tax treaties and are therefore not affected by them. Thus, as a
general rule, nowadays there will be no conflict.42 Nevertheless, not all states do
support this approach43.
Besides the application of express provisions to counteract abusive practices at
obtaining undue double tax treaty benefits (e.g. treaty shopping), there is also
the possibility that treaty benefits are denied by reason of an interpretation of
the relevant double tax treaty on the basis of international law principles.44
Thus, as the Commentaries on the Articles of the 2003 OECD Model Tax
Convention (and their later versions) imply – the principal purpose of double
taxation conventions is to promote, by eliminating international double taxation,
exchanges of goods and services, and the movement of capital and persons. It is
also a purpose of tax conventions to prevent tax avoidance and evasion 45. Art.
41
Recent Developments Regarding Judicial Anti-Tax Avoidance in Russia, Roustam Vakhitov,
European Taxation, April 2005, p. 163
42
The Commentaries on the Articles of the 2003 OECD Model Convention with Respect to
Taxes on Income and on Capital, the commentary on art. 1, §22
43
See observations of Luxembourg, the Netherlands and Switzerland on the Commentary on
article 1 of the 2003 OECD Model Convention with Respect to Taxes on Income and on Capital
44
Supra note 6, p. 236
45
Supra note 42, the commentary on art. 1, §7
24
31(1) of the Vienna Convention on the Law of the Treaties (1969) provides that
a treaty should be interpreted in light of its object and purpose. Accordingly,
the provisions of a bilateral double tax treaty should be interpreted to prevent
tax avoidance46. Hence, even if there is no GAAR/SAAR in the domestic law or
a relevant double tax treaty, the position of the OECD is that it will still be
possible to deny treaty benefits based on an anti-abuse rule inherent in the
double tax treaty. This inherent anti-abuse rule is also based on an economic
substance doctrine.
Touching on applicability of the new version of the Commentaries to the
previously concluded double tax treaties, it should be noted that § 35 of the
Introduction to the 2003 OECD Model Tax Convention and Commentary states
that changes or additions to the Commentaries are normally applicable to the
interpretation and application of conventions concluded before their adoption,
because they reflect the consensus of the OECD member countries as to the
proper interpretation of existing provisions and their application to specific
situations. However, there is no unity among the states or at least among their
courts with regard to the application of the above approach. E.g., in the recent
Yanko-Weiss case47 an Israeli court applied the 2003 OECD Commentaries to
interpret the provisions of the Israel - Belgium Income and Capital Tax Treaty
(1972), while in the Canadian landmark case (Mil Investments) the court
interpreted Art. 31(1)(c) of the Vienna Convention on the Law of Treaties to
mean that one can consult only the OECD Commentaries in existence at the
time the treaty was negotiated without reference to subsequent revisions48.
Summing up, despite the fact that above mentioned doctrines have different
names, forms and ways of adoption they all are based on the same criteria for
determination whether transactions in question or strategy are/is abusive – they
simply disregard forms of the transactions and look at their substance.
Accordingly, if in the tax planning scheme49 an intermediary legal entity does
not perform any sufficient economic (business) activity and the only purpose of
its interposing between the legal entities established in a source state and a final
destination state is to enjoy a more favourable tax regime, the above doctrines
will treat such a situation as abusive with the relevant consequences (the
taxpayer will be denied double tax treaty benefits).
46
Supra note 2, p. 248.
Yanko-Weiss Holdings ltd vs Assessing Officer of Holon case, the decision of the District
Court of Tel Aviv-Yafo of 30 December 2007.
48
Mil Investments S.A. vs Her Majesty the Queen, the decision of the Tax Court of Canada of
18 August 2006.
49
See e.g. Scheme 1 and Scheme 2.
47
25
4. SUMMARY AND ANALYSIS
As the author has shown in the previous chapter there are two principal
strategies used separately or jointly to combat treaty shopping. They are:
-
the first one, the use of limitation on benefits clauses50 limiting the right
to enjoy double tax treaty benefits only to specially qualified persons,
and excluding in such a way conduit structures (or conduit looking
structures) from the scope of a double tax treaty protection;
-
the second one, the use of special anti-treaty shopping strategies
excluding from the scope of double tax treaty protection persons,
creating artificial legal structures not filled up by any (or sufficient)
economic substance in order to enjoy double tax treaty benefits, that
would not be available directly.
The limitation on benefits clauses are composed of one or a few tests
determining whether a certain legal entity or an individual can enjoy double tax
treaty protection. These are:
1) Tests aimed on prevention of treaty shopping:
(a)
(b)
(c)
(d)
a look through test;
an exclusion test;
a subject-to-tax test;
a channeling test.
2) Tests aimed on revelation of bona fide taxpayers (or persons to whom
States wish to grant double tax treaty benefits regardless of whether the
previous tests are fulfilled):
(e) a general bona fide test;
(f) an active business test;
(g) a detailed subject-to-tax test;
(h) a stock exchange test;
(i) an equivalent benefits test;
(j) a multinational enterprises test.
Accordingly, a legitimate use of double tax treaty transforms into treaty
shopping if one or a few of the tests aimed at prevention of treaty shopping is/
are not fulfilled. However, if at least one of the latter six tests is satisfied then a
disputable transaction may be reclassified from a treaty shopping transaction to
a normal business practice aimed at or designed to a legitimate use of double tax
treaty benefits.
50
It should be noted that there are some debates among the scholars about compatibility of the
limitation on benefits provisions with the fundamental principles of EU law. However, in the
author’s opinion, in the light of the Court of Justice of the European Union’s rulings of 12
December 2006 in case C-374/04 Test Claimants in Class IV of the ACT Group Litigation v.
Commissioners of Inland Revenue (often referred as the ACT GLO case) the position of
opponents of the limitation on benefits clauses is rather weak.
26
Unfortunately, the above mentioned tests are not able to counteract treaty
shopping efficiently alone. Hence, in addition, states have developed several
anti-treaty shopping doctrines, which are actually based on the same theory.
The first one, called a beneficial ownership doctrine, is present in the vast
majority of the present-day double tax treaties. This doctrine had been
developed and applied by many states well before the first limitation on benefits
clause was included into the double tax treaties. In accordance with this doctrine
double tax treaty benefits may be granted by a source state only to a real
(beneficial) owner of the passive income. Generally speaking, the term
“beneficial owner” usually means a person to whom the income is attributable
for tax purposes. However, this term is not usually defined in double tax treaties
and, therefore, local judges will interpret it differently. Hence, the fiscal
meaning of the term ‘beneficial owner’, important for determination a
borderline between the use and abuse of a double tax treaty, should be looked
for in the laws or case law of a source state.
An economic substance doctrine51, which is allied to the first one but applicable
against much wider range of abuses of law (e.g. not only for combating treaty
shopping), getting more and more popularity in the world. Simply said, this
doctrine disregards the shape of the transactions or arrangements and assesses
their substance. However, there is also no common policy among states with
regard to the anti-abuse policy aimed at combating with treaty shopping.
Therefore, there is nothing strange that they often disagree as to what constitutes
treaty shopping. However, the common denominator of all the above doctrines
in understanding of what constitutes treaty shopping are such elements as
artificiality, lack of economic substance and taxpayer’s intention to avoid taxes.
51
It could also be called a substance-over-form doctrine, or a business purpose doctrine, or a
general interpretation of a double tax treaty doctrine, or a bona fide tax payer doctrine, or
somehow else.
27
5. CONCLUSION
As this paper has proved, states not only created a fascinating network of double
tax treaties, offering great opportunities for international tax planning, but also
set up a very sophisticated, though not always clear, multi-tier systems of anti
treaty shopping tools differing from each other. Therefore, it is impossible to
draw a common for all states borderline between the use of a double tax treaty
and treaty shopping. The borderline between sophisticated tax planning and
treaty shopping is always floating. Hence, the only thing that is possible on the
current stage of development – is to analyze each specific transaction (scheme)
separately under the provisions of the relevant double tax treaties and national
laws in order to find an answer whether such and such transaction or a group of
transactions correspond(s) a treaty shopping creature or an acceptable use of a
double tax treaty. In the author’s opinion, in order to assess how a source state
will treat the transaction or a group of transactions one needs to follow the
below algorithm of actions:
1) To find out whether the relevant double tax treaty or domestic law (case
law) of a source state apply the ‘beneficial owner’ doctrine. If at least one of
them does so, the next step will be determining whether an intermediary
legal entity, claiming double tax treaty benefits, satisfies its requirements.
2) To ascertain whether the relevant double tax treaty contain limitation on
benefits clauses. If the double tax treaty has it (them), the next step will be
the determining whether an intermediary legal entity, claiming double tax
treaty benefits, satisfies its (their) requirements.
3) To ascertain whether the relevant double tax treaty or domestic law (case
law) of a source state contain any anti-treaty shopping doctrines and whether
the source state courts (the tax authorities) apply them. If such anti-treaty
shopping doctrine exists and the courts (the tax authorities) apply them –
then it is vital to find out whether the business component of a tax planning
scheme is substantial enough to satisfy the requirements of the above
doctrine.
It stands to mention that all above steps should be done one by one in order to
find an answer how a source state will treat the transaction or the group of
transactions at stake. While the second criterion (the limitation on benefits
clauses) is based only upon the analysis of the outward signs of the disputable
transaction or the group of transactions (or their participants), the first and third
criterion, applying anti-treaty shopping doctrines, examine the essence of the
disputable transaction or a group of transactions.
The question whether states should concentrate upon more objective (the
beneficial owner and economic substance doctrines) or more subjective (the
limitation on benefits clauses) criteria to combat with treaty shopping is
currently subject to discussion in academia and professional circles. The more
subjective is the criterion, the broader its ambit and therefore, the more taxinduced behavioural adjustments could potentially be caught. At the same time,
28
however, a subjective approach may create more administrative difficulties and
uncertainty for taxpayers. On the other hand, the more objective the criterion,
the more it is a matter of form and so subject to avoidance. It might offer
certainty, but this would be at the cost misclassifying a range of
circumstances.52 The OECD recommends to its members inclusion into double
tax treaties all discussed above criteria, however, it especially favours the
second one, stating that the limitation on benefits clauses appears to be the only
effective way of combating “stepping-stone” devices53. In the author’s opinion,
the above position is rather erroneous because of the following reasons:
First of all, as the author has mentioned, the limitation on benefits provisions
are based on checking only the outward signs of the disputable transaction or
the group of transactions (or their participants) – they do not analyze their
essence. Therefore, they are not very effective against sophisticated tax
planning strategies, where superficial characteristics of the transactions or their
participants may satisfy all the limitation on benefits provisions requirements.
Secondly, the control over the compliance with all the limitation on benefits
requirements is also quite burdensome for the source state tax authorities and
requires significant resources not always proportional to the results achieved. In
addition, the necessity to comply with the complicated limitation on benefits
requirements may turn off foreign investors.
Finally, being not very effective and burdensome the limitation on benefits
provisions still cannot deal efficiently with treaty-shopping alone without antitreaty shopping doctrines. A good evidence of this statement is the situation
with the US. This country has the most developed limitation on benefits
provisions in its double tax treaties; however, its courts and the tax authorities
still actively apply a substance-over-form doctrine, established in the U.S.
Department of Treasury conduit regulations under section 7701(l) of the
Internal Revenue Code from August 11, 1995.
Summing up, in the author’s opinion, the sophisticated limitation on benefits
provisions should be abolished, while states, in general, and the OECD, in
particular, should focus upon the development of the common anti-treaty
shopping doctrine based on the common denominator. The common
denominator of all the above doctrines could be such elements as artificiality,
lack of economic substance in the arrangement and taxpayer’s subjective
intention to avoid taxes.
52
Double Taxation, Tax Treaties, Treaty-Shopping and the European Community, Cristina HJI
Panayi, Kluwer Law, Alphen aan den Rijn, 2007, p.76
53
The Commentaries on the Articles of the 2010 OECD Model Convention with Respect to
Taxes on Income and on Capital, the commentary on art. 1, §18
29
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32